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Understanding the Different Stages of a Business Cycle

By Edward Zhao


What is a Business Cycle?


Business cycles, also named “economic cycles” or “trade cycles,” refer to the fluctuation of the economy over a period of time. This fluctuation comes from periods of increasing economic activity, or economic expansions, and periods of decreasing economic activity, known as recessions. As seen in the graph below, the four distinct stages of a business cycle are expansion, peak, contraction, and trough; for each, we will delve into further. Within the graph, there is additionally a trend line that marks the growth or decline of an economy. Real gross domestic product (Adjusted GDP for inflation), or aggregate output, is the broadest measure of economic activity in a country and can be found on the vertical axis of a business cycle graph.


Source: Congressional Research Service


All nations with capitalistic economies have business cycles, as they experience natural periods of growth and decline. Moreover, as a result of increased globalization, business cycles across these different nations synchronize more regularly. Multiple factors such as interest rates, total employment, gross domestic product, and consumer spending can determine and influence the different stages of the business cycle. And by understanding the business cycle, investors and businesses can make better financial decisions, and governments can make appropriate policy decisions.


In-Depth: Stages of a Business Cycle


1) Expansion: In a business cycle, expansion is considered the normal state of the economy. During expansion, the economy experiences rapid growth where interest rates are low, production increases, and inflation tends to build. Businesses and companies also grow economically, unemployment rates are low, and stocks tend to perform well.


A healthy period of expansion is determined by the following criteria: the GDP growth rate is between 2% and 3%, the inflation rate is at 2%, the unemployment rate is between 3.5% and 4.5%, and the stock market is rising.


2) Peak: The peak of a business cycle is reached when the expansion or growth hits its maximum rate; this peak marks a turning point at which the limit is reached and it is soon followed by a contraction. A few factors that lead to a peak or imbalance in the economy are overconfident investors, reckless company expansion, or a too-high price level.


3) Contraction: A contraction is a period when there is a decline in economic activity and there is a fall in the graph from peak to trough. This is a correction from the peak where growth slows, unemployment increases, and prices stagnate. The gross domestic product is below 2% which shows that businesses have cut back on production. The economy is considered to be in a recession when the GDP has declined for two consecutive quarters.


4) Trough: The final phase of the business cycle is the trough, which is reached when the economy hits a low point and is beginning to recover. This stage happens when the recession phase begins to turn into an expansion phase to restart the business cycle toward a full economic recovery.

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