Business Cycle – Definition

Cite this article as:"Business Cycle – Definition," in The Business Professor, updated March 26, 2019, last accessed May 31, 2020, https://thebusinessprofessor.com/lesson/business-cycle-definition-2/.

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What is the Business Cycle?

From a conceptual observation, the business cycle is defined as the economy-wide fluctuations in trade and the general economic activity. The cycle is upward as well as the downward movement of various levels from gross domestic products.

A Little More on What is a Business Cycle?

It also refers to the period of expansion coupled with contractions in different economic activities and businesses around a long-term trend of growth. Besides, business cycles are characterized by a great boom in one sector and a period of collapse in the next in different economic activities. These fluctuations are known as phases. They are of four types:

Expansion: The expansion stage is also referred to as prosperity. It includes a steady growth and development throughout the business cycle. In the phase of expansion, there will be some increase noticed that will be coupled with different economic factors including production, output, wages, demand as well as the supply of products.

Peak: The peak phase entails the gradual slow down of the economic cycle which is also accompanied by the increase in growth rate of the business cycle until it reaches a limit. In this phase, some of the economic elements such as profit, sales, employment as well as production are relatively higher, but they don’t increase further than that specified level.

Recession: The peak phase entails a slow stage of a gradual decrease in demand because of the increase in prices of various inputs. When the decline in need of multiple products becomes rapid, the recession phase takes place. In the recession phase, the economic factors including product prices and saving as well as investment begins to decrease. Producers aren’t aware of the decrease in demand for products. This phase is also characterized by the trough stage in which the economic activities of a country decline instantly thereby hitting below average. The interest rates will decrease. So will there be a rapid decline in the general national income.

Recovery Phase: In the trough phase, the economy of a country reaches its lowest level of shrinking. This is the limit to which the economy of a country shrinks. Once it touches the lowest level, it becomes the end of negativism and then the beginning of positivism. The reversal of the business cycle then occurs.

Born in Rome, Italy, Franco Modigliani, was the son of Enrico Modigliani and Olga Flaschel. His father was a revered pediatrician in their city while his mother served as a volunteer in social work. His early school performance was outstanding. In 1932, he lost his father in an operation table. The event took aback as his life was grievously affected.  He then moved to the best school in Rome and managed to challenge himself into registering excellent performance. When he turned 17, he joined the University of Rome. Franco Modigliani became an economist as well as an educator. His works were so outstanding to the point of receiving the Nobel Prize for Economics based on his works on household savings as well as the dynamics. He was also awarded for spearheading research in different fields such as economics and creating the theory of the life cycle in marketing which proposes that people develop a store of wealth in their youthful years while working not to pass their savings to their heirs but to indulge in consumption at old age. As such, he came up with the Modigliani–Miller theorem which reiterates the basis of modern thinking based on capital structure. The fundamental theorem also states that in the absence of various state taxes, agency costs, or asymmetric information, or efficient market, the value of a corporation is unaffected by how the company is financed. The theorem was created in a universe that had no taxes. But, if people were to move to a world with taxes, when the interest debt is tax-deductible, the value of the company would increase instead.

References for Lifecycle

Academic Research on Lifecycle Model

Labor supply flexibility and portfolio choice in a life cycle model, Bodie, Z., Merton, R. C., & Samuelson, W. F. (1992). Journal of economic dynamics and control, 16(3-4), 427-449. This article analyzes the impact of someone’s choice of labor on their economic lives. It addresses the effect that a particular slot of the portfolio may have on the choice of employment. The research model integrates a few elements of flexibility as well as various factors that may be viable in work. One of these elements is retirement. Given the flexibility, the employee determines different optimal levels of consumption, effort at work as well as financial investment strategy.  

A lifecycle model of earnings, learning, and consumption, Heckman, J. J. (1976). Journal of political economy, 84(4, Part 2), S9-S44. This paper considers various human capital models of earning income and behavior over a lifetime. A middle class of life cycle models relating to different earnings behavior is developed and created by considering the alternative formulation of the underlying type model called the Ben-Porath. A solution to a particular issue within the general class is therefore found in the long run. The researcher comes up with an empirical development of the explicit earnings and the function is often estimated using data that has been harvested from cohort persons.

A life cycle model of female labor supply, Heckman, J. J., & MaCurdy, T. E. (1980). The Review of Economic Studies, 47(1), 47-74. This paper highlights the life cycle labor force participation of women. The subject is based on three women born in different eras namely the 1930s, 1940s, as well as 1950s. The research documents massive shifts in labor supply behavior in these three cohorts and the available changes in similar determinants of labor supply. The focus of the study is based on the increase in the labor supply of mothers who were born between the years 1940 and 1950. The researcher constructs a life cycle model that has an endogenous female labor force participation and consumption as well as saving choices made to search for a viable explanation. It was further discussed that the dynamics of labor supply highly depend on child costs and returns to experience.

