Phases of the Business Cycle

An economy can grow for decades and still wobble year to year because long-run growth comes from slow-moving forces like capital, labor, and technology, while short-run swings come from faster-moving shifts in spending and costs. Draw real GDP over time and it traces a wavy line climbing around an upward trend. The high points are peaks, the low points are troughs. Moving down from a peak is a recession, a period where output, income, and employment are broadly falling. Moving up from a trough is an expansion, where those same measures are broadly rising. Each full trip from one peak to the next is one business cycle, though cycles differ wildly in length and severity.

A recession is not just one rough quarter. It is a widespread, sustained decline touching production, employment, sales, and income together, which is why economists look at a cluster of indicators over several months before calling one, not a single data point. As the economy moves through these phases, unemployment and inflation move too, but in opposite directions from output. In expansion, firms hire and output rises, so unemployment falls and demand pressure tends to push prices up. Near a peak, resources are stretched thin and inflation often runs highest. In recession, firms cut back, unemployment rises, and inflation pressure usually eases. At the trough, both output and hiring bottom out before the next expansion begins.

The engine behind these turns is shifting aggregate demand and aggregate supply. A drop in aggregate demand, from falling consumer confidence or tighter credit, pulls real GDP down and starts a recession; a recovery in demand, or a favorable supply shift like cheaper inputs, pushes the economy back into expansion. This links the cycle directly to the AD-AS model used to explain each turn.