A Business Cycle is a very complicated economic phenomenon and The Economist have not been able to so far to discover any compressive explanation for this phenomenon.
The business cycle is associated with the sweeping fluctuations in economic activities such as production, employment, prices etc.
Definitions of Business Cycle
Business cycles have been defined by different economists As given under:
A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages are altering with periods of bad trade characterized by falling prices and high and unemployment percentages. – J. M. Keynes
A business cycle may be defined as a period of prosperity followed by a period of depression. It is not surprising that economic process should be irregular, trade being good at some time and bad of other. – Professor Frederic Benham
On the basis of the above definitions, we can say that the business cycles are an alternative expansion and contraction in overall business activity.
Stages or Phases of A Business Cycle
There are Five different Phases or Stages of a business cycle has given under:
- Recovery or Revival
- Prosperity or full Employment
- Boom or overfull Employment
The above Stages or phases of Business Cycle are discussed as under:
Under this one of the phases of a business cycle. Under this phase business activity in an economy is far below the normal. There is a sharp reduction of production, mass unemployment, low employment, falling prices, falling profit, low wages, contraction of credit, a high rate of business failures and an atmosphere of all-around pessimism and despair.
A decline production is accompanied by A reduction in the volume of employment
All Construction activities come to a complete standstill during the depression. The consumer goods industries such as food, clothing. Area not so much affected by unemployment as the basic capital goods industries. The prices of manufactured goods fall to a low level. The manufacturers suffer huge financial losses. Many of these firms have to close down on account of accumulated losses.
The Fall in prices distorts the relative prices structure. The prices of Agricultural commodities and raw materials fall to a great extent than the prices of finished manufactured goods. The agricultural are hit more than the manufacturing classes.
The Example of depression is the two longest depression in the USA history during 1875-1879 (65 months) and 1929-1933 (44 months).
2. Recovery or Revival
It implies the increase in business activity after the lowest point of the depression has been reached. There is a slight improvement in economic activity during this phase of a business cycle to start with. The entrepreneurs start to feel the economic situation was not so bad as it was in the first phase. This leads to further improvement in business activity. 🙂
The industrial production picks up slowly. The volume of employment also steadily increases. There is a slow rise in prices accompanied by a small rice in proof profits. The wages also rise less than in proportion to the rise of prices. With the rising profits new investment take place in capital goods industries. The banks expand credit. Business inventories are also started rising slowly. The pessimism and despair of the previous phase are replaced by an atmosphere of all-around cautions hope.
The recovery continuous. The most severe depression, The more rapid will be the recovery. Duration of the recovery period cannot be definitely said. The recovery could be initiated by new innovations, government expenditure, change in production techniques, investment in new regions, exploitation of new sources of energy.
3. Prosperity or Full Employment
This phase is characterized by increased production high capital investment in basic industries, expansion of bank credit, high prices, high profits, a high rate offer nation of new business Enterprises and full employment. There is an environment of optimism felt by Businessman and Industrialist.
The example of this phase in the longest sustained period of prosperity occurred in the USA between 1923 and 1929.
4. Boom or overfull Employment
This face is on rapid expansion in business activity to new high marks, resulting in high stocks and commodities prices, high profits and over full employment. The prosperity phase does not end up with a stable state of full employment and it leads to the emergence of the boom. After the stage of full employment inflationary rise in prices starts.
This results in undue optimism among industrialists and Businessmen resulting in additional investments in different sectors of the economy. It puts pressure on the demand for a variable factor of production who are already fully employed, their priced increases at a higher spread.
Profits touch a new hight with the rising profits. Businessman and industrialists increase their capital investments. This leads to the inflationary rise in prices. Prices are skyrocketing and there is an atmosphere of over-optimism round.
But after sometime bottlenecks begin to appear in the various sectors of the economy. Factors of production become scared leading to further rise in their prices. The cost calculations of Businessman and Industrialist are adversely affected. New projects are not undertaken and expansion of the exciting unit is stopped.
The atmosphere of over optimization of the previous phase is replaced by over pessimism. The failure of some business creates panic among Businessman. The banks withdraw loan from business Enterprises more business Enterprises fail. Prices collapse and confidence are shaken. Building construction slows down and unemployment appears in the basic, capital goods industries. This unemployment spreads to the other sectors of the economy, Unemployment leads to falling in income, expenditure, prices, and profit.
The Recession has a cumulative effect. The recession goes on gathering Momentum and finally gets the shape of depression and thus, the first phase of the business cycle is complete.
The Example of 1957-58 recession in the USA was the severe recession.
Business Cycle Diagram or graph
The various phases of Business Cycle can be seen from the following diagram:
The Diagram shows the different phases of Business Cycle. FE is the full employment line. A boom in the upswing and a recession in the down-swing. Below this line, we have two stages of the business cycle- Recovery in the upswing and depression in the downswing. It starts with depression to be followed by recovery, prosperity, boom, recession and ultimately ends up again with depression.
Control or Measures of the Business Cycle
The business cycles create cyclical fluctuations in economic activity. The long waves of business cycles are inevitable in a capitalist economy. But short business cycles should be checked.
The following measures can be used to control or Measures of the business cycles:
In order to control such upswing and downswing of the business cycles government may evolve a suitable monetary policy to deal with the situation. The undue expansion of money supply could be checked by in insisting upon a proper and adequate cover against not issue. As regards bank credit, the central bank of the country could use the various quantitative and qualitative methods of credit control.
Such as bank rate, open market operations, cash reserve ratio, statutory liquidity ratio, fixation of margin requirements, regulation of consumer credit, rationing of credit, morals suasion, publicity and direct action.
Monetary policy may not suffice to check cyclical business fluctuations. When business activities show signs of slackening down, the government should use these three instruments(taxation, Public spending, and public borrowing) of fiscal policy to check downtrend and ensure stability in the economy.
The government should not levy new taxes and existing Texas should be substantially reduced. It will increase the purchasing power of people thereby more goods and services will be purchased by the peoples. It will check the decline in demand and business activity.
When economy set, The government should raise the rates of existing taxes and may levy new taxes to check private spending. Thus, the various instruments of fiscal policy should be followed by the government in such a manner that it may attain stabilization in the economy.
Economist has suggested the introduction of a number of automatic stabilizers to deal with the business cycles. An automatic stabilizer in an economic shock absorber the help smooth the cyclical business fluctuations of its own accord. Of its own accord, without requiring deliberate action on the part of the government, one of such devices is the progressive income tax.
Progressive income tax and unemployment insurance were the two built-in stabilizers used in the USA to control the fluctuations in business activity. Automatic stabilizers are superior to other monetary and fiscal measures as they go into action immediately whenever the economy is confronted with Economic fluctuations.
Theories of Business Cycle
- Hawtrey’s Theory of Business Cycle.
- Hayek’s Over Investment theory.
- Keynesian theory of business cycles.
- Professor Hick’s theory of business cycle.
- Sunspot theory of Business cycle.
- Psychological theory.
- Overproduction theory.
- Over Saving theory.
- Innovation theory.
- Cobweb theorem.
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