What is a business cycle? Describe the different phases of a business cycle. | Managerial Economics Notes

What is a business cycle? Describe the different phases of a business cycle. | Managerial Economics Notes

Answer:
The term business cycle refers to a wave like fluctuation in the over all level  of  economic  activity  particularly  in  national  output,  income, employment  and  prices  that  occur  in  a  more  or  less  regular time sequence. 

 

It is nothing but rhythmic fluctuations in the aggregate level of economic activity of a nation.

According to Prof. Haberler, “The business cycle in the general sense may be defined as an alternation of periods of prosperity and  depression  of  good  and  bad  trade”.

 
 In  the  words  of  Prof.  Gordon, “Business  cycles  consists  of  recurring  alternations  of  expansion  and contraction  in  aggregate  economic  activity,  the  alternating  movements  in each direction being self-  reinforcing and pervading  virtually all parts of the economy”.

According to  Keynes  “A  trade  cycle  is  composed  of  periods  of good  trade  characterized  by  rising  prices  and  low  unemployment percentages,  alternating  with  periods  of  bad  trade  characterized  by  falling prices  and  high  unemployment  percentages.”

Thus,  one  can  notice  a common feature in all these definitions, i.e., variations in the aggregate level of economic activities in different magnitudes.

Different phases of business cycle:

There are five phases of a business cycle  –  Depression, recovery, full employment, boom and recession.

1.  Depression, contraction or downswing

It  is  the  first  phase  of  a  trade  cycle.  It  is  a  protracted  period  in  which business  activity  is  far  below  the  normal  level  and  is  extremely  low.

According to Prof. Haberler depression is a “state of affairs in which the real income  consumed  or  volume  of  production  per  head  and  the  rate  of employment are falling and are sub-normal in the sense that there are idle resources and unused capacity, especially unused labor”.

2.  Recovery or revival

Depression cannot last long, forever. After a period of depression, recovery starts.  It  is  a  period  where  in,  economic  activities  receive  stimulus  and recover from the shocks. This is the lower turning point from depression to revival towards upswing. Depression carries with itself the seeds of its own
recovery. After sometime, the rays of hope appear on the business horizon.

Pessimism  is  slowly  replaced  by  optimism.  Recovery  helps  to  restore  the confidence  of  the  business  people  and  create  a  favorable  climate  for business ventures.

3.  Prosperity or Full-employment

The recovery once started gathers momentum. The cumulative process of recovery  continues  till  the  economy  reaches  full  employment.  Full employment may be defined as a situation where in all available resources are  fully  employed  at  the  current  wage  rate.  

 

Hence,  achieving  full employment  has  become  the  most  important  objective  of  all  most  all economies. Now, there is all round stability in output, wages, prices, income,etc.

4.  Boom or Over full Employment or Inflation

The prosperity phase does not stop at full employment. It gives way to the emergence of a boom.  It is a phase where in there will be an artificial and temporary prosperity in an economy.  

 

Business optimism stimulates further  investment  leading  to  rapid  expansion  in  all  spheres  of  business activities during the stage of full employment, unutilized capacity gradually disappears. Idle resources are fully employed. 

 

Hence, rise in investment can  only  mean  increased  pressure  for  the  available  men  and  materials.

5.  Recession –  A turn from prosperity to Depression

The period of recession begins when the phase of prosperity ends.  It is a period of time where in the aggregate level of economic activity starts declining. There is contraction or slowing down of business activities.

After reaching the peak point, demand for goods decline. Over investment and production creates imbalance between supply and demand. 

 

Inventories of  finished  goods  pile  up.  

 

Future  investment  plans  are  given  up.   

 

Orders placed  for  new  equipments  and  raw  materials  and  other  inputs  are cancelled. Replacement of worn out capital is postponed. 

 

The cancellation of orders for the inputs by the producers of consumer goods creates a chain reaction  in  the  input  market.   

 

Incomes  of  the  factor  inputs  decline  this creates demand recession. In order to get rid of their high inventories, and to  clear  off  their  bank  obligations,  producers  reduce  market  prices.  

 

In anticipation  of  further  fall  in  prices,  consumers  postpone  their  purchases.

Production schedules by firms are curtailed and workers are laid-off. Banks curtail credit. Share prices decline and there will be slackness in stock and financial  market.  

 

Consequently,  there  will  be  a  decline  in  investment, employment,  income  and  consumption.  Liquidity  preference  suddenly develops.  

 

Multiplier  and  accelerator  work  in  the  reverse  direction.

Unemployment sets in the capital goods industries and with the passage of time,  it  spreads  to  other  industries  also.  The  process  of  recession  is complete. The wave of pessimism gets transmitted to other sectors of the economy. 

 

The whole economic system thereby runs in to a crisis.