Business cycle: Meaning, Characteristics, Phases of Business Cycle

Meaning of Business Cycle

Businesses conditions never remain unchanged. A business cycle refers to oscillations is aggregate economic activities, specifically in employment, output and income, prices and profits, etc. but each and every oscillation in economic activities cannot be called a business cycle. Only those fluctuations can be called business cycle, which occurs periodically with certain regularity. A trade cycle has been defined differently by different economists.

According to Prof. Beham, “Trade cycle renders to a period of prosperity followed by a period of depression."

Prof. Haberler’s definition is very simple when he says, “The business cycle in the general sense may be defined as an alternation of periods of prosperity and depression of good and bad trade."

Keynes’s definition in his ‘Treaties of Money’ is more explicit, “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."

Characteristics of business cycle

A business cycle must possess the following characteristics:

1. Fluctuation of Aggregate Economic Activity 

Business cycles refer to the fluctuations in aggregate economic activity rather than as fluctuations in a single specific economic variable such as GDP.

2. Alteration of expansion and contraction in economic activity 

A trade cycle is characterized by alteration of expansion (Prosperity) and contraction (Depression) in economic activity. They are repetitive and rhythmic. The period of prosperity is followed by depression and which again is followed by a period of prosperity. This indicates that the movement is wave like in character, it is not an erratic fluctuation.

3. Co-movement 

Business cycles do not take place in just a few sectors or in just a few economic variables. Instead, expansions or contractions take place at the same time in a number of economic activities. Thus, although some industries are more sensitive to the business cycle than the rest, the level of output and employment in most industries tends to fall in recessions and rise in expansions. Many other economic variables like prices, productivity, investment and government purchases also have regular and predictable patterns of behaviors over the course of the business cycle. The tendency of many economic variables to move together in a predictable way over the business cycle is called co-movement.

4. Self- Reinforcing 

A trade cycle is a self- reinforcing in nature. It means that the process of expansion and contraction is a cumulative self- reinforcing nature. Each upswing or downswing feeds on itself and generates further movement (change) in the same direction until its direction is reversed by external forces.

5. The degree of regularity 

A trade cycle has a degree of regularity. It is possible that the upswing of a trade cycle is longer than the downswing or vice versa, but it maintains regularity.

6. The presence of crisis

A trade cycle is characterized by the presence of a crisis, i.e peak and the trough are not symmetrical. In the words, the change from upward to downward may be more sudden and violent than is the change from downward to upward movement. Consequently, the peak of the trade cycle is pointed with steep bends on either side whereas trough has a gently sloping swing of 16 – 22 years’ duration.

7. International in character 

When business fluctuations occur in a country, it will be spread all over the countries.

Phases of business cycle

A business cycle is commonly divided into four well- defined and inter- related recurring phases:

1. Prosperity (Boom) phase expansion or the upswing.
2. Recession phase: The turn from prosperity to depression (or upper turning point)
3. Depression phase: contraction or downswing
4. Revival or recovery phase: the turn from depression to prosperity (or lower turning point)

According to the figure, the linear curve as dashed form shows the economy’s normal growth path. The solid curve measures the behavior of aggregate economic activity over a typical business cycle. During a contraction of aggregate economic activity falls until it reaches a trough. The trough is followed by an expansion phenomenon during which economic activity increases until it reaches a peak. A complete cycle is measured from peak – to –peak or trough – to – trough.

1. Prosperity

Prosperity is that phase at which demand, output, employment, and income are rising at a high level. They tend to raise prices. But the wages, salaries, interest rates, rentals, and taxes do not rise in proportion to the rise in prices. The gap between prices and cost increases the margin of profit.

The prosperity is characterized by:

• A large volume of production and trade
• A high level of employment and income
• A high marginal efficiency of capital
• A rising price level
• A rising structure of interest rate
• A large expansion of bank credit
• A high level of real investment
• A rise in wages and profits
• Overall business optimism
• Operation of the economy at full capacity

The prosperity phase comes to an end when the forces leading to expansion become progressively weak. Bottlenecks begin to appear at the peak of prosperity. The peak is defined as the high point of prosperity or upper turning point of aggregate economic activities. The peak of prosperity may lead the economy to over full employment and to inflationary rise in prices. It is a symptom of the end of the prosperity phase and the beginning of the recession. Prosperity is defined as the phase at which macroeconomic indicators are rising at a high rate.

The seeds of a recession are contained in the boom in the forms of the following three factors:

1. Scarcities of labor power leads to rising costs relative to prices
2. Scarcities of raw materials to rise in costs relative to prices
3. Rise in the rate of interest due to scarcity of capital and
4. Failure of consumption to rise due to rising prices

All of the above-mentioned factors bring a remarkable decline in profit margins. Investments become very costly are sales as well as consumption lags behind the production. As a result, these factors become cumulative and self-reinforcing. Entrepreneurs, businessmen, and traders become over cautious and over-optimism give way to pessimism. This is the beginning of the upper turning point.

Reference

Bernake and Abel, Macroeconomics, Singapore, Pearson Education latest edition