The Business Cycle

The Business Cycle is a term used in economics to designate changes in the economy. Ever since
the Industrial Revolution, the level of business activity in industrialized capitalist countries has
veered from high to low, taking the economy with it.
Phases of the Business Cycle
The timing of a cycle is not predictable, but its phases seem to be. Many economists cite
four phases - prosperity, liquidation, depression, and recovery - using the terms originally
developed by the American economist Wesley Mitchell, who devoted his career to studying
business cycles. During a period of prosperity, a rise in production becomes evident. Employment,
wages, and profits increase correspondingly. Business executives express their optimism through
investment to expand production. As the upswing continues, however, obstacles begin to occur
that impede further expansion. For example, production costs increase; shortages of raw materials
may further hamper production; interest rates rise; prices rise; and consumers react to increased
prices by buying less. As consumption starts to lag behind production, inventories accumulate,
causing a price decline. Manufacturers begin to retrench; workers are laid off. Such factors lead to
a period of liquidation. Business executives become pessimistic as prices and profits drop. Money
is hoarded, not invested. Production cutbacks and factory shutdowns occur. Unemployment
becomes widespread. A depression is in progress. Recovery from a depression may be initiated by
several factors, including a resurgence in consumer demand, the exhaustion of inventories, or
government action to stimulate the economy. Although generally slow and uneven at the start,
recovery soon gathers momentum. Prices rise more rapidly than costs. Employment increases,
providing some additional purchasing power. Investment in capital-goods industries expands. As
optimism pervades the economy, the desire to speculate on new business ventures returns. A new
cycle is under way. In fact, business cycles do not always behave as neatly as the model just given,
and no two cycles are alike. Business cycles vary considerably in severity and duration. Major and
minor cycles can occur, with varying spans. The most severe and widespread of all economic
depressions occurred in the 1930s. The Great Depression affected the United States first but
quickly spread to Western Europe. From 1933 to 1937 the United States began to recover from the
depression, but the economy declined again from 1937 to 1938, before regaining its normal level.
This decline was called a recession, a term that is now used in preference to liquidation. Real
economic recovery was not evident until early 1941.
Special Cycles
Apart from the traditional business cycle, specialized cycles sometimes occur in particular
industries. The building construction trade, for example, is believed to have cycles ranging from
16 to 20 years in length. Prolonged building slumps made two of the most severe American
depressions worse. On the other hand, an upswing in building construction has often helped to
stimulate recovery from a depression. Some economists believe that a long-range cycle, lasting for
about half a century, also occurs. Studies of economic trends during the 19th and early part of the
20th centuries were made by the Russian economist Nikolai Kondratieff. He examined the
behavior of wages, raw materials, production and consumption, exports, imports, and other
economic quantities in Great Britain and France. The data he collected and analyzed seemed to
establish the existence of long-range cycles. His "waves" of expansion and contraction fell into
three periods averaging 50 years each: 1792-1850, 1850-1896, and 1896-1940. Such studies,
however, are not conclusive.
Causes of Cycles
Economists did not try to determine the causes of business cycles until the increasing
severity of economic depressions became a major concern in the late 19th and early 20th centuries.
Two external factors that have been suggested as possible causes are sunspots and psychological
trends. The sunspot theory of the British economist William Jevons was once widely accepted.
According to Jevons, sunspots affect meteorological conditions. That is, during periods of
sunspots, weather conditions are often more severe. Jevons felt that sunspots affected the quantity
and quality of harvested crops; thus, they affected the economy. A psychological theory of
business cycles, formulated by the British economist Arthur Pigou, states that the optimism or
pessimism of business leaders may influence an economic trend. Some politicians have clearly
subscribed to this theory. During the early years of the Great Depression, for instance, President
Herbert Hoover tried to appear publicly optimistic about the inherent vigor of the American
economy, thus hoping to stimulate an upsurge. Several economic theories of the causes of business
cycles have been developed. According to the underconsumption theory, identified particularly
with the British economist John Hobson, inequality of income causes economic declines. The
market becomes glutted with goods because the poor cannot afford to buy, and the rich cannot
consume all they can afford. Consequently, the rich accumulate savings that are not reinvested in
production, because of insufficient demand for goods. This savings accumulation disrupts
economic equilibrium and begins a cycle of production cutbacks. The Austrian-American
economist Joseph Schumpeter, a proponent of the innovation theory, related upswings of the
business cycle to new inventions, which stimulate investment in capital-goods industries. Because
new inventions are developed unevenly, business conditions must alternately be expansive and
recessive. The Austrian-born economists Friedrich von Hayek and Ludwig von Mises subscribed
to the overinvestment theory. They suggested that instability is the logical consequence of
expanding production to the point where less efficient resources are drawn upon. Production costs
then rise, and, if these costs cannot be passed on to the consumer, the producer cuts back production
and lays off workers. A monetary theory of business cycles stresses the importance of the money
supply in the economic system. Since many businesses must borrow money to operate or expand
production, the availability and cost of money influence their decisions. Sir Ralph George Hawtrey
suggested that changes in interest rates determine whether executives decrease or increase their
capital investments, thus affecting the cycle.
Accelerator and Multiplier Effects
Basic to all theories of business-cycle fluctuations and their causes is the relationship
between investment and consumption. New investments have what is called a multiplier effect:
that is, investment money paid to wage earners and suppliers becomes income to them and then,
in turn, becomes income to others as the wage earners or suppliers spend most of their earnings.
An expanding ripple effect is thus set into motion. Similarly, an increasing level of income spent
 by consumers has an accelerating influence on investment. Higher demand creates greater
incentive to increase investment in production, in order to meet that demand. Both of these factors
also can work in a negative way, with reduced investment greatly diminishing aggregate income,
and reduced consumer demand reducing the amount of investment spending.
Regulating the Cycle
Since the Great Depression, devices have been built into most economies to help prevent
severe business declines. For instance, unemployment insurance provides most workers with some
income when they are laid off. Social security and pensions paid by many organizations furnish
some income to the increasing number of retired people. Although not as powerful as they once
were, trade unions remain an obstacle against the cumulative wage drop that aggravated previous
depressions. Schemes to support crop prices (such as the European Common Agricultural Policy)
shield farmers from disastrous loss of income. The government can also attempt direct intervention
to counter a recession. There are three major techniques available: monetary policy, fiscal policy,
and incomes policy. Economists differ sharply in their choice of technique. Monetary policy is
preferred by some economists, including the American Milton Friedman and other advocates of
monetarism, and is followed by most conservative governments. Monetary policy involves
controlling, via the central bank, the money supply and interest rates. These determine the
availability and costs of loans to businesses. Tightening the money supply theoretically helps to
counteract inflation; loosening the supply helps recovery from a recession. When inflation and
recession occur simultaneously - a phenomenon often called stagflation - it is difficult to know
which monetary policy to apply. Considered more effective by American economist John Kenneth
Galbraith are fiscal measures, such as increased taxation of the wealthy, and an incomes policy,
which seeks to hold wages and prices down to a level that reflects productivity growth. This latter
policy has not had much success in the post-World War II period.

