What Is A Business Cycle? (Definition And Important Stages)

By Indeed Editorial Team

Updated 28 July 2022 | Published 4 May 2022

Updated 28 July 2022

Published 4 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

When you work in business or finance, you can expect the economy to fluctuate regularly. These cycles can have a significant impact on expenditure, which may affect your industry or organisation. By anticipating these changes, you may ensure that a business enterprise suffers fewer negative consequences. In this article, we examine how a business cycle works and the stages that it goes through.

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What Is A Business Cycle?

A business cycle is the natural expansion and contraction of economic growth that occurs in a country over a span of time. It is also known as an economic cycle or a trade cycle. It begins and ends with the rise and fall of a country's gross domestic product (GDP). A trade cycle can also determine the rise and fall of economic activity and stock prices.

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Stages Of A Business Cycle

Business cycles might be as short as a few days or as long as a few years. The time it takes to complete all five stages of a trade cycle becomes the trade cycle's duration. The five stages of a trade cycle are as follows:

1. Expansion

The expansion stage is always the first stage of a trade cycle. There may be positive economic indicators at this stage, including income, employment, demand, supply and profit growth. The frequency of investments increases as a company grows, and both corporations and individuals repay their loans on time.

2. Peak

The trade cycle reaches its peak when the economy becomes saturated and upward expansion can no longer persist. Wages, employment rates and the cost of products and services have reached their maximum levels at this stage. These economic indicators can reach a point where they may not increase further. In anticipation of a drop in economic activity, many businesses and people can review their budgets at this stage.

3. Contraction

Economic growth patterns may reverse as the economy contracts at the end of the peak stage. There are two separate stages of contraction:

Recession

When the expansion phase of the economy finishes and economic activity falls, the recession stage begins. It lasts until the GDP reaches the starting point of the expansion stage. Demand may ‌fall almost immediately during a recession, but producers may not adjust their output until the market supply is high. At this moment, positive economic factors like prices and salaries may collapse.

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Depression

When GDP falls below the pre-expansion level or the steady growth line, the depression stage begins. Unemployment rates may skyrocket during a depression, while economic development slows down frequently. A depression lasts until the economy can no longer fall any lower.

4. Trough

A trade cycle enters the trough stage when the depression stage reaches its lowest point. The country may experience negative economic growth during this time. Supply and demand may become as low as possible.

5. Recovery

The recovery stage begins when the economy's GDP reaches its lowest point in the cycle. The economy may ‌rebound and reverse unfavourable trends at this point. When demand rises, so does supply. Investments may eventually resume, and employment and output can ‌increase. The recovery period lasts until the economy's growth rate recovers to a more consistent level. The current trade cycle ends as it reaches this point, and a new one begins as it enters the expansion stage.

How Do You Measure The Volume Of Business Cycles?

The following are parameters and metrics you can use to measure the volume of a business cycle:

Business cycle timing

Using economic research and analysis, you can determine a trade cycle's start and end dates. Most often, the dates for each step of an economic cycle become identifiable only after the event, sometimes months or even years later. Expansions, on the whole, may‌ endure longer than recessions.

Business cycle severity

Economists measure recession and expansion stages independently to indicate the severity of a trade cycle. Three metrics that determine the severity of the recession stage include:

  • Depth: What is the degree of the recession stage's intensity?

  • Diffusion: In the national economy, how broad has the recession become?

  • Duration: What is the duration of the recession?

To evaluate the severity of the expansion stage, economists use three types of indicators:

  • Pronounced: Is the expansion stage apparent or significant?

  • Pervasive: What percentage of the economy has reached the expansion stage?

  • Persistent: Is the expansion phase taking longer than usual?


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Why Are Business Cycles Important?

For professionals in business and financial and economics experts, understanding how trade cycles work is crucial. You can make more educated strategic decisions if you know what stage of the cycle the economy is currently in. During the expansion phase, investors make investments, but during the peak stage, they often become overconfident and inflate prices. Investors cease buying and start selling during a recession or depression, causing prices to fall. As an investor, you can determine which assets perform well at various points in the economic cycle, allowing you to make more informed financial decisions.

What Is The Difference Between Business Cycles And Market Cycles?

A trade cycle is not the same as a market cycle. A market cycle pertains to a stock market's various development and decline stages, whereas the economy as a whole pertains to a trade cycle. A bear market occurs when investors liquidate their holdings during the contraction phase of a cycle, reducing stock prices. Investors go on a purchasing spree during the expansion period, leading stock values to climb.

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How Long Does A Business Cycle Last?

There are no set time frames for trade cycles. A trade cycle might be brief, lasting only a few months, or it can be lengthy, lasting several years. The lengths of phases of expansion are longer than those of contraction, but they can vary.

What Factors Shape A Business Cycle?

A range of factors can trigger the phases of a trade cycle, ranging from technological advancements to geopolitical situations. The most important factor is aggregate supply and demand within an economy. Economists estimate and evaluate total spending by individuals and businesses. A contraction may occur if demand declines. Similarly, when demand rises, a business may expand.

How Does Supply And Demand Drive A Business Cycle?

Consumers may feel optimistic about an economy when it is expanding. They may feel that their jobs and incomes are stable. This can result in customers spending more, leading to greater demand, which can lead to businesses hiring more staff and boosting capital expenditures to match that need. Stock prices rise as investors assign more capital to assets. Sometimes demand may exceed supply. When this happens, the expansionary phase peaks and enterprises take on higher risks. This may help them meet rising demands and compete effectively.

When interest rates rise too quickly, inflation rises parallel to it, or when there is a financial crisis, the economy contracts. Individuals may save money instead of spending it, lowering demand, while firms reduce production and lay off employees as sales decline. Investors sell stocks to protect their portfolios from losing value. Demand and production may be at their lowest levels during the trough phase. As production and economic activity improve, consumers gradually acquire confidence, often with the aid of government policies and actions. When they start buying and investing, the economy enters a new phase of expansion.

How Do Governments Influence Business Cycles?

Trade cycles have natural phases, but it does not rule out the possibility of manipulation. Using monetary and fiscal policy, countries can strive to control the various stages, slowing or speeding them up individually. The government implements fiscal policy, while the Reserve Bank of India (RBI) implements monetary policies. When an economy is contracting, particularly during a recession, governments utilise the expansionary fiscal policy, which entails raising project spending or lowering taxes. Consumers may have more disposable income as a result of these actions, which can help drive economic growth.

Governments may use a contractionary fiscal policy, which entails lowering expenditure and raising taxes if an economy is developing too quickly. This can slow things down by reducing the quantity of disposable income available to spend. A central bank may raise interest rates to implement a contractionary monetary policy, making borrowing more expensive and spending less appealing.

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Please note that none of the companies, institutions or organisations mentioned in this article are associated with Indeed.

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