Business Cycle Diagram

Kathleen Esposito
The ups and downs of the business cycle

The business cycle diagram is an easy way to illustrate how businesses work in a typical economy. It shows the economic peaks and valleys. While the cycle is more heavily scrutinized during times of recession, it's just as important to know how it works when business is booming. The diagram can be an important predictor of things to come, which garners the attention of both the consumer and the schooled economist.

Features of the Diagram

The diagram has an X axis that represents time and a Y axis that represents economic activity, usually in terms of changes in Gross Domestic Product (GDP). On the axis there are two lines, usually shown in different colors. One represents the actual ebb and flow of business and goes up and down in curves. The second line represents average growth and stays straight while gradually angling upwards. By looking at the diagram, people can foresee good times, or booms, as well as bad times, or recessions, but average growth usually stays pretty constant.

Phases of the Business Cycle

The curves on the diagram look almost like rolling hills, and are meant to represent the business cycle's phases. They go in the following order:

  1. Expansion One - This first trip up the hill, so to speak, occurs when growth begins.
  2. Peak- This is the highest point of the GDP before it enters into a contraction period. It is the "top of the hill."
  3. Contraction - The curve begins to head downward to signify slowed and eventually negative growth.
  4. Trough - This is the valley where the curve evens out again. It is where the GDP hits its lowest point.
  5. Expansion Two - Growth increases again, and the line heads back upward. Then the cycle repeats itself.

Sometimes the business cycle graph lines are further segmented into early and late growth and early and late recession. In these cases, the curved lines are labeled or drawn as dotted lines to delineate these areas.

Finding Examples of the Business Cycle Diagram

While there are a lot of websites that have images of business cycle charts, not all feature what most economists think of as the business cycle diagram. A few that do are:

  • Quickmba.com - Not only does it have a good image of the diagram, it also explains how growth is determined in the United States and gives some history on business cycle changes.
  • Investopedia.com - This site shows a diagram that outlines the business cycle when it goes through a significant recession. It also contains information on how recessions are determined from an economic researcher's standpoint.
  • Capmgt.com -- This site shows a diagram of the business cycle as it relates to the futures market. Note that it is about halfway down the page.

Considerations

The business cycle does not always follow the firm pattern signified in the diagram. It is just a guideline as to where things will be on average. Sometimes the peaks are steep and the valleys are shallow and sometimes it is vice versa. The current business cycle can have strong effect on the following things:

  • Consumer spending
  • Discretionary income
  • Technology stocks
  • Fuel prices
  • Transportation and energy costs
  • Utilities
  • Precious metals

This is why it is so important to economists. For consumers, the cycle can be harder to interpret. Some things to remember are that investing when the cycle is headed upwards can sometimes lead to a good payout in the future, while saving during downturns is often a better thing to do. To get specific advice, it's best to go to a certified financial planner or investment adviser.

Business Cycle Diagram