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 1 2 3
The Business is a term used in to designate changes in the . Ever
4
since the Industrial , the level of business activity in industrialized capitalist countries
5
has veered from high to low, taking the with it.

6 7
of the Business
8 9 10
The timing of a is not , but its seem to be.
11 12 13 14 15
Many four - prosperity, liquidation, , and - using the
16 17
terms originally developed by the American Wesley Mitchell, who his career
18
to studying business .

19 20
During a of prosperity a rise in production becomes . Employment, wages, and
21
profits increase . Business executives express their optimism
22 23
through to production. As the upswing continues, however, obstacles begin
24 25
to that impede further . For example, production costs increase; shortages of raw
26 27
materials may further hamper production; interest rates rise; prices rise; and to
28
increased prices by buying less. As starts to lag behind production,
29 30
inventories , causing a price . Manufacturers begin to retrench; workers are laid
31 32
off. Such lead to a of liquidation. Business executives become pessimistic as
33
prices and profits drop. Money is hoarded, not . Production cutbacks and factory
34 35 36
shutdowns . Unemployment becomes .A is in progress.

37 38 39 40
from a may be by several , including a resurgence
41 42
in demand, the exhaustion of inventories, or government action to stimulate the .
43
Although generally slow and uneven at the start, soon gathers momentum. Prices rise
more rapidly than costs. Employment increases, providing some
44 45 46
additional power. in capital-goods industries . As optimism pervades
47 48
the , the desire to speculate on new business ventures returns. A new is under
way.

49
In fact, business do not always behave as neatly as the model just given, and no
50 51 52 53 54
two are alike. Business in severity and
 55 56 57 58 59
. and can , with spans.

60 61 62 63
The most severe and of all in the 1930s. The
64 65
Great the United States first but quickly spread to Western Europe. From
66 67
1933 to 1937 the United States began to from the , but
68 69 70
the again from 1937 to 1938, before regaining its level.
71
This was called a recession, a term that is now used in preference to liquidation.
72 73 74
Real was not until early 1941.

75
Special
76 77 78 79
Apart from the business , specialized sometimes in particular
80 81 82
industries. The building trade, for example, is believed to have from
16 to 20 years in length. Prolonged building slumps made two of the most severe
83 84
American worse. On the other hand, an upswing in building has often
85 86
helped to stimulate from a .

87 88 89
Some believe that a long-range , lasting for about half a century, also .
90 91
Studies of during the 19th and early part of the 20th centuries were made by the
92
Russian Nikolai Kondratieff. He examined the behavior of wages, raw materials,
93 94 95
production and , , imports, and other quantities in Great Britain and
96 97 98
France. The he collected and seemed to the existence of long-
99 100 101 102
range . His "waves" of and fell into three averaging 50 years
103
each: 1792-1850, 1850-1896, and 1896-1940. Such studies, however, are not .