So now, let's discuss the timeline of an economy as a whole as it goes through what we call the business cycle. A business cycle is not necessarily a set duration and can last any number of years. The different sections of the cycle are based on the increases and decreases in economic activity that occur during that time. The best way to understand the business cycle and to get our key definitions down is to check it out on a graph. Let's check out this graph right here. Notice on our y-axis, we have employment or production. Generally, when we talk about how well an economy is doing, we're going to say, how much production they have. As production increases, that's a good thing for the economy, just like employment. As more of the citizens are employed, well, that's a good thing. Less employment, meaning more unemployment, less citizens employed, that suggests a downturn, right? Let's go ahead and go through these key definitions of the business cycle and check out these different points on the graph. What we have here is a level of employment or level of production on that y-axis, and on this x-axis, we're talking about time. As time passes, observe at different points in time how much production there is in the economy or what the level of employment is, right? That's how we're going to gauge how well the economy is doing.
Notice how we start here on an increase. We're going through an increase and we reach this point, which is at the very top, and guess what we call that top point? We call that point the peak. We've got several peaks here. We've got a peak there, and then the line starts to fall again, and then it goes up, and we reach another peak up here. So, we've got 2 peaks on this graph. And then after the peak, we go through a period of decline. See how the production starts to decline here after the peaks? We call these sections of the business cycle recessions, which are indicated here in this light purple on the graph. A recession is when production is decreasing over time. After we go through this period of decrease, we're going to bottom out. At the end of the recession, we hit the very bottom. Notice we've got a couple of points here where we hit rock bottom, and we call that the trough, so that's the very bottom. It's the opposite of a peak. The peak marks the very top where we head into a recession, and then we hit the bottom, the trough, and then we come back up. What happens while we're coming back up? We're experiencing what's called an expansion. I'll do that in a different color here. As we're going up, we're going through an expansion. These are the 4 key terms when we talk about the business cycle: the peak, the trough, the recession, and the expansion.
Let's go ahead and lay out some formal definitions down here. We're going to follow the order. Starting with a recession, hitting a trough, going through an expansion, getting to a peak, and then it cycles back around into a recession again. This is basically how the business cycle unfolds. The recession, it's a periodic period of economic downturn when employment and production decrease, as observed on the graph. This downturn is sometimes referred to as a contraction of the economy; contraction and recession are interchangeable terms. After the recession comes the trough, the rock bottom for that business cycle, marking the point where the economy turns from recession to expansion. During the expansion, a periodic period of economic upturn, both employment and production increase, as illustrated on the graph. Sometimes expansions are also referred to as recoveries, indicating the economy is recovering from the recession. Finally, we reach a peak, which is the point where we turn from expansion back into a recession. We've covered the key definitions here: the recession leads to the trough, then we expand through the expansion, hit a peak, and repeat – recession, trough, expansion, peak.
This cycle keeps revolving in this manner and gives rise to the definitions we use in discussing economic conditions. Let's take a quick pause right now, and we'll do a practice problem related to business cycles.
