A business cycle is an economic phenomena individuals and nations observe in free-market economies. Though many may think that different types of business cycles exist, the truth is there are a few different stages in a single cycle. The most commonly observed stages include growth, peak, contraction, trough, and recovery. These stages start with increases to economic output and then lead to downturns that contract the economy. Business cycles start over again once the trough is over and the economy enters a new growth stage.
Business cycles are an external force that affects more than just a single individual or company. The immediate players in an economy are certainly affected by business cycle stages. As the economy enters the different stages, however, it can spread to other parties. For example, growth occurs when many companies begin to meet increased consumer demand through higher production output. This growth may require more inputs from other countries, increasing the international economy.
It can be difficult to measure each stage of business cycles. In most cases, an economy will already be in the stage once private sector companies, nonprofit organizations, or governments have the ability to quantitatively measure the economy. For example, growth is often easy to measure because the increase in companies or sales can indicate a growth period. Peak periods and contractions are usually the most difficult to determine. Companies typically look for these periods in order to remove themselves from the market and maintain profits.
In classical terms, a contraction is the result of too much supply with not enough demand. The peak stage typically means equilibrium exists between supply and demand. Once the supply side of the equation begins to outpace demand, a contraction may begin, among other more complex reasons. The contraction stage leads to companies reducing output and shuttering operations in order to meet lower consumer demand. At the bottom of the contraction, a trough begins.
The trough stage of business cycles is a period of low supply and demand when compared to the peak stage. While the economy still moves along, it is much slower than before. Both private sector companies and governments tend to experience lower profits and tax revenues, respectively. This continues until the free market flushes out the excess companies or supply from the economy. Once the supply side of the equation corrects itself, the economy often begins a new growth stage.