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What is a Business Cycle and how is it affected?

  • Pragya Soni
  • Nov 25, 2021
What is a Business Cycle and how is it affected? title banner

Economics plays an important role in a country’s progress and development. Most of the time, the economic studies are done by the means of a business cycle. These business cycles help the economists in a billion ways. 


Read this blog to the end, to learn a few of those billions. We also have the necessary information related to the components and stages of a business cycle.



What is a Business Cycle?


A business cycle basically defines the entire process of an economic task. It includes the periodic growth and decline of a nation’s economy. A business cycle of a country is usually measured in GDP and GNP. The central government maintains the business cycles by spending, raising or lowering taxes. 


The same can also be achieved by adjusting interest rates. These business cycles have different impacts on individuals and organizations. A business cycle is basically a type of fluctuation that is found in the aggregate economic task. 


A business cycle has two components i.e., expansions and recessions. Aggregation of economy includes the aggregate measures of industrial production, employment, income, and sales. The business cycle is a chain of four processes, contraction, expansion, trough, and peak. These processes occur in continuous order.


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Components of a Business Cycle


The two main components of a business cycle are here explained:


Recession in economy


A recession in simple words is described as a period of decline. And when we say decline, it is not an usual temporary decline, but a significant decline. The changes and effects of this decline are visible in the net GDP of the nation. 


It lasts for a significant period. The effects of recession are visible in real income, employment, industrial production and wholesale taxes. It is the opposite of economic expansion.


For example, the great depression of the 1930s and the financial crisis of 2008.


Expansion in economy


Expansion, as the name suggests, is a growth in the economy. It is the opposite of economic recession. Expansion is a phase in which the economy is in an upward trend. It is counted as an increase in production and employment. 


It is observed as a continuous increase in the economy that results in the increase in GDP. It is the increase in the level of goods and services.



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Some interesting facts related to a business cycle


  1. Sometimes, an expansion turns into contraction or vice versa. For example, the crisis of 1930 had a deep trough and was a phase of economic contraction. But later, the same year turned into an economic expansion.


  1. The increase in business production is responsible for an overall increase in the net output and produce. Thus, it is responsible for economic expansion.


  1. Similarly, decrease in production may cause an economic contraction.


  1. Customer behaviour is a major component of economic aggregate. 


  1. Interest rates are directly proportional to the loan expenses. And, thus a decrease in interest rates are responsible for expansion.


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  1. Similarly, increases in interest rates are responsible for contraction.


  1. Sometimes, natural disasters, pandemic, and foreign wars also affect the net aggregate supply.


  1. Economics infer the business cycles by using leading, coincident, and lagging economic indicators.


  1. The organization, National Bureau of Economic Research (NBER) is responsible for studying the business cycles.


  1. Coincident indicators include factors like employment, sales volume, and personal income.


  1. Coincident factors change at the same time as changes in real GDP.


  1. Lagging indicators include factors as length of unemployment.


  1. Lagging indicators usually change after real GDP changes.


  1. An extreme contradiction sometimes turned into depression.


  1. Business decisions, consumer behavior, interest rates, and eternal matters are the important factors of a business cycle.


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What are the stages of Business Cycle?


A business cycle has following four stages:

There are four phases or stages in a business cycle, i.e. peak, expansion, contraction and trough.

Stages of a business cycle

  1. Expansion


Expansion as defined earlier is defined as the growth period of an economy.



  1. Peak


Peak is the maximum expansion. It is the highest value of expansion. In simple words, the height of expansion is called a peak.



  1. Contraction


Contraction as defined above is the decline in the economic process.



  1. Trough


Trough is the maximum decline faced during economic contraction. In simple words, trough is defined as the depth of contarcation.



What are the factors affecting a Business Cycle?


Business investment, consumer expectations, external shocks and interest rates affect the business cycles.

Factors affecting a business cycle

There are different factors which affect a business cycle. Usually, these factors are related to economics and the fiscal process. Major factors which affect a business cycle are as follows:


  1. Business investment


Business investments are the funds or infrastructure put forward for working with an industry or business. These funds have direct or indirect effects on the business cycle. At the same time, they help in the maintenance of day to day revenue.


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  1. Consumer expectations


Consumer expectations are defined as the economic outlook of the household. It is defined as the willingness of consumers to buy goods and borrow. 


  1. External shocks


Shock in economics is defined as any sudden change in economics. An external shock is defined as the sudden economical change in the economy from an external network. The external shock can be classified as negative shock as well as positive shock. For example, the crisis occured during pandemic times is a negative external shock.


  1. Interest rates


Interest rates are the extra charges charged by banks and other agencies on the amount of money issued. These interests affect the business cycle in a positive way.


Except the mentioned ones, there are several other factors too, like cost of production, sales charges, and credit taxes.


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What are the uses of a business cycle?


The uses of a business cycle are as follows:


  1. Business cycle helps the economists to forecast the direction of the economy.


  1. Economic cycle helps to show the fluctuations in economic activity for a continuous period.


  1. The business cycle helps the entrepreneur to make big business decisions.


  1. A business cycle helps in deciding full employment, stable prices, and growth.


  1. A volatile business cycle is an identification of a bad economy.


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A way forward


The main purpose of a business cycle is to inform economists about the direction of economics of the country. The fluctuations in the economic cycle represents the economic process of a country or an organization. A continuous and varying economic cycle is essential for the sustainable and suitable economic development of the country.

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