Business cycles occur when economic activity speeds up or slows down. More precisely, we define a business cycle as follows: A business cycle is a swing in total national output, income, and employment, usually lasting for a period of 2 to 10 years, marked by widespread expansion or contraction in most sectors of the economy.

Typically economists divide business cycles into two main phases, recession and expansions. Peaks and troughs mark the turning points of the cycles. The downturn of a business cycle is called a recession, which is often defined as a period in which real GDP declines for at least 2 consecutive quarters. A recession begins at a peak and ends at a trough.

A depression is a prolonged period characterized by high unemployment, low output and investment, depressed business confidence, falling prices, and widespread business failures.

The following are a few of the customary characteristics of a recession.

• Often, consumer purchase decline sharply while business inventories of automobiles, and other durable goods increase unexpectedly. As businesses react by curbing production, real GDP falls. Shortly, afterward, business investment in plant and equipment also falls sharply.
• The demand for labour falls first seen in a drop in the average workweek, followed by layoffs and higher unemployment.
• As output falls, inflation slows. As demand for crude materials declines, their prices tumble. Wages and prices of services are unlikely to decline, but they tend to rise less rapidly in economic downturns, and may result in Cost Push Inflation.
• Business profits fall sharply in recessions. In anticipation of this, common-stock prices usually fall as investors sniff the scent of a business downturn. However, because the demand for credit falls, interest rates generally also fall in recessions.

We have spoken in terms of recessions. Expansions are the mirror image of recessions, with each of the above factors operating in the opposite direction.

EXTRA NOTES on Business Cycles

Recession? Depression? What's the difference?
Part 1: What's a recession? How do we know if we're in one?
Theres an old joke among economists that states: A recession is when your neighbor loses his job. A depression is when you lose your job. The difference between the two terms is not very well understood for one simple reason: There isn't a universally agreed upon definition. If you ask 100 different economists to define the terms recession and depression, youd get at least 100 different answers. I'll try to summarize both terms and explain the differences between them in a way that almost all economists could agree with. Recession: The Newspaper Definition The standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters. This definition is unpopular with most economists for two main reasons. First, this definition does not take into consideration changes in other variables. For example this definition ignores any changes in the unemployment rate or consumer confidence. Second, by using quarterly data this definition makes it difficult to pinpoint when a recession begins or ends. This means that a recession that lasts ten months or less may go undetected. Recession: The BCDC Definition: The Business Cycle Dating Committee at the National Bureau of Economic Research (NBER) USA provides a better way to find out if there is a recession is taking place. This committee determines the amount of business activity in the economy by looking at things like employment, industrial production, real income and wholesale-retail sales. They define a recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out. When the business activity starts to rise again its called an expansionary period. By this definition, the average recession lasts about a year.

Recession? Depression? What's the difference?
Part 2: If you thought the last definition was imprecise...
Depression The simple definition of a depression is a recession that lasts longer and has a larger decline in business activity. The Difference: So how can we tell the difference between a recession and a depression? A good rule of thumb for determining the difference between a recession and a depression is to look at the changes in GNP. A depression is any economic downturn where real GDP declines by more than 10 percent. A recession is an economic downturn that is less severe. Now you should be able to determine the difference between a recession and a depression without resorting to the poor humor of the dismal scientists.

There are 4 kinds of employment:

1. Frictional unemployment arises because of the incessant movement of people between regions and jobs or through different stages of the life cycle. Even if an economy were at full employment, there would always be some turnover as students search for jobs when they graduate fro school or women reenter the labour force after having children. "Because frictionally unemployed workers are often moving between jobs, or looking for better jobs, it is often thought that they are voluntarily unemployed.
2. Structural unemployment signifies a mismatch between the supply and the demand for workers. Mismatches can occur because the demand for one kind of labour is rising while the demand for another kind is falling, and supplies do not quickly adjust. We often see structural imbalances across occupations or regions as certain sectors grow while other decline.
3. Cyclical unemployment exists when the overall demand for labour is low. As total spending and output fall, unemployment rises virtually everywhere.
4. Seasonal unemployment results because of fluctuations occurring in the demand and supply of labour during seasonal changes.

The distinction between cyclical and other kinds of joblessness helps economists diagnose the general health of the labour market. High levels of frictional or structural unemployment can occur even though the overall labour market is in balance, for example when turnover is high or when geographical imbalances are large. Cyclical unemployment occurs during recessions, when employment falls or a result of an imbalance between aggregate supply and demand.

There is a clear connection between movements in output and the unemployment rate over the business cycle. According to Okun's Law, for every 2 percent that actual GDP declines relative to potential GDP, the unemployment rate rises 1 percentage point. This rule is useful in translating cyclical movements of GDP into their effects on unemployment.

The government gathers monthly statistics on unemployment, employment, and the labour force in a sample survey of the population. People with jobs are categorized as employed people without jobs who are looking for work are said to be unemployed; people without jobs who are not looking for work are considered outside the labour force.

As of 30 July 2003, the total labour force in Malaysia is 10,258,900; those employed is 9,870,600; and those unemployed is 388,300 [Statistics Department, Malaysia].