The Impact of Business Cycles on the Economy

by Sue-Lynn Carty; Updated September 26, 2017

A business cycle is the rise and fall of business activities within an industry that include periods of profitability and periods of loss. Business cycles do not occur at regular intervals. These cycles occur irregularly but repetitively. Typical business cycles include expansion, a peak, contraction and recovery. When dramatic business cycles occur in different industries, it often affects the national economy as a whole and not just the industry experiencing the fluctuation.

Expansion

During the expansion phase, businesses are growing and creating more jobs. This causes an increase in employment and decrease in the unemployment rate. If the economy is growing at a relatively fast pace, it puts upward pressure on the general prices of goods and services, resulting in inflation. Inflation is also an indicator of too much currency circulating in the economy, which depreciates the value of the dollar. To help slow the rate of inflation and stabilize currency value, the Federal Reserve Board might increase interest rates to discourage borrowing. This helps to decrease the economic money supply and prevent further depreciation of the dollar

Peak

A peak occurs when the expansionary phase of the business cycle is about to end. Certain economic indicators such as a drop in the number of new jobs added to the economy and a rise in the unemployment rate can signify the peak of an expansion cycle. During an economic peak, the economy is no longer growing, retail sales are declining and economic output is decreasing. Economic output is the total value of all goods and services produced in an economy. All these factors can lead to further job loss and often signify an oncoming economic contraction.

Contraction

The contraction phase of the business cycle is when the economy begins to shrink. Economists also refer to this period as a recession or trough in the business cycle. During this period, economic output decreases. This results in job losses and an increase in the unemployment rate. During periods of economic contraction, there is not enough currency circulating in the economy because consumer spending is down. To encourage borrowing and increase consumer spending, the Federal Reserve Board might decrease interest rates.

Recovery

When economic outputs increase and businesses begin to expand, it indicates that the business cycle is in the recovery phase. During this phase, the employment rate is rising while the unemployment rate is falling. The economic recovery period of a business cycle can be difficult to forecast because other factors might cause a short-term stimulation in the economy but does not necessarily indicate a permanent recovery. An example of a short-term stimulation is the holiday shopping season. During this period, retail sales and employment might increase but only temporarily.

About the Author

Sue-Lynn Carty has over five years experience as both a freelance writer and editor, and her work has appeared on the websites Work.com and LoveToKnow. Carty holds a Bachelor of Arts degree in business administration, with an emphasis on financial management, from Davenport University.