Business Cycle

• A swing in total national output, income and

employment, usually lasting for a period of 2
to 10 years marked by widespread expansion
or contraction in most sectors of the economy.
 BUSINESS CYCLE

The business cycle or economic cycle and or trade cycle is the

downward and upward movement of Gross Domestic Product
(GDP) around its long-term growth trend. The length of a
business cycle is the period of time containing a single boom
and contraction in sequence.
 Generally, these are the phases of business cycles

• 1. Expansion (Boom, Upswing or Prosperity)

• 2. Peak (upper turning point)
• 3. Contraction (Downswing, Recession or
Depression)
• 4. Trough (lower turning point)
 Expansion

• Expansion: The line of cycle that moves above the steady

growth line represents the expansion phase of a business
cycle. In the expansion phase, there is an increase in various
economic factors, such as production, employment, output,
wages, profits, demand and supply of products, and sales.
 Expansion-Parameters
• Increased production
• Heavy capital investments in basic industries
• Expansion of bank credit
• High prices
• High profits
• Large number of business enterprises start up
• Good employment
 Peak
• A peak is the highest point between the end of
an economic expansion and the start of a
contraction in a business cycle. The peak of
the cycle refers to the last month before several
key economic indicators, such as employment
and new housing starts, begin to fall.
 Peak -Parameters
• Maximum possible growth attained
• Almost reflects a saturation
• Overfull employment
• Skyrocketing prices
• Too much overall optimism
 Recession
• A recession is a significant decline in economic activity
spread across the economy, lasting more than a few
months, normally visible in real GDP, real income,
employment, industrial production, and wholesale-retail
sales
 Recession-Parameters
• Even the largest and most successful business
houses are on alert
• Financial Institutions roll back their fresh loans
• Many business units collapse
• Unemployment mounts
 Trough
• A trough is the stage of the
economy's business cycle that marks the end
of a period of declining business activity and the
transition to expansion.
• The business cycle is the upward and
downward movement of gross domestic product
and consists of recessions and expansions that
end in peaks and troughs.
 Trough-Parameters
• A sharp and massive reduction in production
• Large scale unemployment
• Very low wages
• Contraction of credit
• Pessimism and business failures
 Characteristics of Business Cycles
• Cyclical movements
• International in nature
• Varying degree of impact
• Irregular patterns
• Fluctuations in price and productive capacities
• Wave like movement
 Causes of Business cycles
• Changes in money supply
• Changes in bank credit
• Over investment in capital goods
manufacturing
• Excessive savings or under consumption
• Waves of optimism and pessimism in business
cycles
 Causes
• Technological innovations
• Good climatic conditions
• Disturbance factors
• Rate of growth in population
• Artificial Political Climate
 Measures
• Monetary Policy
• Fiscal Policy
 Business Cycles: Meaning, Phases and Features

• Meaning of Business Cycle:

• The period of high income, output and employment has been
called the period of expansion, upswing or prosperity, and the
period of low income, output and employment has been
described as contraction, recession, downswing or depression.
• The economic history of the free market
capitalist countries has shown that the period
of economic prosperity or expansion alternates
with the period of contraction or recession.
• These alternating periods of expansion and
contraction in economic activity has been called
business cycles. They are also known as trade
cycles.
• .M. Keynes writes, “A trade cycle is composed of
periods of good trade characterized by rising prices
and low unemployment percentages, altering with
periods of bad trade characterized by falling prices
and high unemployment percentages.”
• “The period of good trade or upturn in the
economy is called boom and the period of bad
trade or downturn in the economy is called
recession or depression”
• The duration of a business cycle has not been
of the same length; it has varied from a
minimum of two years to a maximum of ten to
twelve years,
• though in the past it was often assumed that
fluctuations of output and other economic indicators
around the trend showed repetitive and regular pattern
of alternating periods of expansion and contraction.
• A significant point worth noting about
business cycles is that they have been very
costly in the economic sense of the word.
• During a period of recession or depression many
workers lose their jobs and as a result large-scale
unemployment, which causes loss of output that
could have been produced with full employment
of resources, come to prevail in the economy.
• Besides, during depression many businessmen
go bankrupt and suffer huge losses.
Depression causes a lot of human sufferings
and lowers the levels of living of the people.
• Fluctuations in economic activity creates a lot of
uncertainty in the economy which causes anxiety
to the individuals about their future income and
employment opportunities and involve a great
risk for long-run investment in projects.
• Even boom when it is accompanied by
inflation has its social costs. Inflation erodes
the real incomes of the people and makes life
miserable for the poor people.
• Inflation distorts allocation of resources by
drawing away scarce resources from
productive uses to unproductive ones.
• Inflation redistributes income in favour of the
richer sections and also when inflation rate is
high, it leads to fluctuations in economic growth.
 Features of Business Cycles:

