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Economic cycle - definition, phases & effects

Economic cycle - an overview

Definition: Model that shows the links between economic agents in an understandable way; builds understanding of the interrelationships of an economy based on the division of labor

Economic entities: Also aggregate variables that trade with one another, differentiation between private households, foreign countries, companies, the state and banks

Types of circuits: Closed and open economic cycle

Types of representations: Difference between simple, expanded, complete and open representation of the cycle, the difference arises from the different inclusion of the aggregate sizes

Definition: what is an economic cycle?

The economy has become one over the years Braid developed which one from different economic entities consists. The state deals with companies, companies in turn deal with banks, banks with private individuals, and so on. Both money and goods flow. Transfer payments have to be made for these exchanges, and the public sector may grant individual companies or branches of industry subsidies. So it can be said that everyone is dependent on everyone.

The Economic cycle is a model that the Schematically depicts connections between economic agents that are understandable for everyoneto better understand the interrelationships of an economy based on the division of labor.

These so-called "aggregate sizes" include:

  • Private households
  • foreign countries
  • Companies
  • Country
  • Banks ("capital collection points")

The founder of the circulatory analysis is John Maynard Keynes. He developed this instrument based on the Experiences of the Great Depression in the 1920s and used it to analyze macroeconomic problems. But John Maynard Keynes was not the first to look at the economic cycle. Already in 18th century The French economist François Quesnay used this model to show how goods and money relate to individual economic subjects.

The circulatory analysis reduces the various business and exchange relationships, which are maintained together in an economy, to a few, manageable sizes. So it can be said that they are a economic Model is. In addition, various assumptions are made for the model of the economic cycle, which sometimes seem more, sometimes less, logical. They are important in defining the model.

The assumptions include:

  • Economics: The question here is which one room depicts the economic cycle. The space is that in which the economic agents Focus of their economic employment exercise or where they areresidence to have. The economy in itself is as inland defines what distinguishes it from the world economy.
  • Unit sizes: As mentioned above, a distinction is made between the aggregate sizes of private households, foreign countries, companies and the state. This results in the abbreviation in the economic model "HOUSE". The Banks ("Capital collection points") are mostly called independent sector considered. By breaking it down into aggregate sizes, the many different economic processes, such as household consumption, can be summarized. Depending on which unit sizes are included, different cycle models are created.
  • Economic objects: These include goods, services, rights and patents.
  • Economic activities: This means the production and use of Goods, Obtaining and using income as well as the formation of Assets - "flows of money" and "flows of goods"

In the case of economic subjects, a distinction must also be made between performance and financial transactions as transfer payments. A Performance transactionchanges the amount of financial wealth of economic agents (e.g. the purchase of goods). Under one Financial transaction one understands, how the financial wealth of economic agentscomposed. A financial transaction includes taking out a loan, for example.

As mentioned above, there are different cycle models, depending on which economic agents are involved. Such a model is also called macroeconomic model. In general, a distinction is made between four different variants when depicting the economic cycle.

These four forms of representation of the economic cycle are:

  • The two-sector model: Also called the simple economic cycle. This is understood to mean a closed economy households and businessesbut without banks or the state.
  • The three-sector model + banks: Also called the extended economic cycle. It behaves like the two-sector model, but with the inclusion of the Banking sector.
  • The four-sector model:Also called the complete economic cycle. This also means a closed economy, however with the state and banks.
  • The five sector model: This is the cycle of an open economy with State, banks and abroad.

The representation of the cycles can graphically or by means of a system of equations respectively. The latter is mainly used for in-depth analyzes. There is also the option of displaying accounts, which acts as the basis for the national accounts.

Nevertheless, they have the fact that the economic cycles are designed differently two similarities. These include the poles and the currents. The Poles are understood to mean the different Aggregates. They represent the starting and ending points of the streams. The streams are those period-related quantitieswhich are recorded in the cycle. They are valued in monetary units.

A wide variety of economic processes exist within each state. Consumers (private households) receive money from their employers (companies), which they exchange for goods or services or save in their savings books or accounts. This creates flows of money and goods as well as transfer payments. Here is betweenclosed and open economic cycles differentiated.

