While each business is unique, the economy as a whole tends to ebb and flow in a predictable pattern. Economists refer to this pattern as the four phases of the business cycle. The amount of time it takes to pass through a phase can vary, but each phase will eventually come to pass. Although called by varying names, the four phases are often referred to as expansion, prosperity, contraction and recession. Each phase is characterized by specific traits.
The expansion or growth stage of the business cycle is marked by a strong economy. During this phase, people are making money and the demand for goods and services begins to increase. As a result of the increased demand for goods and services, the demand often begins to exceed the supply, which results in inflation, which is higher prices for goods and services.
The prosperity stage typically follows the expansion stage. As the economy continues to operate at full, or near to full, capacity, and prices for goods and services increase, workers tend to ask for raises. Consequently, wages also tend to rise during periods of prosperity. The costs associated with higher wages also translates into additional inflation as higher wages means a higher cost to produce goods and services.
A contraction, or decline, in the business phase marks the end of the expansion or prosperity phase. The economy can only sustain growth for so long before the inflationary results begin to have a negative effect on the economy. During the contraction phase, businesses start to decrease spending and cut costs related to production. Workers may face layoffs during the contraction phase of the business cycle as demand for goods and services begins to decrease.
A recession, sometimes referred to as a trough, is the phase of the business cycle that follows a contraction, during which time economic demand is substantially reduced. A serious recession is called a depression. During a recession, the decreased demand for goods and services results in an overall decreased gross domestic product level which, in turn, creates high levels of unemployment.