Determine the impact of

business cycles on business

activities
 Objectives
• Define the following terms; business cycles, expansion,
peak, contraction, and trough.
• Identify the phases of a business cycle.
• Describe the peak phase of a business cycle.
• Describe the contraction phase of a business cycle.
• Describe the trough phases of a business cycle.
• Explain how knowledge of business cycles benefits
businesspeople.
• Describe internal causes of business cycles.
• Explain external causes of business cycles.
 Business Cycles
• The business cycle describes the phases of
growth and decline in an economy.
• The goal of economic policy is to keep the
economy in a healthy growth rate -- fast
enough to create jobs for everyone who wants
one, but slow enough to avoid inflation.
 Prosperity Phase
When there is an expansion of output, income, employment, prices and profits, there is also a
rise in the standard of living. This period is termed as Prosperity phase.
• The features of prosperity are :-
• High level of output and trade.
• High level of effective demand.
• High level of income and employment.
• Rising interest rates.
• Inflation.
• Large expansion of bank credit.
• Overall business optimism.
• A high level of MEC (Marginal efficiency of capital) and investment.

Due to full employment of resources, the level of production is Maximum and there is a rise in
GNP (Gross National Product). Due to a high level of economic activity, it causes a rise in prices
and profits. There is an upswing in the economic activity and economy reaches its Peak. This is
also called as a Boom Period.
 Expansion
• An expansion, which is a period of increasing economic activity
• The second of the two primary business-cycle phases is an expansion.
• An expansion, which is a period of increasing economic activity. Clearly real GDP
increases over this segment.
• An expansion generally takes the economy from below the long-run trend to at or
above the long-run trend.
– The early part of an expansion is usually termed a recovery because the economy is
"recovering" from the contraction
– An expansion typically lasts about three to four years, but could be as short as one year or as
long as a decade.
– The longest expansion on record, occurring during the 1990s, lasted ten years.

• The inflation rate tends to increase during an expansion.

• The unemployment rate, is almost guaranteed to decrease during an expansion and

 Peak
• The transition from expansion to contraction is a peak.
• An expansion, like a contraction, eventually comes to
an end. The end of an expansion, and the onset of a
contraction is a peak.
• While a peak, the highest level of the business cycle,
might seem like a good thing, it really has a down side.
• A peak means that the expansion has ended and that
a contraction is about to begin.
 Recession Phase

The turning point from prosperity to depression is termed as Recession

Phase.
• During a recession period, the economic activities slow down. When
demand starts falling, the overproduction and future investment plans are
also given up.
• There is a steady decline in the output, income, employment, prices and
profits.
– The businessmen lose confidence and become pessimistic (Negative). It reduces
investment.
– The banks and the people try to get greater liquidity, so credit also contracts.
– Expansion of business stops, stock market falls. Orders are cancelled and people
start losing their jobs.
– The increase in unemployment causes a sharp decline in income and aggregate
demand. Generally, recession lasts for a short period.
 Contraction
• A contraction, which is a period of declining economic
activity
• A period of decline in which economic
• activity decreases for at least six months
is termed a contraction.
– Contractions, also termed recessions.

– The inflation rate, tends to decrease during a contraction

– The unemployment rate, for example, is almost guaranteed to

increase during a contraction.
 Contraction (Continued)
• One of the two primary business-cycle phases is a contraction.
• A contraction, which is a period of declining economic activity.
• A contraction generally takes the economy from at or above the
long-run trend to below the long-run trend.
– Because the long-run trend represents full employment, unemployment
results when real GDP is below the long-run trend, or when actual real GDP
is less than potential real GDP.
– Moreover, the lower real GDP dips below the long-run trend, then the
greater is unemployment.
• A contraction typically lasts about a year, but could be as short as six
months or as long as eighteen months.
– The longest contraction on record, occurring during the Great Depression,
lasted almost four years.
 Depression Phase
When there is a continuous decrease of output, income, employment, prices and
profits, there is a fall in the standard of living and depression sets in.
• The features of depression are :-
• Fall in volume of output and trade.
• Fall in income and rise in unemployment.
• Decline in consumption and demand.
• Fall in interest rate.
• Deflation.
• Contraction of bank credit.
• Overall business pessimism.
• Fall in MEC (Marginal efficiency of capital) and investment.
In depression, there is under-utilization of resources and fall in GNP (Gross National
Product). The aggregate economic activity is at the lowest, causing a decline in prices
and profits until the economy reaches its Trough (low point).
 Trough
• The transition from contraction to expansion
• is a trough .
• A contraction does not last forever, at least none have so far. The
end of a contraction, and the onset of an expansion is a trough.
• The trough in the previous exhibit is indicated by point B. It is the
end of the previous contraction that took the economy from
point A to point B.
• While a trough, the lowest level of the business cycle, might not
seem like a good thing, it really is.
• A trough means that the contraction has ended and that an
expansion is about to begin.
 Recovery Phase
The turning point from depression to expansion is termed as Recovery or Revival
Phase.
• During the period of revival or recovery, there are expansions and rise in
economic activities. When demand starts rising, production increases and this
causes an increase in investment.
• There is a steady rise in output, income, employment, prices and profits.
– The businessmen gain confidence and become optimistic (Positive). This increases
investments. The stimulation of investment brings about the revival or recovery of the
economy.
– The banks expand credit, business expansion takes place and stock markets are activated.
– There is an increase in employment, production, income and aggregate demand, prices
and profits start rising, and business expands. Revival slowly emerges into prosperity, and
the business cycle is repeated.
• Thus we see that, during the expansionary or prosperity phase, there is inflation
and during the contraction or depression phase, there is a deflation.
Explain how knowledge of business cycles benefits businesspeople.