• Though different business cycles differ in

duration and intensity, they have some
common features which we will discuss now:
• Business cycles occur periodically. Though they do not
show same regularity, they have some distinct phases
such as expansion, peak, contraction or depression
and trough. Further the duration of cycles varies a
good deal from minimum of two years to a maximum
of ten to twelve years.
• Secondly, business cycles are synchronic. That is, they
do not cause changes in any single industry or sector
but are of all-embracing character. For example,
depression or contraction occur simultaneously in all
industries or sectors of the economy.
• Recession passes from one industry to
another and chain reaction continues till the
whole economy is in the grip of recession.
• Similar process is at work in the expansion phase,
prosperity spreads through various linkages of
input-output relations or demand relations between
various industries, and sectors.
Thirdly, it has been observed that fluctuations
occur not only in level of production but also
simultaneously in other variables such as
employment, investment, consumption, rate
of interest and price level.
• 4. Another important feature of business cycles is
that investment and consumption of durable
consumer goods such as cars, houses, refrigerators
are affected most by the cyclical fluctuations.
• 5. An important feature of business cycles is that
consumption of non-durable goods and services does
not vary much during different phases of business
cycles. Past data of business cycles reveal that
households maintain a great stability in consumption of
non-durable goods.
• 6. The immediate impact of depression and
expansion is on the inventories of goods. When
depression sets in, the inventories start
accumulating beyond the desired level. This leads
to cut in production of goods.
• On the contrary, when recovery starts, the inventories go
below the desired level. This encourages businessmen to
place more orders for goods whose production picks up
and stimulates investment in capital goods.
• 7. Another important feature of business
cycles is that profits fluctuate more than any
other type of income.
• The occurrence of business cycles causes a lot of
uncertainty for businessmen and makes it difficult to
forecast the economic conditions.
• During the depression period profits may even become
negative and many businesses go bankrupt. In a free
market economy profits are justified on the ground that
they are necessary payments if the entrepreneurs are to
be induced to bear uncertainty.
• 8. Lastly, business cycles are international in
character. That is, once started in one country they
spread to other countries through trade relations
between them.
• . For example, if there is a recession in the USA,
which is a large importer of goods from other
countries, it will cause a fall in demand for imports
from other countries whose exports would be
adversely affected causing recession in them too.
 Phases of Business Cycles:

• Business cycles have shown distinct phases the study

of which is useful to understand their underlying
causes. These phases have been called by different
names by different economists.
 Generally, these are the phases of business cycles

• 1. Expansion (Boom, Upswing or Prosperity)

