9.1 The Business Cycle

What is the business cycle?

A recurring pattern of alternating rises and declines in economic activity, measured by changes in real GDP.

What are the four phases of the business cycle?

Peak, Recession, Trough, Expansion.

What happens during the peak phase?

Economy is at or near full employment; real output is at or near capacity; price levels may rise.

What defines a recession?

A decline in output, income, and employment lasting at least six months; real GDP falls and unemployment rises.

What occurs during the trough phase?

Output and employment bottom out at their lowest levels; may be short or long.

What characterizes the expansion phase?

Rising real GDP, income, and employment; economy moves toward full employment; inflation may occur if spending exceeds capacity.

What are economic shocks?

Unexpected events that shift demand or supply, causing fluctuations in output and employment due to sticky prices.

Why do sticky prices matter in business cycles?

They prevent quick market adjustments, so output and employment change instead of prices.

Name six sources of economic shocks.

Irregular innovation, productivity changes, monetary factors, political events, financial instability, public health emergencies.

How do financial bubbles affect the business cycle?

They alter lending and confidence, leading to booms or busts in the broader economy.

What is the impact of irregular innovation?

Sparks investment and growth, followed by slowdowns once the innovation is absorbed.

How do productivity changes influence the cycle?

Unexpected increases boost the economy; decreases lead to recession.

What role do monetary factors play?

Too much money causes inflationary booms; too little leads to output decline and recession.

What made the COVID-19 recession unique?

It was triggered by a global public health crisis, not a typical economic shock.

Which industries are most affected by recessions?

Capital goods and consumer durables (e.g., cars, appliances, equipment).

Why are service and nondurable goods industries less affected?

Their goods/services are harder to postpone (e.g., food, medical care).

What does "cyclical" mean in economics?

"Cyclical" refers to patterns that repeat over time. In economics, it describes how economic activity rises and falls in a recurring sequence—known as the business cycle—with phases like peak, recession, trough, and expansion.

What happens when level of spending unexpectedly rises?

Output, employment, income rises.

What happens when level of spending unexpectedly sinks and firms cannot lower prices?

Firms sell fewer units of output (fixed prices, lower spending implies fewer items purchased), slower sales cause firms to cut back on production. As they do, GDP falls, fewer workers are needed to produce less output, employment falls.

Why do economists sometimes prefer the term "business fluctuations" over "business cycle"?

Because "cycle" implies regularity, while economic ups and downs vary in duration and intensity. "Fluctuations" better reflect the unpredictable nature of these changes.

What do gray bars represent in business cycle graphs?

Recessions.

What does the business cycle show about the economy over time?

The economy alternates between periods of growth and contraction.

What are the four phases of the business cycle?

Peak, Recession, Trough, Expansion.

What happens during the peak phase?

The economy reaches full employment and maximum output; follows a period of growth.

What defines a recession?

A period of economic decline lasting 6+ months, marked by falling GDP and rising unemployment.

What is a trough in the business cycle?

The lowest point of a recession where output and employment stabilize before growth resumes.

What characterizes the expansion phase?

Rising GDP, income, and employment; the economy grows again.

What is the long-term trend of the economy?

The economy grows over time despite short-term fluctuations.

What happens at the bottom of a recession?

Economic activity stabilizes before entering expansion.

What causes business cycle fluctuations?

Economic shocks combined with sticky prices.

What does “sticky prices” mean?

Prices resist moving up or down quickly, especially downward.

What is the typical inflation level during stable periods?

Moderate inflation, which is considered healthy.

What changes in response to economic shocks?

Output and employment.

Name examples of major innovations that cause shocks.

Railroads, electricity, telephone, cars, internet, AI.

What are productivity shocks?

Unexpected changes in output per unit of input—can be positive or negative.

How does the Federal Reserve influence the business cycle?

By raising or lowering interest rates and adjusting the money supply.

What happens when the FRB supplies more money?

Interest rates go down.

What happens when the FRB supplies less money?

Interest rates go up.

What is a real estate bubble?

Overbuilding homes beyond demand, leading to economic instability.

Why was COVID considered an economic shock?

It disrupted global economies unexpectedly, triggering a recession.

What is the major immediate cause of cyclical changes?

Changes in consumer and business spending.

Which goods are most affected by recessions?

Durable goods—capital goods and expensive consumer items.

Which goods are less affected by recessions?

Nondurable goods—services, food, and clothing.

How does the economy respond to shocks?

Changes in output and employment rather than the change in prices.

What is the rate of inflation equal to?

The percentage growth of CPI from one year to the next.