What is a closed economic cycle?

The closed economic cycle is that most common model. Two to five of the aggregate sizes can be included in the representation. It is a closed economic cycle if all the inflows that flow to an actor correspond to the outflows.

For a better understanding, an example with only two protagonists is used in the following: private households (mostly employees) and companies. In this model, which is also called "Simple economic cycle" is referred to, households provide the first Factors of production (Labor, land and capital) are available to the companies from which the goods are then produced.

Private households receive the flow of money for this Reward from the company. Private households then use this remuneration completely to everyone to consume manufactured goods. This leads to the cycle being closed again.

In reality, however, private households do not consume the entire wage, but rather save a part. The same applies to companies that also make investments. The extended economic cycle therefore still contains the actor Banks (“Capital collection points”), which means that three of the five protagonists are now included in the model.

This gives private households the opportunity to save and receive interest in return. In contrast, the banks give the companies a loan with an interest rate, which closes the cycle again. The prerequisite for this cycle is that the The savings amount corresponds to the investment amount.

If companies and households each pay one monetary unit to the banks, a total of two monetary units are withdrawn from the cycle. If the banks only pass one monetary unit on to the companies as a loan, one monetary unit has been withdrawn from the cycle. In order to the inflows do not correspond to the outflows and the cycle is not closed. Then it's one open economic cycle.


The closed cycle is the most common model of the economic cycle. In a closed circuit, the sum of the inflows must always correspond to the sum of the outflows.

What is an open economic cycle?

With an open economic cycle, which too Involves actors outside of its own economic cycle, for example, can be quickly imported and exported Imbalance of inflows and outflows arise. This results in the openness of the cycle.

As mentioned earlier, the closed form is mostly used when depicting an economic cycle. Another example is used to better understand how an open economic cycle works: A private household receives 20 monetary units as a salary payment from the company. If it were a closed economic cycle, these 20 units would have to flow out of the private household.

For example, 15 units could flow back to the companies in the purchase of goods and services. The remaining 5 units, however, are saved at the bank. If this is not the case, however, and a monetary unit is retained by the household, it is called aopen economic cycle.

In order to formulate the example more precisely and to make it easier to understand, the household is represented by Peter Weber, who works as an employee in a supermarket. He works at an hourly wage of € 10 per month in 150 hours, so earns € 1,500. Because the factor “State” does not exist in this examplehe does not have to pay any taxes on this wage.

In order to be able to maintain a closed economic cycle, Mr. Weber has to spend this € 1,500 in full again. He pays € 900 rent (including ancillary costs) and € 100 is invested in landlines, mobile phones and the Internet. Furthermore, Mr. Weber spends € 400 per month on groceries, the remaining € 100 is spent on clothing and hygiene products. Since Mr. Weber through the absence of the “banks” factor has no way of saving money, the economic cycle will remain closed.

Would the supermarket now import goods worth € 500 and could not sell completely, € 500 have gone abroad from the economic cycle, but some of the foreign goods remain in stock. As a result, the model would no longer be closed, it is an open cycle.


The open circuit is less common than the closed circuit. In an open economic cycle, the sum of the inflows does not correspond to the sum of the outflows.

What are the consequences of a non-closed economic cycle?

It is assumed that in the previous example there was not enough demand for loans to finance investments. This can put a damper on the economy. Thus, companies may need to have their Cut costs and therefore often pay lower wages. This in turn leads to a lower consumption of goods, which reduces the Economic output is decreasing.

Will now be added to the economic cycle foreign countries included and more funds flow from abroad to the domestic marketExport surplus. This surplus can then lead to inflation domestically, but it can also cause insolvency abroad in the long term. But that can be done by, for example counteracted higher imports become.

Simple economic cycle

If you look at all 5 economic operators in one model, it becomes very complex. Therefore, the simple economic cycle, which is also calledsmall economic cycle only that is referred tohouseholds and businesses with a. The influence of the state, banks and foreign countries is initially left out. That is why the small economic cycle closed to external influences and homogeneous in itself.