• 2. Peak (upper turning point)
• 3. Contraction (Downswing, Recession or
Depression)
• 4. Trough (lower turning point)
• Expansion: The line of cycle that moves above the steady
growth line represents the expansion phase of a business
cycle. In the expansion phase, there is an increase in various
economic factors, such as production, employment, output,
wages, profits, demand and supply of products, and sales.
• In addition, in the expansion phase, the prices of factor of
production and output increases simultaneously. In this
phase, debtors are generally in good financial condition to
repay their debts; therefore, creditors lend money at
higher interest rates. This leads to an increase in the flow
of money.
• In addition, in the expansion phase, the prices of factor of
production and output increases simultaneously. In this
phase, debtors are generally in good financial condition to
repay their debts; therefore, creditors lend money at
higher interest rates. This leads to an increase in the flow
of money.
• In addition, in the expansion phase, the prices of factor of
production and output increases simultaneously. In this
phase, debtors are generally in good financial condition to
repay their debts; therefore, creditors lend money at
higher interest rates. This leads to an increase in the flow
of money.
• In expansion phase, due to increase in investment
opportunities, idle funds of organizations or individuals are
utilized for various investment purposes. Therefore, in such a
case, the cash inflow and outflow of businesses are equal. This
expansion continues till the economic conditions are
favorable.
Peak: In other words, peak phase refers to the phase in
which the increase in growth rate of business cycle
achieves its maximum limit. At this phase, the
economic factors, such as production, profit, sales,
and employment, are higher, but do not increase
further.
• In peak phase, there is a gradual decrease in the
demand of various products due to increase in the
prices of input. The increase in the prices of input leads
to an increase in the prices of final products, while the
income of individuals remains constant.
• 3. Recession: As discussed earlier, in peak phase,
there is a gradual decrease in the demand of various
products due to increase in the prices of input. When
the decline in the demand of products becomes rapid
and steady, the recession phase takes place.
• In recession phase, all the economic factors, such as
production, prices, saving and investment, starts decreasing.
Generally, producers are unaware of decrease in the demand
of products and they continue to produce goods and services.
In such a case, the supply of products exceeds the demand.
• Over the time, producers realize the surplus of supply
when the cost of manufacturing of a product is more
than profit generated. This condition firstly
experienced by few industries and slowly spread to all
industries.
• 4. Trough: During the trough phase, the economic
activities of a country decline below the normal level.
In this phase, the growth rate of an economy
becomes negative. In addition, in trough phase, there
is a rapid decline in national income and expenditure.
• In this phase, it becomes difficult for debtors to
pay off their debts. As a result, the rate of
interest decreases; therefore, banks do not
prefer to lend money. Consequently, banks face
the situation of increase in their cash balances.
• Apart from this, the level of economic output of a
country becomes low and unemployment becomes high.
In addition, in trough phase, investors do not invest in
stock markets. In trough phase, many weak organizations
leave industries or rather dissolve. At this point, an
economy reaches to the lowest level of shrinking.
• 5. Recovery: As discussed above, in trough phase, an
economy reaches to the lowest level of shrinking. This
lowest level is the limit to which an economy shrinks.
Once the economy touches the lowest level, it happens
to be the end of negativism and beginning of positivism.
• This leads to reversal of the process of business cycle. As
a result, individuals and organizations start developing a
positive attitude toward the various economic factors,
such as investment, employment, and production. This
process of reversal starts from the labor market.
• Consequently, organizations discontinue lying off
individuals and start hiring but in limited number. At this
stage, wages provided by organizations to individuals is
less as compared to their skills and abilities. This marks
the beginning of the recovery phase.
• In recovery phase, consumers increase their rate of
consumption, as they assume that there would be no
further reduction in the prices of products. As a result,
the demand for consumer products increases.
• In recovery phase, consumers increase their rate of
consumption, as they assume that there would be no
further reduction in the prices of products. As a
result, the demand for consumer products increases.
• Therefore producers are always able to earn a
certain amount of profit, which increases at
trough stage. The increase in profit also
continues in the recovery phase.
• Apart from this, in recovery phase, some of
the depreciated capital goods are replaced by
producers and some are maintained by them.
• As a result, investment and employment by
organizations increases. As this process gains
momentum an economy again enters into the phase
of expansion. Thus, a business cycle gets completed.