The business cycle model is one often referred to in the media, which likes to use terms like “boom’ and ‘bust’. It is a model that can communicate several important pieces of information about a nation’s economy. Basically, the business cycles is a graph which shows the level of real GDP over time. The vertical axis shows the level of GDP, and horizontal axis time.
A typical nation’s business cycle will most likely look like a wave, showing how GDP rises and falls over time. Assuming the country is achieving economic growth over the long-run, business cycle’s ‘line of best fit’ or ‘trend line’ will slop upwards, indicating that over the span of years or decades, a nation’s economy will produce more output. But over shorter periods of time, output may fluctuate, as the economy experiences those ‘booms and busts’ the media are so fond of.
There are four fundamental phases in any nation’s business cycle:
- Expansion: Also known as the recovery phase, when the nation’s output is rising at a rate faster than the long-run trend.
- Peak: This is the end of a period of expansion, when output begins to decline
- Contraction: Also known as the recession phase, when the nation’s output is falling over time.
- Trough: This is the end of a period of recession, when output begins to recover (the economy enters an expansion phase again).
This video lesson will explore the four phases of a nation’s business cycles and explain how the goal of macroeconomic policies is to ‘smooth out’ the fluctuations in the business cycle, and thereby reduce the amount of uncertainty faced by a nation’s households and firms regarding the future level of economic activity.