Explained: Business cycle and its phases

Business cycle can help you identify economic trends and changes more easily.

The business cycle is the fluctuations in the economic activities that occur between the periods of expansion and contraction phase of the economy. Gross Domestic Product (GDP), unemployment rate and interest rates are some of the key factors that are used to determine the current phase of the business cycle. A business cycle is also referred to as an economic cycle. 

Business cycle can help you identify economic trends and changes more easily. Understanding the business cycle also enables you to make better, more informed financial decisions regarding your investments, as it has a direct impact on stocks and bonds, as well as profits and corporate earnings. 

It consists of four phases: expansion, peak, contraction or recession and trough. Let's understand each phase in detail. 

Expansion phase:  During the expansion phase, economic growth is rapid, resulting in an increase in GDP. The interest rates in the economy also become lower while production rises rapidly. Economic indicators that tend to determine economic growth, such as the rate of employment and wages, corporate profits and output, aggregate demand, and the supply of goods and services, tend to demonstrate consistent uptrends throughout the expansionary period. The cost of raising money is low since interest rates are low as a result the flow of money through the economy remains robust. However, an increase in the money supply may cause inflation to rise throughout the economic expansion period. 

Peak:  As the economic expansion reaches the peak of a cycle, growth reaches its highest rate. Prices and economic indicators may stabilise for a short while before turning to the downside at this economic high point. Peak growth usually causes certain economic imbalances that must be addressed. As a result, when businesses think the economic cycle has reached its height, they may begin to review their budgets and spending. 

Contraction/Recession: During the period of contraction, a correction takes place which causes a GDP slowdown, an increase in unemployment, and the prices stagnate. If demand begins to collapse, businesses may not adjust production levels rapidly, resulting in oversaturated markets with surplus supply and accelerating price declines. Economic indicators that were on an upward trend during the growth period begin to deteriorate during this stage. If the decline persists, the recessionary situation might descend into depression. 

Trough: The trough phase of the cycle occurs when the economy reaches a low point, with supply and demand scraping the bottom before growth begins to rebound. The cycle's low point is a tough time for the economy, with stagnant spending and income having a widespread negative influence. The low point of the cycle, like the peak, gives a chance for individuals and businesses to restructure their finances in preparation for a rebound. 

The key aspect of a business cycle is that they are recurring. However, the intervals of recurring are not regular. In the past, economies have experienced business cycles as short as a year to longer than a decade.