The lifecycle model of consumption and saving, Browning, M., & Crossley, T. F. (2001). Journal of Economic Perspectives, 15(3), 3-22. This paper analyzes the consumption as well as saving measures of an ordinary citizen using the life cycle model of the economy. Research shows that consumption, as well as saving decisions, is at the heart of short and long-term macroeconomic analysis and other microeconomics. In the short run, different spending dynamics are of great value for business cycle analysis as well as management of monetary policy. On the other hand, in the long term, the aggregate saving highly determines the size of the capital stock. There will also be consequences for wages and interest rates.

Micro and macro elasticities in a life-cycle model with taxes, Rogerson, R., & Wallenius, J. (2009). Journal of Economic theory, 144(6), 2277-2292. This paper analyses different life cycle models were revolving around micro as well as macro elasticities. It reiterates the fact that besides building a cycle model of labor supply that integrate changes along intensive as well as extensive margins and utilizing the results of changes in tax, we establish that consistency between the established findings and empirical findings of small labor elasticities for ripened age works. In this research model, micro, as well as macro elasticities, aren’t related.

A life cycle model of life insurance purchases. Fischer, S. (1973). International Economic Review, 132-152. This research paper highlights the need for insurance companies to find out more about their clients before creating insurance packages for certain people. It disintegrates the existing differences between the insurance needs of clients and applies a model that’s similar to Hakansson in which the life span of an individual is pretty uncertain. Therefore, there is a need to assess life-cycle patterns of various consumptions and savings. This article emphasizes the statistics that highlight the real comparisons between the factors affecting insurance companies.

Expanding the lifecycle model: Precautionary saving and public policy, Hubbard, R. G., Skinner, J., & Zeldes, S. P. (1994). The American Economic Review, 84(2), 174-179. In this article, the researcher analyses the existing life cycles of a product from the beginning to the end while discussing the impact of an expanding life cycle model. The product life cycle model is a perfect marketing tool that’s used to explain four main stages that products must pass through during a limited lifetime. But, as the traditional stages such as introduction, growth, maturity as well as decline, deal with a product’s life when it’s been launched in the market, the model has overlooked the valuable stages of getting a product to a market as well as withdrawing it when it’s not profitable. The paper further delves into the possibilities of saving in highly designed models of business. As such, the perfect model begs to understand the usefulness of the saving docket in different family settings. The model may be useful in assessing the effects of government policy particularly when it comes to the saving behavior.

Dollars, sense, and sunk costs: A life cycle model of resource allocation decisions, Northcraft, G. B., & Wolf, G. (1984). Academy of management review, 9(2), 225-234. This article analyzes the failure rates of startups including whether it is prudent to cut off such businesses from the sector when they fail. The research uses a new model to disintegrate the viability of a business succeeding once it has been unable. As proposed in the study, the model borrows a leaf from a rough accounting measure that validates the possibilities of the time adjusted rate of return to extensively explain the negative impact of sunk costs on the prospecting rate of returns. The model in this paper is also used to examine the value of negative feedback when it comes to decision making where an individual is supposed to commit more resources.

Conceptualizing cluster evolution: beyond the life cycle model?, Martin, R., & Sunley, P. (2011). Regional Studies, 45(10), 1299-1318. This paper highlights the interaction of industrial clusters as well as cluster development alongside regional economic growth and how they can be manifested. It was emphasized that the stated elements could be of beneficial impact on the growth of different life cycles. Although the participants of these clusters created close relationships, it was noted that their innovation, as well as improved productivity, will enhance growth in the local community. Other than that, it was discovered that the thriving regional economy would bring immense profits to further attract external enterprises to gather around a cluster.

Competing in product and service: a product lifecycle model, Cohen, M. A., & Whang, S. (1997). Management science, 43(4), 535-545. This paper highlights the set of strategic choices that many manufacturers are facing at the moment. The article uses a model that represents a product life-cycle designed to conjoin the bundle for a service product that may need maintenance as well as repair support after its launch in the industry. The selection parameters of interest may be such as the price of the product, quality rendered as after-sales service. Alongside the price that shall be charged for the after-sales service. The research uses a somewhat competitive theoretic business framework. The amount of the product and service quality features equilibrium to a differentiated sequential game.

Government debt, human capital, and bequests in a lifecycle model, Drazen, A. (1978). Journal of Political Economy, 86(3), 505-516. This paper highlight uses the overlapping generations model as a framework of analysis in disintegrating macroeconomic dynamics as well as economic growth. Research delves in the conditions affecting an efficient transfer of intergenerational motives including how they are derived without unique assumptions regarding the form of the utility function. The rate at which an individual’s heir and their utility will be is going to be relative with the interest rate.

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