Phases of the Business Cycle

In the previous post, we looked at what the business cycle is and what the different phases of the business cycle are. In today's post, we are going to analyze the different phases of the business cycle by using the Brick Wall Economic Theory as an example.

If you want to learn more about the theory behind the Business Cycle you can go read about it here as this post will be a practical analysis of the different phases of the business cycle. On that post, we covered that the business cycle consists of two main phases called the contraction phase and the expansion phase. The contraction phase can then be further broken down into the recession phase and the depression phase where the expansion phase can also be broken down into the recovery phase and the prosperity phase.

The different phases of the business cycle coincide with certain human behaviours.

Contraction:

The contraction phase is where the economy slows down and the total production is less than a time before. In other words, the contraction phase is where the gross domestic product (GDP) is smaller than it was previously. 

In short, what this means for the wall building company and my neighbour is that when the business cycle is in this phase they will probably reconsider building the wall as my neighbour won't have enough money to spend on the wall and the wall-building company won't be able to build the wall in a way that is effective.

Recession

The recession phase is where businesses start to lay off workers because the economy is doing worse and consumption is lower than before. When consumption is low the business aren't making money and needs to start cutting their expenses. 

For the wall building company, this is also true. When the economy is in a recession they have fewer customers than they would like and so they don't have enough money to pay for the same amount of workers they used to have. By laying off a certain amount of workers the wall building company can keep their doors open and still get an income but this will mean that they are not operating in a way that is effective. We will explain effectivity in a future post.

During the recession phase of the business cycle, individuals aren't getting raises at work. They are uncertain if they will even still have their job in the future as the company they work at have also begun to lay off workers in order to keep operating. This holds true for my neighbour as well. The company he works at may have given him a smaller salary or even layed him off. What this means is that he would have to rethink what he can afford to buy and what not. He needs to evaluate his expenditures and cut back on the things that are not essential to his life. While doing this assessment he probably realised that to make a wall higher between him and his neighbours aren't really an essential thing he needs to buy. 

Depression

The depression phase is the phase that makes the recession phase look like a good thing. The economy is in a very bad shape and a lot of people cannot find any jobs.

The wall building company can at this stage not afford any workers to build walls for them because they can't find clients. They have to close their doors, file for bankruptcy and seize to operate. 

My neighbour is also one of those people who can't find any jobs to get an income. He is currently living of off his unemployment insurance which he luckily paid for when the economy was in a better state. The unemployment insurance is barely enough to pay his mortgage so he had to sell his house and move somewhere cheaper just so he can put food on the table for his family. As you guessed it, the wall was never built.

Expansion:

During the expansion phase of the business cycle, the economy reached a turning point and is starting to grow again. Businesses can afford to hire new people and can find customers again. The people working for those businesses now also receive higher salaries and can afford to buy more things again.

What this means for the wall building company and my neighbour the wall building company now have enough clients to build walls in a fast and effective manner again. My neighbour also got a new job and can rest assured at nights because he can provide for his family. Thoughts about building the wall return and he is considering it.

Recovery

In the recovery phase, the wall building company hires more people and start to resume building walls. They start to make enough income and start to think of ways they can make their business even more efficient.

My neighbour makes enough money to the point where he can start to buy a new car. He also looks at making some investments to build his wealth. He resumes paying his unemployment insurance because he knows the importance of having the insurance in the future when he might need it again. 

Prosperity

The prosperity phase means that the wall-building company is thriving. They have enough money to invest in new technology which will increase their production output by at least twice as much. They start to expand into other industries such as painting walls instead of just building them. They hire more and more workers and even import other types of bricks so that their customers can have a wider array to choose from.

My neighbour can afford to build the wall and even ask them to paint the wall. He diversified his investment portfolio and even bought a new car for his wife. He has never been happier and really enjoys not having to worry about his finances. The only thing worrying him is the ever-increasing prices because of the high inflation.

In conclusion:

During the different phase of the business cycle, people and businesses will shift the way they go about handling their finances. In the expansion times of the business cycle, they will spend and invest more and make preservations for the future. During the contraction phase of the business cycle, they will spend less money on non-esential goods and focus on the things that matter. Businesses will also have fewer people employed because they can't afford to pay their salaries.

By looking at the different economic concepts with an easy to understand example you better grasp how the whole picture falls in place. I try to explain the concepts with the brick wall theory in order to make economics fun and practical.

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