economic cycle

Economies tend to have periodic expansion and contraction {economic cycle}|.

multiplicative effects

Economies cannot expand at optimum moderate rate, because expansion tends to cause more expansion, and contraction tends to cause more contraction. See Figure 1.

multiplicative effects: contraction

If economy starts to contract, people become more pessimistic. They try to save money and spend less. Demand goes down, and economy contracts more. Economic cycle is on downward curve and goes toward recession.

However, lower demand makes prices lower. Lower demand for money makes interest rates lower and money cheaper. People have saved money. Eventually, lower prices make demand increase. Lower interest rate makes saving less attractive. People can no longer postpone buying things that have worn out. People start to save less and spend more. Recession ends. Economic cycle is at downward-curve bottom.

multiplicative effects: expansion

If economy starts to expand, people become more optimistic. They spend more money and save less. Demand goes up, and economy expands more. Economic cycle is on upward curve and goes toward expansion.

However, higher demand makes prices higher. Higher demand for money makes interest rates higher and money more expensive. People have little saved money. Eventually, higher prices make demand decrease. Higher interest rate makes saving more attractive. People already have everything they need and can postpone buying things. People start to spend less and save more. Expansion ends. Economic cycle is at upward-curve top.

cycle period

If expectation changes are rapid, economic-cycle period is short. See Figure 2.

cycle amplitude

If expectation changes are large, economic-cycle amplitude is high. See Figure 3.

efficiency

For maximum efficiency, economy can minimize economic fluctuations and maintain stable business conditions. Demand and supply can balance, so prices reflect real value, not expectations about the future. Efficient economic cycles have long periods and small amplitudes. See Figure 4.

National government can dampen economic-cycle amplitudes and lengthen economic-cycle periods. During expansion, government can tax more and spend less to decrease demand. During contraction, government can tax less and spend more to increase demand. Taxation and spending rates can depend on previous economic cycles.

equilibrium

Economy is in equilibrium {equilibrium, economy} if total spending equals total costs, because prices equal costs. Economy is in equilibrium if personal savings equal business investment, plus government purchases, minus taxes, plus exports, minus imports {national income identity, cycle}, because consumption equals output. Gross national product (GNP) is in equilibrium if planned expenditures equal present output, with no excess demand or supply. Economy can be at equilibrium, but not at full employment, when demand is unequal to output.