ECONOMICS (15B11HS211)
Learning Objectives
After studying this chapter, you will be able to
1. Explain the concept of business cycle.
2. Define various phase of business cycle.
The Business Cycle allows people to understand the direction the
economy (GDP) is going (growing or shrinking) and plan
accordingly.
The economy follows the Business Cycle regularly.
The business cycle, also known as the economic cycle or trade
cycle, is the downward and upward movement of gross domestic
product (GDP) around its long-term growth trend. The length of
a business cycle is the period of time containing a single boom
and contraction in sequence.
Phases of the Business Cycle
Expansion (Growing)
Peak (Top)
Contraction (Shrinking)
Trough (Bottom)
Business Cycle
Peak
Peak
Trough
Expansion is the phase of the business cycle where real GDP
grows for two or more consecutive quarters, moving from a
trough to a peak. This is typically accompanied by a rise in
employment, consumer confidence, and equity markets.
Expansion is also referred to as an economic recovery.
During a period of expansion:
Wages increase
Low unemployment
People are optimistic and spending money
High demand for goods
Businesses start
Easy to get a bank loan
Businesses make profits and stock prices increase
A peak is the highest point between the end of an economic
expansion and the start of a contraction in a business cycle. The
peak of the cycle refers to the last month before several key
economic indicators, such as employment and new housing
starts, begin to fall.
When the economic cycle peaks:
The economy stops growing (reached the top)
GDP reaches maximum
Businesses can’t produce any more or hire more people
Cycle begins to contract
Contraction, in economics, refers to a phase of the business cycle
in which the economy as a whole is in decline. A contraction
generally occurs after the business cycle peaks, but before it
becomes a trough.
During a period of contraction:
Businesses cut back production and layoff people
Unemployment increases
Number of jobs decline
People are pessimistic (negative) and stop spending money
Banks stop lending money
A trough is the stage of the economy's business cycle that marks
the end of a period of declining business activity and the
transition to expansion. These increase during expansion, recede
during contraction, and bottom out during a trough.
When the economic cycle reaches a trough:
Economy “bottoms-out” (reaches lowest point)
High unemployment and low spending
Stock prices drop
A prolonged contraction is called a recession (contraction for
over 6 months)
A recession of more than one year is called a depression
4 variables cause changes in the Business Cycle:
1.
Business Investment
When the economy is expanding, sales and profit keep rising, so
companies invest in new plants and equipment, creating new
jobs and more expansion. In contraction, the opposite is true.
2.
Interest Rates and Credit
Low interest rates, companies make new investments, adding jobs.
When interest rates climb, investment dries up and less job
growth
3.
Consumer Expectations
Forecasts of an expanding economy fuels more spending, while fear
of a recession decreases consumer spending
4.
External Shocks
External Shocks, such as disruptions of the oil supply, wars, or
natural disasters greatly influence the output of the economy
Ex. 1992-2000 was the longest period of expansion in U.S. history.
Early in 2001, signs of contraction appeared, though the Bush
administration denied it. The Sept. 11th 2001 terrorist attacks
quickly caused the business cycle to shift into a contraction.
Business cycles are the "ups and downs" in economic activity,
defined in terms of periods of expansion or recession. During
expansions, the economy, measured by indicators like jobs,
production, and sales, is growing--in real terms, after
excluding the effects of inflation.
If the economy is going into a contraction, jobs will become
more scarce. If you quit, you may not find another job!
But, if the economy is in a period of expansion, jobs are readily
available. It may be a good time to switch careers.
Only if you know that you won’t lose your job in a contraction.
So, buy your house during an expansion.
HOWEVER,
When the economy starts to slow down (contraction), interest
rates will decrease. Wait to buy a house until the rates drop to a
low point, if you are sure you won’t lose your job.
What phase of the business cycle do wages go up? Expansion
What phase of the business cycle do wages go down?
Contraction
When are wages at their highest? Peak
When are wages at their lowest? Trough

When will borrowing decrease? Contraction

When will borrowing increase? Expansion

When will borrowing be at it’s lowest? Trough

When will unemployment be at its lowest? Peak

When will business profits be the highest? Peak

When should you look for a new job? Expansion
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Help Frame Appropriate Policies
Strategic Business Decisions
Greatly Affect Cyclic Businesses
Entry and Exit from Market
S. Damodaran, Managerial Economics, 2nd ed., Oxford University
Press, 2010.
P.A. Samuelson, W.D. Nordhaus, Economics, 19th ed., Tata McGraw Hill, 2010.
S.K. Misra & V. K. Puri, Indian Economy, 37th ed., Himalaya
Publishing House, 2019.
The term business cycle refers to
a.
fluctuation in aggregate economic activity over time
b.
ups and downs in the production of goods
c.
increasing unemployment
d.
declining savings
Answer : fluctuation in aggregate economic activity over time
Expansion phase all but one of the following characteristics
a.
increase in national output
b.
increase in consumer spending
c.
excess production capacity of industries
d.
expansion of bank credit
Answer : excess production capacity of industries
Which one of the following is a not characteristic of business
cycle
a.
they are recurrent
b.
they are not at regular intervals
c.
they have uniform causes
d.
all the above
Answer : they have uniform causes
The turning points of business cycle are
a.
expansion and peak
b.
peak and contraction
c.
contraction and trough
d.
peak and trough
Answer : peak and trough
……………. refers to the top or the highest point of Britney cycle.
a.
Expansion
b.
Peak
c.
expansion and peak
d.
none of the above
Answer : Peak
The economy is said to be overheated at the ……….. Phase of
business cycle.
a.
Expansion
b.
Peak
c.
Contraction
d.
Depression
Answer : Peak
Cost of living increases when business cycle is………
a.
Expanding
b.
Contraction
c.
at peak
d.
at lowest point
Answer : at peak
There is a large scale of involuntary unemployment in the………
Phase of business cycle.
a.
Expansion
b.
Peak
c.
Contraction
d.
none of the above
Answer : Contraction
all but one are the endogenous factor of business cycle.
a.
War
b.
change in government spending
c.
money supply
d.
fluctuation in investments
Answer : War
fall in the interest rates is a typical features of
a.
recovery
b.
boom
c.
depression
d.
contraction
Answer : depression