Business cycle

The business cycle describes the way a market economy repeatedly grows and shrinks around its long-run trend. Economists divide it into four phases: expansion, when output and employment rise; the peak, the high point before growth reverses; contraction (a recession if it is deep or prolonged enough), when output and employment fall; and the trough, the low point from which recovery begins.

Real GDP is the headline measure, but the cycle shows up across many indicators at once. During an expansion, unemployment falls, consumer spending and business investment rise, and inflationary pressure typically builds. During a contraction, unemployment rises — cyclical unemployment specifically — corporate profits shrink, and demand for credit weakens. Indicators are grouped by timing: leading indicators such as new building permits and stock prices turn before the economy does, coincident indicators such as industrial production turn with it, and lagging indicators such as the unemployment rate turn afterward.

Cycles are recurring but not regular — they vary in length and depth, and no two look alike. Governments and central banks respond with countercyclical policy: expansionary fiscal and monetary policy during contractions, and restraint as an expansion overheats. Investors track the cycle because different sectors behave differently within it; defensive industries such as utilities and consumer staples hold up better in downturns, while cyclical industries such as autos and construction swing hardest.

The business cycle is a core topic on AP Macroeconomics and the CIMA Certificate BA business economics paper, where you may be asked to identify phases from data or explain the policy response to each. It also underlies securities exam content on the SIE, where cyclical versus defensive stock classification and the economic backdrop for market activity are tested.