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Most of the nations of the world today have a free economy A free economy is one which operates automatically However this automatic regulation of the economy is actually achieved by the price level Price level can be defined as the weighted average of all the final goods and services produced in an economy A healthy economy is characterized by a stable price level Fluctuations in price level affect the economys real domestic output RDO unemployment and its growth A high increase in price level can bring down a nations output by affecting the aggregate demand It will lower total spending and increase the unemployment level Similarly a decrease in price level will increase the real income of the masses investment will increase and unemployment will fall This decrease and increase in price level along with the fluctuations in unemployment interest rates and output forms the business cycle that characterizes all market economies The BUSINESS CYCLE is an irregular and non-repeating up-and-down movement of business activity that takes place around a generally rising trend and that shows great diversity It is also sometimes referred to as a trade cycle A trade cycle can be Kitchin 3-4 years Medium Term 7-11 years or Long-run 50-55 years The picture below illustrates a framework in which business cycle theories were often constructed Starting at point T the economy grew very rapidly in a self-feeding growth Because of this self-feeding process the economy would develop momentum Once started growth would continue until the system hit a limit or boundary that would stop it The economy would then turn around and enter a contraction that was also self-feeding This downswing would continue until a lower boundary was encountered which would stop the contraction and start a new upswing ie expansion Notice that the 2nd swing is always at a higher rate and the economy is never in equilibrium but perpetually adjusting Typically a business cycle is divided in
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