During the expansion phase of the business cycle, production, employment, and income

Read this chapter and attempt the "Try It" exercises. Also, complete the concept problems and the numerical problems at the end of the chapter. In the first section of this chapter, you will read about the definition of Gross Domestic Product and some of the issues around measuring it. You will also learn about the 4 phases of the business cycle. As you will see, the economy goes through naturally alternating periods of economic growth and recession. You will review certain sections of this chapter later in the unit.

Inhaltsverzeichnis Show

• 1. Growth of Real GDP and Business Cycles
• What happens during the expansion phase of a business cycle?
• How does the expansion phase of the business cycle affect employment?
• What happens to employment during expansion?
• In which phase of the business cycle does income production and employment increase?

1. Growth of Real GDP and Business Cycles

Phases of the Business Cycle

Figure 5.1 "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 in the direction of increasing levels of 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. Typically, an economy is said to be in a recession when real GDP drops for two consecutive quarters, but in the United States, the responsibility of defining precisely when the economy is in recession is left to the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER). The committee defines a recession as a "significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales".

Figure 5.1 Phases of the Business Cycle

The business cycle is a series of expansions and contractions in real GDP. The cycle begins at a peak and continues through a recession, a trough, and an expansion. A new cycle begins at the next peak. Here, the first peak occurs at time t1, the trough at time t2, and the next peak at time t3. Notice that there is a tendency for real GDP to rise over time.

At time t1 in Figure 5.1 "Phases of the Business Cycle", 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 t2). 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 t3. Some economists prefer to break the expansion phase into two parts. The recovery phase is said to be the period between the previous trough and the time when the economy achieves its previous peak level of real GDP. The "expansion" phase is from that point until the following peak. A complete business cycle is defined by the passage from one peak to the next.

Because the Business Cycle Dating Committee dates peaks and troughs by specific months, and because real GDP is estimated only on a quarterly basis by the Bureau of Economic Analysis, the committee relies on a variety of other indicators that are published monthly, including real personal income, employment, industrial production, and real wholesale and retail sales. The committee typically determines that a recession has happened long after it has actually begun and sometimes ended! In large part, that avoids problems when data released about the economy are revised, and the committee avoids having to reverse itself on its determination of when a recession begins or ends, something it has never done. In December 2008, the committee announced that a recession in the United States had begun in December 2007. In September 2010, the committee announced that this recession had ended in June 2009.

October 06, 2022 | Publication

Market economies have a history of booms and busts called business cycles. The study of these economic cycles is important for making economic and policy decisions. The track record of precisely predicting when the business cycle moves from an expansion to a contraction or when a boom ends with a bust is not great. But the ability to understand when the economy is about to change direction can be critical for workforce planning, timing strategic investments, and mitigating risks due to rising costs or shortfalls in demand.

Business cycles are measured by looking at a variety of indicators that reflect the flows of transactions between households and firms in the economy. History shows that these indicators undergo alternating periods of rises and falls. The business cycle framework was established by economists to study the ups and downs in economic activity.

In the early 20th century, the National Bureau of Economic Research (NBER) was one of the first organizations to establish a research program on the measurement and analysis of market fluctuations. NBER developed a standardized approach to describing and measuring business cycles based on observed economic statistics that are now used around world as one basis for forecasting economic movements. In the United States, NBER has organized a Business Cycle Dating Committee, which uses a variety of data points to determine when recessions have occurred in the US economy. The Conference Board’s indicator program follows this lead and applies it globally, with indicators such as leading and coincident indexes designed for predicting future trends in the US and other economies.

The common elements of economic activity that recur in the history of market economies around the world can be used to predict when these economic movements will occur. This is what helps business executives and policymakers to foresee and adjust their hiring, spending, or investments as the economy evolves. Investors also rely on these common patterns to make decisions about asset allocations. The expansion periods denote the phase of the business cycle when overall economic activity is growing, with rising outputs and incomes, sales, and employment. A peak in the business cycle occurs when economic activity reaches its highest point and begins to slow down or turn down. The contraction phase begins when economic activity starts to fall, or economic growth becomes negative. The trough in the business cycle marks the lowest point of the contraction phase, when incomes and output reach their lowest point and the economy starts to expand again. 

Data used to determine when recessions have occurred include indicators of employment, sales (or demand), personal income, and industrial production along with GDP. For example, in the US, the NBER’s Business Cycle Dating Committee considers a diverse set of indicators including employees on nonagricultural payrolls, the industrial production index, manufacturing and trade sales, and personal income less transfer payments to identify beginning and end dates of recessions. Those variables can be combined into coincident economic indexes, which are broad measures of monthly economic activity.  The coincident index, thus, summarizes a group of economic indicators that are analyzed to look for consistent patterns in the business cycle. The index aggregation helps to pinpoint more precisely when recessions have occurred. A recession chronology developed from The Conference Board Coincident Economic Index® for the US corresponds closely to the committee’s decisions, which often occur months, if not years, after the turning point. Hence, The Conference Board global indicators program relies on coincident indexes to help define expansion and contraction periods for economies around the world with a great degree of accuracy. 

For a more detailed description of these topics, please see this article.

What happens during the expansion phase of a business cycle?

How does the expansion phase of the business cycle affect employment?

What happens to employment during expansion?

In which phase of the business cycle does income production and employment increase?