TRADE CYCLE OR

BUSINESS CYCLE
BY: MARIAM & KHOOSHI
What is a Business Cycle?

A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP)

around its long-term natural growth rate. It explains the expansion and contraction
in economic activity that an economy experiences over time.
The economic trade cycle shows how economic growth can fluctuate within
different phases, for example:

● Boom (which is a period of high economic growth possibly causing

inflation)
● Peak (top of trade cycle, where growth rates may start to fall)
● Economic downturn/Recession ( where the growth rate falls and may
become negative – leading to a fall in national output)
● Economic recovery (economic growth becomes positive and growth rates
pick up.
Causes of economic trade cycle

1. Momentum effect. When there is positive economic growth, this tends to cause:
○ A rise in consumer and business confidence
○ With economic growth, banks are more willing to lend, increasing
investment.
○ Rising asset prices such as houses; this causes a rise in wealth and
consumer spending. The higher economic growth increases incomes and
causes more demand for housing
○ Accelerator theory of investment. This suggests investment depends on
the rate of change of economic growth. An improved growth rate leads to
higher investment.
2) Interest rate changes. When there is higher economic growth, inflation tends to rise. In response,
Central Banks tend to increase interest rates to reduce growth and inflation. High-interest rates in 1990-92
were an important cause of bringing the economic downturn. High-interest rates made mortgages
expensive, reducing disposable income and causing a rise in home-repossession rates.

3) Technology. Improvements in technology may cause a boost in economic growth. A lull in technological
innovation may cause slower growth.

4) Political Business cycle. Some economists suggest that there is a political business cycle. This is
when politicians try to have a boom (high economic growth) before an election to help win the election.
Since 1997, UK monetary policy has been given to the independent Bank of England with a remit of
keeping inflation at 2%

5) Global Trade Cycle. A global economic downturn will tend to affect individual economies. The recession
of 2008/09 occurred in all major global economies
 Boom
A boom is a period of rapid economic expansion resulting in higher GDP, lower unemployment, a
higher inflation rate and rising asset prices.

Booms usually suggest the economy is overheating creating a positive output gap and inflationary
pressures

A boom suggests the economy is growing at a faster rate than the long-run trend rate of economic
growth.

Economic booms tend to be unsustainable and are often followed by a bust – an economic recession
or downturn. Hence the phrase “Boom and Bust”.

Monetary policy tries to avoid boom and busts by moderating the economic cycle – e.g. if growth is
too fast, the Central bank will increase interest rates to moderate inflationary pressures.
.
Potential causes of economic booms

1. Expansionary monetary policy. If the economy is growing close to the long-run trend rate and
monetary policy is loosened (cut in interest rates). This will further increase demand in the economy.
The lower costs of borrowing will encourage investment and consumer spending. This will cause a
further rise in aggregate demand. Lower interest rates will also make it more attractive to take out a
mortgage and buy a house.
2. Expansionary fiscal policy. If the economy is getting close to full capacity and the government cut
taxes – financed by higher borrowing, then this will have the effect of boosting consumer spending
and aggregate demand.
3. Confidence. If consumers and firms are confident – then they are more likely to borrow to finance
investment and spending. This can cause a fall in the savings ratio and encourage a higher
percentage of income to be spent.
4. Rising asset prices. Rising asset prices, such as housing and stocks create a positive wealth effect.
This increases confidence and also the ability to remortgage to gain equity withdrawal. Higher growth,
rising prices and high confidence also causes a feedback loop to put upward pressure on asset prices
to continue to rise. This enthusiasm for buying assets which are rising in value – can become
divorced from an underlying valuation. It is something economists can refer to as irrational
exuberance.
5.
Recession
The recession is the stage that follows the peak phase. The demand for
goods and services starts declining rapidly and steadily in this phase.
Producers do not notice the decrease in demand instantly and go on
producing, which creates a situation of excess supply in the market. Prices
tend to fall. All positive economic indicators such as income, output, wages,
etc., consequently start to fall.

There are, however, characteristics that most recessions have in common:

High interest rates, high inflation, or both. High interest rates limit the amount
of money available to borrow and can signal the beginning of a recession.
During a recession, economic activity slows, wages drop, and unemployment
rises. Eventually, the economy will begin to stabilize and enter the trough period
before beginning the next expansion. In a healthy economy, expansions are the
norm with recessions being short and infrequent.
Slump
A slump refers to a period of poor performance or inactivity in an economy,
market, or industry. Within an economy, slumps can be precursors to an oncoming
recession. Stock market slumps result in lower share prices and trading volumes,
creating an opportunity for contrarians and value investors to buy further.
many business failures include; rapidly rising unemployment; prices may start
falling (deflation)
In economic terms, slump usually refers to the beginning of a recession. A
recession is not officially declared until several months of declining activity have
passed, so the months leading up to the declaration of recession are simply
described as a prolonged economic slump.
GROWTH
growth (increases in gross domestic product (GDP)) may appear to be
unambiguously good because income can only rise over time if output rises.

In the growth phase, companies experience rapid sales growth. As sales increase
rapidly, businesses start seeing profit once they pass the break-even point.
However, as the profit cycle still lags behind the sales cycle, the profit level is not
as high as sales.