The Business Cycle

Booms and Busts

A free market economy does not grow at a constant rate.  It goes through a series of booms and busts called the business cycle.  The following graph illustrates the business cycle:

Explanation 

A.  The letter A on the graph represents a decline, sometimes calls a recession or bust.  During a decline, consumer spending decreases as consumers and investors become cautious about the future.  This causes factories to slow production and lay off workers.  The increased unemployment tends to reduce spending in the marketplace even further, contributing to the economy's decline.

B.  The letter B on the map represents the lowest point of the recession.  This is a period of high unemployment  and low prices.  Prices have dropped because there is less money being circulated in the economy.

C.  The letter C on the map represents a boom, sometimes called prosperity.  A boom is a period of prosperity.  Most people have jobs.  As a result they tend to be buying goods and services.  This keeps the economy strong.  This period will see the highest levels of inflation as producers try to slowly increase their prices in order to get a bigger share of the thriving market.

D.  The letter D on the map represents a depression.  A depression is a very big decline whereas a recession is only a small decline.  During a depression, unemployment is very high and there is very little money circulating in the marketplace.  A depression is a serious problem for a country.  The most famous depression was the Great Depression in the 1930's.

E.  The letter E represents a recovery.  During a recovery, the economy is improving.  As people begin spending more, producers are encouraged to increase production.  This means more jobs and, in turn, even more spending.  A recovery was the intended effect of Franklin Delano Roosevelt's New Deal in the 1930's

The oil industry is a good example of the business cycle at work.  Fluctuating prices for (and production of) oil have occurred since the beginning of the industry (Drake's Oil Well).  During Rockefeller's day, the price of oil even fell below the price of water!  Nowadays, in Alberta we can see the effect that  changing oil prices have on our economy.  When prices are low, we tend to have higher unemployment and a slower economy.  When they rise again, we are able to increase spending at all levels.  

When an economy has been prosperous for a long time, raw materials tend to get used up, skilled laborers become scarce, and stockpiles of goods in warehouses increase.  This causes some factories to lay off workers.  All these factors will eventually work together to cause a recession

Recovery will eventually come during a recession or depression.  Sometimes it is caused by new consumer demands.  Other times it is the result of inventories finally being used up or debts being paid off.  At still other times, the economy gets a boost from the government as a result of increased government spending.  This was the case in the United States when World War II and Roosevelt's New Deal brought massive government spending into the economy.

Further reading