The business cycle


Cycle means repetition of certain phases. GDP does not develop straightforward - there is a pattern of ups and downs.


1. Expansion. Economy begins to recover. During an expansion business and consumer spending begin to increase, business begins to increase production. Unemployment declines as additional workers are hired, and this leads to higher level of consumer spending and still further expansion of employment, output and consumption. Interest rates grow.

2. Peak (boom). At the peak of an expansion, the economy is booming. Business is normally producing at or near capacity and those looking for work can generally find jobs. During peak times, business investments and consumer spending are at the highest levels. But because the economy is at or near full employment and the demand for goods and services is increasing, prices are also increasing and so is inflation. Interest rates are at their highest point, to discourage companies so they wouldn't produce so much.

3. Recession. In recession consumers and businesses begin to reduce their spending level. Businesses may lay off workers, reduce their purchases of materials and reduce production, because they have built up excess inventories. Some businesses may decide to continue to use old factories and equipment rather than investing in new machines and buildings. Workers are laid off, consumers have less money, and thus buy less. This leads to still more reductions in production and additional worker layoffs. Interest rates start to fall. A long period of severe recession is a depression or a slump.

4. Depression. The economy will reach the lowest point of a business cycle. Factories will be operating at less than capacity and unemployment will reach high levels, some companies will even go bankrupt. Total output of goods and services continues to decline. Interest rates are at their lowest point to encourage people to produce, so that the economy could recover.

What causes business cycles

A) External factors occur outside the economic system, can't be influenced:


B) Internal factors occur within the economy itself, can be influenced:


Business cycles according to periodicity:

Consequences of cyclical development are inflation and unemployment.



Inflation refers to a general rise in the level of prices of goods and services.

Stagflation is used to describe situation when prices and unemployment rise at the same rate, or there is no economic growth.

The main causes of inflation are: more money in circulation, labor union pressure to raise salaries but the productivity stays the same, or too high national debt.

The rate of inflation is measured by calculating the percentage price increase in goods and services usually over a year. Percentage price rises are usually shown by a retail price index.


RPI (current year)–RPI(previous year) Inflation = ---------------------------------- . 100 RPI(previous year)

RPI = retail price index, it is the average price of all items selected


We distinguish:


According to the reason we distinguish:


Those most likely to suffer from inflation are:


Those who are not affected (or benefit):



Unemployment is a situation, when not everyone in their productive age is employed. Unemployed people are those who are in productive age from 16 to 62, they are capable of, available for and actively seeking work but unable to find jobs.

The Labour Department gathers this information and gives it to Bureau of Labour Statistics that then calculates the unemployment rate. People claiming unemployment benefits must enter a Jobseekers Agreement, setting out the action they will take to find work and improve their prospects of finding employment.

Number unemployed Unemployment rate = –––––––––––––––––––––– x 100 Working population

People working in part-time jobs or young people on government training schemes, or graduates are not counted in unemployment figures because they are not in the Jobseekers Agreement. Groups of people like these are said to be the hidden unemployment.


We distinguish different types of unemployment:

Frictional unemployment occurs as people voluntarily change their job and spend some time looking for a new one. It is a short-term and often voluntary unemployment

Seasonal unemployment occurs because consumer demand for some goods and services is seasonal. Jobs in tourism, the building industry, agriculture

Cyclical unemployment occurs when there is too little demand for goods and services in the economy during an economic recession.

Structural unemployment. If the fall of demand for some goods or services is permanent because of change in peoples tastes maybe because of cheaper sources of supply from overseas firms, the change in demand is called structural. Structural unemployment arises from long-term changes in the structure of the economy as entire industries close down because of a lack of demand for the goods or services they produce. Workers whose skills are no longer wanted have to be re-trained in new skills which may help them become more mobile and find a new job. (coal mining, elevator operator)

Full employment does not mean the total elimination of unemployment. Frictional and structural unemployment are expected, and economists combine these two rates in what is described as the natural rate of unemployment. When the actual rate of unemployment equals the natural rate = about 5% of unemployment, the economy is at full employment


Imperfections in the labor market:

  1. Powerful trade unions demand wages for their members that are too high and not matched by improvements in productivity. As wages rise, employers may not be able to afford as many workers so they reduce their demand for labor.
  2. Benefits paid to the unemployed reduce the incentive to work. Some people would only be willing to work at much higher wages. This is called voluntary unemployment.
  3. Employers' national insurance contributions. For every worker a firm employs it must pay the government a tax in the form of employer's insurance. Cutting employers' contribution may give them the incentive to employ more workers.
  4. The immobility of labour prevents workers from finding new jobs. If workers are unable to move to a different job because it requires different skills and people are not qualified, this is called occupational immobility. If a worker is unable or unwilling to move to a different area, this is called geographical immobility.