The different phases that an economy goes through over time, such as periods of booms (expansions) and economic recessions (contractions), is known as the business cycle or the trade cycle. One entire business cycle is the completion of an expansion and a contraction sequentially.
The line through the business cycle is known as the trend line, which shows that the economy is always moving upwards or growing in the long run. The trade cycle is used to analyze the state of the economy.
You can review where the US economy is in the business cycle on the National Bureau of Economic Research’s website. They’ve documented business cycles in the U.S. since 1854.
The Stages of the Business Cycle
The Business Cycle Graph
1. Expansion or Boom
The curve above the trend line represents the expansion phase of the business cycle. The periods of expansion (economic growth where real output increases) follow a period of recessions. The booms characterize fast economic growth which tends to be inflationary and unsustainable. During this expansion period employment, investment income, wages, profits, demand and supply are high.
The peak is the second stage of the trade cycle. This is the maximum growth the economy can achieve and there are no further signs of economic growth. The end of the peak marks the beginning of the contraction of the economy.
The peaks are expansions or booms, and the troughs are recessions. The period of recessions is often characterized by high unemployment, negative economic growth, and real output fall. If rapid expansion takes place, then economy can heat up and the rate of inflation could rise.
If the economy continues to fall below the trend line, then the economy enters a depression period. Economic activity continues to decline.
The trough is the lowest point in the economy. All indicators of good economic health are at their lowest now. The economic growth rate is negative.
The recovery phase of the business cycle marks the beginning of improvement in the economy. Economic activity starts to pick up again. Investment, employment, confidence, spending, and prices begin to increase as the economy begins to grow.
Factors that Affect the Trade Cycle
1. Natural Factors
The trade cycle may change due to natural factors, for example during the periods of heavy or unexpected rainfall; agricultural productivity may be affected. It results in a shortage of raw material, and therefore industrial production is also affected. This shortage can affect the whole economy, particularly those that rely on agriculture as their main component of the Gross Domestic Product (GDP).
During a war, economic growth can slow down because of uncertainty in the market and loss of business confidence and consumer confidence. This reduces spending and investment in the economy.
3. Political Factors
In developing countries, often there is political instability. The new government formulates new policies and abandons the policies of previous governments. This kind of political climate creates uncertainty in the economy and causes business confidence and investment to fall.
4. The Supply of Money
Unplanned changes in the supply of money can cause business fluctuation in an economy. An increase in the supply of money leads to the expansion in aggregate demand. But an excessive increase in credit and money can also set off inflation in the economy. On the other hand decrease in the supply of money initiate recession in the economy.
5. Future Expectation
Expectations about future business is also a major factor of the business cycle. When businesses are optimistic about future expectations, it triggers an expansion in business activities whereas pessimism about profits in the future results in contraction of business activities.
6. Population Explosion
An abnormal increase in population can be a major factor in the business cycle. When the population increases at a higher rate than an increase in national output, it can become difficult to provide employment. However, an increase in the population also pushes the country’s Production Possibility Curve.
7. International Factors
Most countries of the world are economically interdependent. Any economic fluctuation in big economies like USA or Japan affect the other economies, like how the housing market crash in the USA resulted in a global recession.