Fundamental elements of the economy:(1)

1. The Basic Concept

The performance of an investment will be influenced by the economy. The effects of inflation or deflation may interfere with anticipated returns. Thus, the direction of the economy must be considered when formulating an investment strategy.

A. The Business Cycle

The business cycle represents changes in economic activity. It has four phases: expansion (also called recovery), peak, recession (also call contraction), and trough.

In the expansion phase, business activity is growing, production and demand are increasing, and employment is expanding. Businesses and consumers normally borrow money to expand, which causes interest rates to rise.

B. Inflation

As the cycle moves into the peak, demand for goods overtakes supply and prices rise. This creates inflation. During inflationary times, there is too much money chasing more for their items causing prices to rise. This, in turn, reduces the purchasing power of the consumer.

As prices rise, demand slackens which causes economic activity to decrease. The cycle then enters the recessionary phase.

C. Deflation

As business activity contracts, employers lay off workers and demand slackens. Usually, this cause prices to fall creating deflation. The cycle enters the trough. Deflation is the persistent and appreciable fall in the general level of prices. Eventually, lower prices will stimulate demand and the economy moves into the next cycles, expansion.