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What Is the Role of the Business Cycle in Economics?

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  • Written By: Osmand Vitez
  • Edited By: PJP Schroeder
  • Last Modified Date: 10 December 2016
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The business cycle is a period of stages that starts with growth and peak and runs through contraction, trough, and recovery. The role of the business cycle in economics is to help private sector companies and governments understand how to make decisions. For example, the growth stage often leads to higher production output. This decision and others need input from the external economy. Governments often use the role of the business cycle in economics to drive tax and spending decisions in order to maintain economic growth.

Business cycles are common occurrences in free markets. While once thought to be an unnatural or fairly uncommon occurrence, economists have learned that business cycles occur for different reasons at different times and in various manners. As an external force, it is difficult for private sector companies and the government to know what stage of the business cycle is occurring. That is why the role of the business cycle in economics is important. Learning and studying past cycles allow each group to understand what to expect in future cycles.

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Understanding business cycles and how they work allows private sector companies to invest operations into other countries. Therefore, the business cycle in economics applies to other economies outside of the company’s home country. In many cases, free markets and the business cycle allow companies to increase profits through the study of economics. Economic studies require constant review in order to stay prevalent in the market. Knowing when to exit a market prior to a decline is key to preserving profits.

The role of the business cycle in economics also plays a part in government policy decisions. During growth and peak economic times — where private sector companies and individuals typically make the most money — a government may alter tax policies. For example, it is often tempting to increase taxes in order to achieve higher government revenues. During contraction and trough economic periods, tax breaks and other rollbacks of government regulations can help the free market recover. In more government-led economies, a contraction or trough may result in more spending in order to jump-start the economy, per Keynesian economic theory.

Fluctuations in an economy should not be fearful times. A common term applied to the contraction and trough periods of the business cycle is destructive capitalism. The role of the business cycle in economics here is to rid the economy of poor-performing companies. Old, inefficient, and weak companies tend to liquidate or merge with stronger organizations. Once the economy begins to grow, the new companies will be stronger and more beneficial to the overall economy.

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ZipLine
Post 3

@ysmina-- I don't agree with this. Economic analysts can make predictions about the economy by looking at many different factors. There are certain changes that take place during different stages of the business cycle. These changes can be warning signs about an upcoming recession and precautions can definitely be taken.

For example, during economic growth and boom, inflation increases. This can be a sign to economists that the economy is reaching a peak and may experience a downturn soon after. Similarly, during a boom, employment increases.

If on the other hand prices are high, GDP is low and unemployment is increasing, this shows that the economy is stagnant and may experience a recession.

Economists and policymakers can use this information and adjust things like interest rates, government spending and taxes to prevent an economy from worsening.

ysmina
Post 2

@fBoyle-- That's true. If economist and policymakers have a hard time knowing which stage of the business cycle we're in, then it's not of much use to them anyway.

fBoyle
Post 1

I don't think that the role of the business cycle is to help the government or companies make decisions. Whether the government and companies pay attention to the business cycle and take advantage of the data for their benefit or not, this cycle exists. The business cycle is what occurs in every national economy. It also occurs in the economy of a small business. It's the natural byproduct of a free market economy.

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