As a rule, the simple form is sufficient to depict an economy, since it represents a market in which goods are traded. So there is supply from businesses and demand from households. Both protagonists can also take on the other role.This is because there are two different types of markets:

  • Goods markets: The goods produced are sold here.
  • Factor markets: This is about the factors with which the goods are produced. These include capital, land and labor.

With the production factor "Job" Above all, households offer businesses theirs Worker that is necessary to manufacture a product. The second production factor "Capital" contains among other things the importantPhysical capitalsuch as buildings, machines and tools. Without this physical capital, no products can be manufactured. The third production factor "Ground" contains all relevant raw materialsthat the companies receive from the households in return for a rent.

Because there are two different markets in the economy, there are also two cycles or streams that uniformly describe the relationships between the sectors. These two cycles ("exchange processes") are:

  • Money cycle: The focus here is on the bill Amount of money x velocity of circulation. The flow of money consists of the income and consumption expenditure of households, as well as the income and expenditure of entrepreneurs.
  • Goods cycle: This is about the bill Prices x transactions. In the flow of goods, goods flow from companies to consumers and production factors from households to companies.

In the simple cycle, households provide companies with their own Worker to disposal. This allows the company Produce goods. The households receive a for the work done incomewhich they use to purchase necessary goods that have been produced by companies. So one comes back to the original statement, accordingly Households providers of work as well as consumers could be.


The connection between the exchange relationship is explained by the small cycle, but it does not correspond to the real and yet far more complex economic world. Therefore, the simple economic cycle is not ideally suited as an explanatory model for the exchange relationships.

Extended economic cycle

The extended economic cycle, which is also known as evolutionary or.dynamic economic cycle is based on the basic concept of the simple cycle. It also describes exchanges between private households and companies, but below Consideration of a third protagonist, the banks ("capital collection points").

The model assumes that households do not fully spend income on consumption, they save up also a part. This is where the importance of the capital market comes into play. He “administers” them, so to speaksavings of consumers and passes them on as loans to the companies with which they Investments can do.

The extended economic cycle is called closed referred to as the flows of money and goods correspond to each other in terms of value. The capital within the cycle therefore remains constant and the fundamental relationship applies Savings = investments.

As already mentioned, the banks have largely taken on the function of Transferring funds back and forthand if necessary. Distribute subsidies. But if the amount of the inflow and outflow does not match, then the cycle does not receive the entire capital back. Thus the investments do not correspond to the capital through saving. The economic output decreases and stagnation is the consequence.

For the evolutionary economic cycle, too, certain requirements be fulfilled. The economic area is closed here too, so foreign factors do not play a role. The influence of the state, for example through taxes or laws, is also excluded here.But since there are at least state influences in every economic area, the extended economic cycle is also incomplete and can therefore only be used rough figure be used.


In the extended economic cycle, the model of the simple cycle is supplemented by the “banks” factor. Even if this model corresponds more closely to reality due to the additional protagonist, it can only be understood as a rough reflection of reality due to the lack of the factors “state” and “foreign country”.

Complete economic cycle

Because an economy would not be complete without the state, the complete economic cycle takes the sector into account "Country". The state contains revenue, for example (but not only) through taxes, but also does expenditure.

The state can withdraw and return funds from the cycle in many ways. The revenues relate mainly to direct and indirect taxesthat affect workers, citizens and entrepreneurs. These include income tax, corporation tax, flat tax, tobacco tax and beer tax.

At the same time, the state leads the ereceived funds back as transfer payments to the households. For example, families receive child benefit and job seekers receive unemployment benefits. The state thus has a special role to play in an economy. On the one hand, only he is allowed to charge tax, on the other hand the state offers serviceswhich every citizen or private household sees as the responsibility of the state.

The state maintains the following relationships:

  • To the households: The state receives taxes and other levies from private households. This forms a direct source of income for him. The households in turn receive transfer payments from the state.
  • To the companies: The state also receives taxes from companies. On the other hand, it also grants companies subsidies and even appears as a consumer, as it often intervenes directly in market events through state purchases.
  • To the banks:The state has a budget through income and expenditure, which can show deficits or surpluses. The banks manage this budget by collecting surpluses and making them available to the credit market as government savings. The state itself can compensate for deficits by borrowing.

