What to make of the business cycle and its phases (expansion, contraction, trough, recovery)?

Economics Economics Questions
1

Hello,

For a financial/economics course, we’re learning about the business cycle.

We are taught that the fluctuations in a country’s GPD over the years is called a business cycle.

Expansion

In times of normal growth, the economy is expanding. Inflation is stable. Profits rise. Market activity is strong.

Peak

Demand begins to be stronger than supply. The shortage in products and labor causes an increase in wages and inflation. Thus, interest rates rise and bond prices fall. People hold back on buying big-ticket items. Business sales decline. Stock prices fall, stock market activity declines.

Contraction

Real GPD decreases. Firms with unwanted inventories and declining profits reduce its workforce, postpone investments. Consumers, especially those affected with decreasing employment, cut back on spending and increase their savings, which cuts sales and fuels the recession.

Trough

Firms can’t raise prices and employees can’t demand higher wages because of falling demand and excess capacity (supply). Inflation falls and interest rates soon follow. The trough is reached when consumers are spurred by low interest rates to make purchases.

Recovery

GDP returns to its previous peak. Firms that reduced inventories during the recession must increase production to meet new demand.

  1. What do we make of this theory?

  2. For those countries that are undergoing a business cycle now, was there a time that they didn’t undergo one?

2

Uh. What?

:EDIT:

Okay, well now that you basically re-did your whole post and actually explained something I might be able to offer some kind of answer. Although, I’m still not sure what you mean by “we”. If you mean Austrians, the short answer is, that explanation is mediocre at best. I mean, it does get some attributes right, but it’s like an abridged version of a book that’s reversed: it takes out the essentials and the only stuff left is a lot of things that could have been cut down, or at least should not be the main focus.

The biggest problem with that whole thing is that it’s not a real “theory”. It doesn’t offer any sort of explanation for anything. It’s basically a recounting of effects without any identificaiton of causes.

  1. You start off with “inflation is stable”. Why is there inflation at all?

  2. “Demand begins to be stronger than supply.” Why?

  3. “Real GDP decreases”. “GDP” is meaningless. [1] [2]

  4. “because of falling demand and excess capacity (supply)”. But you just said the whole reason for all of this was demand was stronger than supply.

  5. “GDP returns to it’s previous peak”. (a) [see #3], (b) Why?

Do you see the issues here? The Austrians are the only ones who can explain all of this. And if you’re asking if there was some time and place in history in which there was not the typical “boom-bust” cycle we’re used to, the answer is yes.

For more information I recommend you check out these resources:

“Fear the Boom and Bust” - Hayek vs. Keynes### Fight of the Century: Keynes vs. Hayek Round Two#

Austrian Business Cycle Theory learning materials

3

It’s not a theory, it’s a description. I imagine the theories regarding the cause of the BC will come later in your course.

4

I seriously doubt they will go any deeper than that. Even Krugman just rests on phrases like “for whatever reason” in place of where an actual cause should go. Has for over a decade. I’m actually surprised those three words didn’t begin most of those sections he outlines in the OP.