The business cycle

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The business cycle demonstrates fluctuations in the level of economic activity over time. More simply, the business cycle is a graph that shows how the output of goods and services, measured by gross domestic product (GDP), varies over time.

We tend to highlight four stages of the business cycle. I’ve matched them with the letters from my graph below.

‘Business cycle’. Artist: Mr Symonds

‘Business cycle’. Artist: Mr Symonds

Point A: The upswing

This is where the economy is expanding (GDP is growing). It is producing more and more goods and services. Hooray! 

At this stage, here’s what we’re seeing:

  • Rising incomes

  • Higher consumption and investment

  • Unemployment is falling, as firms need more workers to meet the growing demand for goods and services

Part B: The BOOM

This is the peak point of economic activity. Essentially, the economy’s output is getting ‘maxed out’ and extra resources are in short supply. As a result, production costs rise which leads to growing inflation across the economy. 

Given the rise in inflation, the government and the Reserve Bank of Australia (RBA) might need to intervene with contractionary macroeconomic policies (fiscal and monetary) to slow things right down.

Part C: The downturn (or downswing if you prefer)

Economic activity slows, leading to a fall in output. We’re likely to see less demand for goods and services, which leads to less demand for labour, resulting in a rise in unemployment. Incomes will also fall as a result. This are getting worse, economically speaking.

Part D: The recession

This is a very difficult situation. Output has fallen further leading to less demand for labour, lower wages and higher unemployment...which in turn leads to less demand for output and even lower wages and higher unemployment, and so on. Prices are falling and an economy may even experience deflation (not a good thing — see here). 

To combat this situation (to fix this situation), the government and RBA will likely need implement expansionary macroeconomic policies to accelerate economic activity.

Feel free to draw the business cycle diagram in short answers and essays to illustrate your point. It can add a little extra to your responses.