4.8 Business Cycles

Figure 4.11, “Phases of the Business Cycle,” shows a stylized picture of a typical business cycle. It shows that economies go through periods of increasing and decreasing real GDP but that, over time, they generally move toward increasing real GDP. A sustained period in which real GDP is rising is an expansion; a sustained period in which real GDP is falling is a recession. An economy is typically in a recession when real GDP drops for two consecutive quarters. Typically, a business cycle has two phases: expansion and recession and two turning points, peak and trough.

At time [latex]t1[/latex] in Fig 4.11, an expansion ends, and real GDP turns downward. The point at which an expansion ends and a recession begins is called the peak of the business cycle. Real GDP then falls during a period of recession. Eventually, it starts upward again (at time [latex]t2[/latex]). The point at which a recession ends and an expansion begins is called the trough of the business cycle. The expansion continues until another peak is reached at time [latex]t3[/latex]. A complete business cycle is defined by the passage from one peak to the next.