12.3. Business Cycles

Chart 12-4 shows the American economy in the 20th century. Although it may not look much like a pic­ture, it illustrates a pattern of ups and downs in the U.S. economy called the business cycle.

Times of prosperity are above the mid-line, while difficult economic times are below. Find the Great Depression. "Depression" refers to an extended peri­od of general underemployment of economic resources: factories are idle, millions of workers are unable to find jobs, and the rate of business failure is high. The Great Depression lasted from 1930 to 1940. There were 13 million people unemployed in1933-about one of every four workers. That same year businesses failed at a record rate, and countless people lost their savings when more than 4,000 banks closed permanently. The chart's view of the economy during World War II is somewhat mislead­ing, however. During the war many goods were scarce, but factories and the labor force were fully employed.

Shorter, less dramatic changes in business activity are more common, though. These changes can be described in several different ways, including peaks, recessions, troughs, and expansions (see Figure 12-5).

Peak. At the peak of an expansion, the economy is booming. Business is normally producing at or near capacity, and those looking for work can generally find jobs. During peak times, business investment and consumer spending are at very high levels. But because the economy is at or near full employment and the demand for goods and services is increasing, prices are also increasing.

Recession. A recession is defined as two quarters (six months) of declining real gross domestic prod­uct. After a period of "peak" business activity, con­sumers and businesses begin to reduce their spending levels. Businesses may lay off workers, reduce their purchases of raw materials, and reduce production because they have built up excess inven­tories. Some businesses may decide to continue to use old factories and equipment rather than invest­ing in new machines and buildings. Some businesses and consumers will even reduce spending because economists predict that business will be slowing down in the next few months. Whatever the reason, reductions in business and consumer spending mark the beginning of a recession.

As spending reduces, other business firms begin to cut back their activities. Their production is reduced and more workers are laid off. Because of the lay-offs, workers, who are also consumers, spend less. This leads to still more reductions in production and additional worker layoffs. Since World War II recessions have lasted between 6 and 18 months.

Trough. After a period of recession, the economy will reach the low point of a business cycle. Factories will be operating at less than capacity and unemployment will reach high levels; total out­put of goods and services contin­ues to decline. Times are hard at the trough of the cycle, jobs are difficult to find, and many businesses fail.