Business Cycles.

Essay by wardahUniversity, Bachelor'sA-, November 2003

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Most of the nations of the world today have a free economy. A free economy is one which operates automatically. However, this automatic regulation of the economy is actually achieved by the price level. Price level can be defined as the weighted average of all the final goods and services produced in an economy. A healthy economy is characterized by a stable price level. Fluctuations in price level affect the economy's real domestic output (RDO), unemployment and its growth. A high increase in price level can bring down a nation's output by affecting the aggregate demand. It will lower total spending and increase the unemployment level. Similarly a decrease in price level will increase the real income of the masses, investment will increase and unemployment will fall. This decrease and increase in price level along with the fluctuations in unemployment, interest rates and output forms the business cycle that characterizes all market economies.

The BUSINESS CYCLE is an irregular and non-repeating up-and-down movement of business activity that takes place around a generally rising trend and that shows great diversity. It is also sometimes referred to as a trade cycle. A trade cycle can be Kitchin (3-4 years), Medium Term (7-11 years) or Long-run (50-55 years).

The picture below illustrates a framework in which business cycle theories were often constructed. Starting at point T, the economy grew very rapidly in a self-feeding growth. Because of this "self-feeding" process, the economy would develop momentum. Once started, growth would continue until the system hit a limit or boundary that would stop it. The economy would then turn around and enter a contraction that was also self-feeding. This downswing would continue until a lower boundary was encountered, which would stop the contraction and start a new upswing i.e. expansion. Notice that the 2nd swing...