Understanding Business Cycles

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Business cycles are periods of growth followed by a contraction in economic activity followed by recovery in economic activity. The period of the business cycle is generally considered to be two years because a longer period of boom leads to less contraction in economic output and employment. They have powerful effects on the economy, both positive and negative. For example, a period of the business cycle is one in which all business activity is growing at a rapid pace with indicators suggesting growth in almost all economic activities and a corresponding reduction in unemployment. If a period of business cycle exists and there are no recessions, it implies that there has been a period of robust economic growth and employment which will continue in the coming years.

In a period of recession, expansion is constricted because businesses feel the pinch of increasing inventory costs and labor cost. They opt to cut down costs, but this causes employment to fall thus creating the business cycle’s reverse journey, from boom to recession. The two phases of expansion and contraction could take many months or even years before the other phases catch up. During the expansion phase, companies expand their business operations to fill the orders generated by the expanding market and invest the proceeds in assets such as equipment, buildings, and inventory.

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In a period of recession, companies either do not expand or they scale back expansions because they have run out of funds or have reached the limits of their financial resources to undertake new projects. The business cycle’s opposite phases are known as recessions and there are four known phases – trough, peak, trough to base and trend oriented recessions. When the expansion phase resumes, recessions will be surpassed by a second stage called trend oriented recession which will cause layoffs and mass bankruptcies.