• First, on the academic side, business cycles are an inherent part of the
macroeconomy, they are part of the mechanism of the economy.
– Understanding the ups and downs of business cycles means a better understanding of the
macroeconomy.
– Through this understanding, key macroeconomic problems, especially unemployment and
inflation, can be addressed.
• Second, on the selfish side, human lives are seriously affected by the ups and downs
of business cycles.
– The unemployed take a serious hit to their living standards during recessionary downturns.
– Those with fixed incomes or financial wealth take a serious hit to their living standards during
inflationary upturns.
• The study of business cycles makes it possible to anticipate and prepare for these
problems.
– Knowing that the economy is on the verge of higher inflation, gives people the opportunity to
convert financial wealth into something less affected, or even helped, by inflation.
– Knowing a downturn is imminent, lets people plan for an extended period of unemployment.
Explain how knowledge of business cycles benefits businesspeople.

• Small business owners can take several steps to help ensure that their
establishments weather business cycles with a minimum of uncertainty
and damage.
• "The concept of cycle management may be relatively new," wrote
Matthew Gallagher in Chemical Marketing Reporter, "but it already has
many adherents who agree that strategies that work at the bottom of a
cycle need to be adopted as much as ones that work at the top of a cycle.
• While there will be no definitive formula for every company, the
approaches generally stress a long-term view which focuses on a firm's key
strengths and encourages it to plan with greater discretion at all times.
• Essentially, businesses are operating toward operating on a more even
keel."
Specific tips for managing business cycle downturns include the
following:

– Flexibility—According to Gallagher, "part of growth management is a flexible business plan that allows for
development times that span the entire cycle and includes alternative recession-resistant funding
structures."
– Long-Term Planning—Consultants encourage small businesses to adopt a moderate stance in their long-
range forecasting.
– Attention to Customers—This can be an especially important factor for businesses seeking to emerge from
an economic downturn. "Staying close to the customers is a tough discipline to maintain in good times, but
it is especially crucial coming out of bad times," stated Arthur Daltas in Industry Week. "Your customer is
the best test of when your own upturn will arrive. Customers, especially industrial and commercial ones,
can give you early indications of their interest in placing large orders in coming months."
– Objectivity—Small business owners need to maintain a high level of objectivity when riding business
cycles. Operational decisions based on hopes and desires rather than a sober examination of the facts can
devastate a business, especially in economic down periods.
– Study—"Timing any action for an upturn is tricky, and the consequences of being early or late are serious,"
said Daltas. "For example, expanding a sales force when the markets don't materialize not only places big
demands on working capital, but also makes it hard to sustain the motivation of the sales-people. If the
force is improved too late, the cost is decreased market share or decreased quality of the customer base.
How does the company strike the right balance between being early or late? Listening to economists,
politicians, and media to get a sense of what is happening is useful, but it is unwise to rely solely on their
sources. The best route is to avoid trying to predict the upturn. Instead, listen to your customers and know
your own response-time requirements."
 Internal Causes of Business Cycles
• Psychological Factors-Optimistic and pessimistic mood of the
entrepreneur. When entrepreneurs are optimistic about future
market conditions they take up investiment.
• Money Supply – if there is expansion in money and credit supply,
there will be raise in economic activity. If there is contractions
there will be down fall in economic activity.
• Over investment – excessive investment in capital goods industries
brings upswing and downswing when there is a fall in investment.
• Marginal Efficiency of capital- When the rate of marginal
efficiency of capital gets higher the expansion phase of trade cycle
commences. There is a contraction phase when the rate of
marginal efficiency of capital I lower.
 External Causes of Business Cycles
• Wars-available resources are utilized for the production of weapons which greatly
affect the product of both capital and consumer goods. This fall in production
decreases income, profits which further create unemployment. These create
contraction in the economic activity.
• Postwar Period-the level of consumption and investment goes upward. Bothe the
government and individuals involve the construction (houses, roads, bridges, etc.
All these activities increase the effective due to which the economics variable,
output, income and employment goes upward.
• Scientific Development-Every day new products come to the markets like mobile
phones, laptops, etc. These products require huge amount of investment through
which new technology of products is adopted. All this increases income,
employment and profit etc. and plays an important part in the revival of economy.
• Gold Discoveries – and mines stimulate the volume of international trade and help
in adjusting trade deficit, loans etc. the rising income lead to expansion in economic
activity.
External Causes of Business Cycles
• Surplus, Exports and Foreign Aid- raises the level of
consumption and investment spending which helps
in increasing output, income and employment level.
• Weather-is an important factor which can cause
economic activities. If in any year, weather is good
the ouptu of agricultural sector will go upward.
• Population Growth Rate- when it is higher than the
economic growth rate, income level and
consumption expenditure and savings will be low.