What is a Business Cycle

Nattakorn Maneerat/iStock/GettyImages

Understanding the Highs and Lows of the Economy

Ever notice how things seem to go in waves? Everything seems to be on the rise, but sometimes it feels as if you’re speeding downhill. Even the ocean ebbs and flows, racing toward the shoreline only to rush back out to sea. The economy tends to follow the same trend of peaks and valleys that make up the business cycle. Understanding the business cycle gives you a better picture of the economy as a whole and how it affects your everyday life.

What Is a Business Cycle?

The term “business cycle” is used to describe the natural up-and-down movement of the economy. Those changes are often called “expansions and contractions” or “booms and busts.” It’s a periodic shift in the economy, but it’s not predictable or the same every time. A full cycle means the economy goes through all four stages in the process. The length of the cycle can fluctuate every time as can the intensity.

Gross domestic product is a major indicator of the business cycle. Changes in the GDP help measure the fluctuations in the business cycle. Unemployment is another important factor to study when considering the business cycle. Unemployment rates tend to ebb and flow with the business cycle.

Stages of a Business Cycle

Each business cycle includes four stages. Those stages happen in the same order each time, but they don’t always last the same amount of time. Peaks and troughs mark the highs and lows of the cycle. A business cycle, as a whole, generally lasts anywhere from two to 12 years with six years the average length.

The stages include:

  • Expansion: This is the period of transition from a trough, or low point in the economy, to the peak, or high point. GDP increases during this phase, and the economy improves. Unemployment rates usually decrease.
  • Peak: The peak is the high point in the cycle just before the economy starts trending downward.
  • Contraction: The contraction period includes everything from the peak down to the trough. The GDP starts to drop, and the economy weakens. Unemployment rates typically increase.  
  • Trough: The lowest point of the cycle is the trough, the tipping point just before expansion starts again. 

Business Cycle on a Macroeconomics Level

Economists often use the business cycle to describe the economy as a whole. It’s a broad look at economic events that describe the general state. Even though a graphic showing the business cycle has a smooth up-and-down appearance, the actual changes in the economy are often inconsistent. Smaller economic events can cause sudden spikes during a cycle.

Effects of the Cycle on Businesses

Changes to the economy as a whole have an effect on individual industries and businesses, so it’s important to understand how business cycles work. Businesses that manufacture goods usually see a bigger impact than service-based businesses. The fluctuations also typically affect wholesale and industrial prices more than retail pricing.

Planning for the business cycle helps avoid issues during the contraction phase. Avoiding extra expenses during economically strong times can help a business do better when the economy weakens, for example. That’s especially true about expenses that are tough to cut. Hiring extra people during an economic boom can lead to difficulties during a bust in the form of layoffs, severance pay, unemployment insurance and other expenses.

Even though the business cycle usually applies to the economy as a whole, it can also describe the natural ups and downs of industries or businesses. Being aware of those fluctuations and planning for them can improve the strength of a business. Long-term planning, flexibility and adapting to economic changes can improve a company’s success.