The state can intervene in the event of an imbalance in the flow of money in the banks. If the savings component outweighs the investments, the state can Take on debt and pay interest to the bank. This means that the banks can, among other things, service savings interest and the economic performance of the economy does not decrease.

But the cycle is not in any Imbalance in money flows, the state intervenes anyway and increases his debt, so money is withdrawn from the cycle. Borrowers or companies cannot borrow any further funds and thus carry out investments in property, plant and equipment. The Economics falter.


In the complete economic cycle, the extended model is supplemented by the “state” factor. It depicts a closed, complete economy.

What role do consumption and the market play in the economic cycle?

Not only private households, but also private organizations and the state consume. This includes private consumption all purchases of goods and services by private households and independent sole proprietorships. In addition to the private expenses of employees, pensioners, unemployed and entrepreneurs, the expenses of innkeepers and domestic freelancers are also recorded.

To this extent, goods also countdurable goodssuch as furniture in a restaurant or a worker's car. In contrast, there is also still Consumer spending by private organizations, i.e. from trade unions or churches, as well as those of the State. The latter includes all Serviceswhich the state itself offers on the market. Also count as well ongoing government costs, such as salaries for civil servants and teachers, to government consumer spending.

Consumption and income are inextricably linked. Because just as consumption influences the economy, that also decides disposable income on the amount of private consumer spending. Disposable means that of the income or the total income of the household, the Net taxes deducted become.

The more disposable income is available to the household, the more expenses does this for consumption. The distribution of consumer spending also changes: With higher incomes, relatively more is invested in luxury consumer goods, while less is invested in consumer goods that are necessary for life, such as clothing or food.

Economic cycle of an open economy

In the complete economic cycle, only 4 actors have been represented so far: private households, companies, banks and the state.

The economic cycle of an open economy, which is also known as large economic cycle now still contains the sector "Foreign countries", which has a significant influence on the domestic market. The most important factors are the export and the Import. Here goods and money are exchanged with other countries. Foreign money can also flow domestically in the form of income if, for example, B. the workplace is abroad and the place of residence is in Germany. The same applies to a cash outflow when foreigners work in Germany.

In addition to income from work, savings payments that flow from abroad to Germany can also be made. This is the case when someone has put their money in a foreign bank in order to get better interest income. Capital can also flow abroad from private households.

The "foreign country" factor maintains the following relationships:

  • To the companies: Import and export payments are made between foreign countries and companies. That part of the production that the companies cannot sell on the domestic market they export abroad. The other way around, goods from abroad can also be imported into Germany.
  • To the households: Factor income flows from abroad to domestic households, or vice versa. For a better understanding, one can imagine the wages that guest workers send abroad.
  • To the banks:From the above relationships, i.e. how foreign countries stand to households and companies, it emerges how the domestic world appears and stands in relation to foreign countries.

In the relationship between foreign countries and the banks, a distinction is made between a positive and a negative external contribution. At the positive external contribution (also: net export) are those Exports> Imports. That means money inland flows. At the negative external contribution (also: net import) are those Exports . That means that money abroad flows.

Of course, foreign countries also maintain relationships with the state, which are, however, in terms of quantity and negligible for the overall understanding of the model.


The cycle of an open economy includes all five protagonists, including the “foreign country” factor. It is therefore best suited to depict the exchange relationships of the business world as realistically as possible.

Consequences of an imbalance in the great economic cycle

In order for the great economic cycle to be in equilibrium, the Inflows and outflows within a sectorbalance. There is an imbalance as soon as the country has, for example, one Export surplus achieved. That means that more money flows into Germany than abroad.

Then domestic incomes will grow and private households can save more. However, the banks do not offer attractive interest rates and so the excess money flows into consumption. The companies consequently raise the prices of goods and it arises inflation. At the same time, however, also takes the Foreign solvencyas it piles up more and more liabilities.

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