Chapter 30: Business Fluctuations
Introduction
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Business Cycles are alternating periods of ups and downs in the economy.
Phases of the Cycle
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A business cycle shows four distinct phases:
Peak
Recession
Tough
Expansion
Trough
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A Trough is the lowest point in a business cycle.
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A Depression is a severe trough.
Expansion
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During a Expansion phase, output expands and income increases.
Peak
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In a Peak phase, real GDP is at its highest level.
Recession
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During the Recession phase, income and consumption decline.
Length and Intensity of Phases
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Business cycles vary in frequency and intensity.
Economic Causes of Business Fluctuations
The Under-Consumption Theory
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Variations in consumer spending cause economic fluctuations.
The Volatile Investment Theory
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Changes in inventory investment cause fluctuations in economic activity.
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Inventory Cycles are the cycles of low inventory and production during recession, and high inventory and production during good economic activity.
The Expectations Theory
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Changes in expectations cause business cycles.

The Innovations Theory
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Innovations are a prime cause of business cycles.
The Monetary Theory
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Changes in the availability of money and interest rates cause business fluctuations.
The Multiplier-Accelerator Theory
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The Principal of Acceleration suggests that the level of investment is proportional to the rate of change of output.
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The capital-output ratio is the ratio of the value of capital to total output. (eg. Its takes $4 worth of capital to produce $1 of output per year)
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A change in income leads to an accelerated change in investment.
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Required Investment = v(Change in Total Output)
 K = required capital stock
 Y = Total Output
 K/Y = v
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Multiplier-accelerator interaction intensifies the business cycle.
Politics and the Business Cycle
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The Political business Cycle is caused by the government’s use of its spending and taxing powers to secure its political future.
The Real Business Cycle
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The Real Business Cycle theory suggest that the main causes of business cycles are shifts in aggregate supply.
Have we Conquered the Business Cycle
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Through the correct use of stabilization policies, we have managed to avoid severe depressions.
Forecasting Business Cycles
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Leading Indicators turn downward before the cycle peaks and upward before the trough.
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Coincidental Indicators coincide exactly with the business cycle.
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Lagging Indicators turn downward after the cycle peaks and upward after the trough.
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Economists use leading indicators to help them forecast business cycles.