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4
The business cycle 
Business cycles 
or 
trade cycles 
are the continual sequence of rapid growth in national income, followed 
by a slowdown in growth and then a fall in national income (recession). After this recession comes 
growth again, and when this has reached a peak, the cycle turns into recession once more.
4.1 Phases in the business cycle 
Four main phases of the business cycle can be distinguished. 

Recession 

Recovery 

Depression 

Boom 
Recession tends to occur quickly, while recovery is typically a slower process.
4.2 Diagrammatic explanation 
At point A in the diagram below, the economy is entering a recession. In the recession phase, consumer 
demand falls and many investment projects already undertaken begin to look unprofitable. Orders will be 
cut, inventory levels will be reduced and business failures will occur as firms find themselves unable to 
sell their goods. Production and employment will fall. The general price level will begin to fall. Business 
and consumer confidence are diminished and investment remains low, while the economic outlook 
appears to be poor. Eventually, in the absence of any stimulus to aggregate demand, a period of full 
depression
sets in and the economy will reach point B.
A
B
C
D
Trend in
output
Actual 
output
Output
Time
Figure 4 The business cycle 
At point C the economy has reached the 
recovery
phase of the cycle. Once begun, the phase of recovery 
is likely to quicken as confidence returns. Output, employment and income will all begin to rise. Rising 
production, sales and profit levels will lead to optimistic business expectations, and new investment will 
be more readily undertaken. The rising level of demand can be met through increased production by 
bringing existing capacity into use and by hiring unemployed labour. The average price level will remain 
constant or begin to rise slowly. 
In the recovery phase, decisions to purchase new materials and machinery may lead to benefits in 
efficiency from new technology. This can enhance the relative rate of economic growth in the recovery 
phase once it is underway. 
As recovery proceeds, the output level climbs above its trend path, reaching point D, in the 
boom 
phase 
of the cycle. During the boom, capacity and labour will become fully utilised. This may cause 
bottlenecks in some industries which are unable to meet increases in demand, for example because they 
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