What is business cycle?
A business cycle ‘is a short term picture of the behavior of real output in a private enterprise economy Business cycle refers to upturn and downturn in the level of economic activity that extends over a period of time’. The business fluctuations occur in aggregate variable such as national income, employment and price level. The variables nearly move at the same time and in the same direction. However they vary in duration and intensity. The upturns and downturns in the level of economic activity are generally divided into four phases which in brief are as under.
The phases of business cycle.
There are four phases of business cycle which are generally labeled as Boom, Recession, Trough and Recovery. We start explaining with the top of a cycle which is called Peak or Boom.
(1) Peak or Boom
The top of a business cycle is called Peak or Boom or prosperity phase. In the boom period, the overall business activity is rising at a more rapid rate. There is a rise in real output and incomes of the people. There is a rise in production, prices, employment, wages, interest rates, profits and in the volume of bank credit. The general mood of the businessmen is that of optimism and commercial.
The industrial activity both speculative and non speculative shows remarkable expansion. Construction activity gets a big boost. Share markets give handsome gains to the investors. Financial institutions tend to expand credit. In the words of Haberler. ‘‘Prosperity is ‘a state of affairs in which the real income consumed, real income produced and the level of employment are high or rising and there are no idle resources or unemployed workers or very few of either”. During prosperity period, there is a high level of demand for capital goods and consumer goods and services. Risky investments are undertaken by the entrepreneurs. Inefficient firms enter into the market and manage to survive. The high level of demand for the various inputs creates shortage of some of them. Inflation goes up. The economy becomes supply constrained. The state of prosperity proves to be short lived and the downturn of its period starts.
The end of prosperity comes and enters into recession. Recession is a slow down of business activity. In recession employment and output both decline. The forces which bring the contractionary phase of business fluctuations (recession) are as follows:
(1) As prices of the commodities rise the wages of the workers tend to lag behind. The reduction in the purchasing powers of the workers brings down the demand for consumer goods
(2) Due to shortage of some inputs the expansion in production of goods is hampered.
(3) The non-availability of credit beyond a particular limit of expansion acts as a serious brake on prosperity. The financial institutions begin to recover the loans. The firms which are unable to pay back the loans begin to liquidate their stocks. When more firms sell their output at the same time the price level starts falling. If a few firms get involved in losses a wave of pessimism runs through the share markets. The firms begin to curtail production. Workers are laid off. The outstanding orders for raw materials are cancelled. The new projects are shelved. The wave of pessimism passes on to other sectors of the economy and the businessmen become panicky and the whole economic system runs into crisis. Then the next stage of business cycle called depression starts
3. Depression or Trough
Depression is the most fearful stage of a trade cycle. The phase of depression (also called slump) is characterized by low economic activities, rapid decline in general output and employment. The decline in economic activity is not uniform. There is much more decline in output in manufacturing mining construction transport industries. However there is comparatively less contraction in output in retail trade and agriculture.
In slump, there is a marked fall in the average prices of the commodities. The costs are relatively higher the profits of the entrepreneurs decline. The purchasing power of the money is high but due to low income there is too much contraction in effective demand for consumer goods. The expenditure on capital goods or its replacement greatly falls Most of the firms reduce their output or close down. The income of the share holders goes down.
Depression or slump leads to redistribution of national income Profits and wages fall faster relatively to rent and other fixed incomes. The bankers follow the policy of credit contraction. Due to dull business conditions producers are also reluctant to borrow funds Summing up in a period of slump there is negative net investment by firms falling demand of consumer as well as capital goods high unemployment and low level of imports. In the words of Haberler, Depression is a state of affairs in which real income consumed or volume of production per head and the rate of employment are falling. There are idle resources and unused capacity especiaIlyunsuedlabour.’’ In the economic life of the world such acute crises have occurred in the years 1710 1827 1873 1907 and 1929.
(4) Revival or Recovery
The economic conditions which we have described in depression phase do not remain as such for ever. After sometime revival or recovery sets in under the influence of a variety of factors. The revival phase develops when the accumulated stock of commodities with the businessmen are exhausted. The costs under the impact of prolonged depression begin to fall. The prices which have reached its lowest level stop falling further. There is then complete harmony between costs and price relationship.
When profits begin to reappear, the businessmen are induced to invest their hoarded money in some enterprises: In order to steal a march over other industrialists, they start repairs, renewal and replacements of their capital equipments and stocks. The capital goods industries resume activities. There is gradual of labor.
The money incomes begin to increase and the effective demand is revived. The government also tries to break the spell of depression by starting construction or expanding some public works with a view to give more employment. The commercial, banks which have accumulated large reserve offer credit on favorable terms. The marginal efficiency of capital begins to rise and investment opportunities brighten up. The consumers start buying commodities to avoid the rise. Due to increase in demand for commodities, investment in various industries is stimulated and thus the revival takes place.
The recovery phase of business cycle thus is characterized by rising production, increasing prices of both consumption and capital goods, rising of wages, rates, enlarged opportunities of employment, and greater amount of spending on consumption and investment goods.
Prior to 1940’s, their were frequent booms and depressions in the capitalistic world. However, after the World War-Il, the strong cyclical upswings and downswings have been considerably tamed by the timely applications of fiscal and monetary measures. The fluctuations in economic activity are now moderate. Consequently, the term economic expansion and economic contraction are used now for the terms boom and recession.
Business fluctuations reflect moments of economics activity around a trend line of long tern growth as shown in Fig. 9.1 below. A recession begins after a previous expansion has reached its peak and continues until the economy reaches a trough. An expansion begins when economic activity starts to increase and continues until the economy reaches a peak.
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