Phases of the Business Cycle

December-03-08
9:01 AM

Business cycle is divided into the major phases:

- Expansion
- Contraction

Expansion

- Is a period of increase in consumer confidence and economic activity. It is made up 3 smaller stages
known as
○ Recovery
 Is the first part of an expansionary phase. Consumer confidence starts to increase a little
people start to replace small items such as clothes and small appliances. This results in
business starting to replace or increase their inventory levels. Businesses start to increase
their output hiring more employees.
 Unemployment is decreasing while inflation is occurring
○ Boom
 Is the second part of an expansionary phase. Consumer's confidence starts to increase at a
faster pace buying more and more consumer goods. As businesses start to hire even more
people national incomes rise an unemployment levels fall. People now start to buy
consumer durable goods such as cars, houses. Resulting in businesses to start increase their
construction levels on homes, factories and stores. Businesses now also start to buy new
equipment and machines increasing their efficiency levels. This results in workers receiving
higher pay. Prices increase.
 Unemployment levels fall approaching full employment, inflation increases at very high
rates
○ Peak
 Occurs when expansion reaches a climax. Output starts to standstill and level off. Consumer
confidence starts to decline to the point where people start to stop their buying.

Contraction

- Is a period of decrease in consumer confidence and economic activity. It is made up of 3 smaller

stages known as
 Recession
□ Is the first part of a contractionary phase. Consumer's confidence starts to decrease a
little. People start to stop buying large items such as cars, major appliances and
houses. This results in businesses starting to reduce their output of these items
(inventory levels). Businesses start to decrease their hiring they may even start to lay
off some of their employees. Workers might have to take wage cuts. Resulting in
prices going down.
□ Unemployment is increasing while inflation is dropping
 Depression
□ Is the second part of a contractionary phase. Consumer's confidence starts to
decrease at a faster pace buying less of all consumer goods. Now businesses have to
try to get rid of their inventory levels on their shelves. Businesses decrease or slow
their production levels to a very low level. Business try to cut cost so they start to lay
off even more people national incomes fall as unemployment levels rises. This results
in an even lower level of confidence in people. Resulting in even less buying. Prices
must fall even lower; companies start to go bankrupt.
□ Unemployment levels increase approach Keynesian range, inflation becomes non
existent prices start to fall
 Trough
□ Contraction reaches a minimum. Output starts to standstill and level off. Consumer
confidence starts to level off at a low point to the point where people start to stop
their savings, they have to buy a little.

Unit 3 - Fiscal Policy Page 1

 Conclusion
- If I+G+X =S+T+M - a country is in a state of economic equilibrium were the economy is not growing or
contracting.
- Therefore, periods of contractions:
- (I+G+X) < (S+T+M)
- And period of expansion:
- (I+G+X) > (S+T+M)
- These are not periods of equilibrium

Unit 3 - Fiscal Policy Page 2