Section 2 Business Cycles

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Objectives

After studying this section you will be able to:

1. Identify the phases of the business cycle.
2. Describe four key factors that keep the business cycle going.
3. Explain how economists forecast fluctuations in the business cycle.
4. Analyze the impact of business cycles in U.S. history.
5. Analyze why U.S. business cycles may change in the future.

Section Focus

A business cycle consists of successive periods of improvement and decline in a macroeconomy. Policymakers study business cycles to try to predict declines, lessen their effects, and speed economic recovery.

Key Terms

• business cycle
• expansion
• economic growth
• peak
• contraction
• trough
• recession
• depression
• stagflation
• leading indicators

Many economic analysts and historians of the nineteenth century recognized economic panics and collapses. But most did not see a pattern in the occurrence of these changes.

One early economist did see a pattern, however. He attributed it to, of all things, sunspots. In a way, his theory wasn't so crazy. William Stanley Jevons, a British economist of the mid-1800s, believed that periodic sunspot activity affected crop harvests. In the 1800s, when most people worked on farms, crop surpluses and shortages would have had widespread economic effects.

Economists long ago dismissed Jevons's sunspot theory, but they embraced his notion that the economy undergoes periodic changes. A modern industrial economy repeatedly experiences cycles of good times, then bad times, and then good times again. Business cycles are of major interest to macroeconomists, who study their causes and effects. In this section we will learn about these periodic swings in economic performance: how we describe them, what might cause them, and how they have shaped the country's economy.

Phases of a Business Cycle

As you read in Chapter 3, a business cycle is a period of macroeconomic expansion followed by a period of macroeconomic contraction. Figure 12.7 illustrates the phases of a business cycle.

Business cycles are not minor ups and downs. They are major changes in real GDP above or below normal levels. The typical business cycle consists of four phases: expansion, peak, contraction, and trough.

1. Expansion An expansion is a period of economic growth as measured by a rise in real GDP. In economists' terms, economic growth is a steady, long-term increase in real GDP. In the expansion phase, the economy as a whole enjoys plentiful jobs, a falling unemployment rate, and business prosperity.

   expansion a period of economic growth as measured by a rise in real GDP

   economic growth a steady, long-term increase in real GDP

2. Peak When real GDP stops rising, the economy has reached its peak, the height of an economic expansion.

   peak the height of an economic expansion, when real GDP stops rising

3. Contraction After reaching its peak, the economy enters a period of contraction, an economic decline marked by falling real GDP. Falling output generally causes unemployment to rise.

   contraction a period of economic decline marked by falling real GDP

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