1.1. Business Cycles

Fluctuations in the economy come in more or less regular cycles called business cycles. A business cycle includes four phases. The first phase, expansion, is characterized by an increase in economic activity and above average economic growth. In this phase, the production of goods rises and unemployment falls. Lenders make credit more available because they believe businesses and people will be able to repay their loans. Available credit means lower interest rates, which fuels expansion, resulting in more jobs.

The expansion phase feels good because jobs are plentiful and wages rise. But a risk of the expansion phase is the possibility of inflation, because increasing wages and available credit tend to boost prices.

As the economy reaches full employment, it hits a maximum point of economic activity, called the peak. The peak, the second phase in the business cycle, marks the end of the expansion phase and the beginning of the third phase, called contraction. Perhaps inflation has caused consumers to reduce their spending, or perhaps production has exceeded demand for products, and business inventories have begun to pile up. Either situation will trigger a reduction of employment and production.

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