Business Cycle
The business cycle is called a "trade cycle" or "economic cycle". The business cycle is a cycle of fluctuations in the GDP in the long term, consisting of intervals of general expansion followed by recession in economic growth.
According to Christina D. Romer," periods of economic expansion are typically called booms; periods of economic decline are called recessions or depressions. The combination of booms and recessions, the ebb and flow of economic activity, is called the business cycle".
In a boom, not only does the output of goods and services rise, but employment also rises and unemployment falls. New construction and prices typically rise during a boom as well, but in a recession, not only does the output of goods and services decline, but employment falls and unemployment rises as well. New construction also declines.
Changes in the cycle can be determined by analyzing economic indicators such as gross domestic product (GDP), employment figures, housing starts, and consumer spending.
Phases of the Business Cycle
Four stages of the business cycle are related to economic growth.
Expansion
This is the first stage of the business cycle in which an increase in positive indicators such as employment, income, output, wages, profit, demand, and supply of goods and services occurs. The environment is favorable for new investment, and entrepreneurs make critical decisions to expand their businesses. In this stage, more people are hired, there is more money to spend, and the rate at which production and consumption change is positive.
Characteristics of Expansion
Rising GDP: Gross Domestic Product grows, indicating that the overall economic output is increasing. The economy is producing more goods and services than in the previous period.
Increased Employment: As businesses grow, they hire more workers, reducing unemployment rates. Job opportunities rise, wages increase, and labor markets tighten.
Higher Consumer and Business confidence: People and businesses feel optimistic about their financial futures. Consumers spend more on goods and services, and businesses invest in new projects, equipment, and infrastructure.
Rising Income and Demand: When people have employment and higher wages then their disposable income is increased. This boosts demand for consumer goods and services, which in turn fuels business growth.
Increase in Investment: Businesses expand by investing in new capital, technology, and infrastructure. Entrepreneurs are more likely to start new ventures, and existing firms may introduce new products or services.
Rising Stock Markets: The stock market often performs well during the expansion phase because companies are growing, profits are rising, and investors feel confident about future economic conditions.
Moderate Inflation: Demand for goods and services tends to increase during an expansion, which can lead to moderate inflation. Prices rise as businesses respond to higher demand.
Expansion is the longest phase of the business cycle in many cases, as economies tend to grow for extended periods before a recession or slowdown occurs. However, the length and strength of each expansion can vary based on factors like government policies, global conditions, and innovations.
Boom/Peak
The peak is the second phase of the cycle. It depicts the climax of the activities that occur in the expansion phase. It is a period of low unemployment, increased prices, and real growth of GDP. The economic growth is at its peak, people are satisfied to earn reasonably, and it is a period of prosperity, supply fulfills the demand.
Characteristics of the Boom
High GDP Growth: Economic growth accelerates, with the GDP increasing at a faster-than-normal rate. Industries expand, and there is a strong surge in the production of goods and services.
Full Employment: The labor market reaches full employment, meaning there are very few unemployed workers and job creation is at its highest. Employers may find it difficult to hire workers, leading to increased wages and competition for skilled labor.
High Consumer Confidence: Consumers are highly optimistic about their financial situation and the overall economy, leading to increased spending on both essential and luxury goods. This confidence fuels even greater demand.
Increased Investment: Businesses invest heavily during a boom, expanding their operations, upgrading technology, and increasing capacity to meet rising demand. New ventures, startups, and capital expenditure flourish.
High Demand for Goods and Services: Consumer demand surges, driving up sales for businesses across various sectors. This can lead to higher prices due to increased competition for limited goods and resources.
Rising Inflation: Prices for goods and services increase as consumers are willing and able to pay more. Inflationary pressures can become a concern for policymakers.
Asset Price Bubbles: Booms are sometimes accompanied by speculative bubbles in asset markets, such as real estate, stock markets, or commodities. As prices for these assets rise rapidly, investors may continue to bid up prices, sometimes without regard to underlying value.
Recession or Depression
It is the 3rd phase of the cycle, it begins after the economy peaks and ends when GDP and other indicators cease to decrease. It is a period of decline, in which demand falls, and unemployment rises.
Due to uncertain market conditions, business activities are slowing down. In this phase, investors hesitate to invest and avoid starting new projects. It is difficult for businesses to earn a profit.
Characteristics of the Recession
Declining GDP: During a recession, the economy experiences negative GDP growth. Due to reduced demand, businesses produce fewer goods and services, leading to an overall contraction in economic activity.
Rising Unemployment: As economic activity slows, businesses cut their workforce to cut costs, leading to an increase in unemployment. Jobs are lost across various sectors, and new job creation becomes scarce. Unemployment rates can rise significantly during deep or prolonged recessions.
Decrease Business Investment: Businesses cut back on investment in capital projects, new ventures, and expansions. They become more cautious about spending, often postponing or canceling new initiatives due to uncertain economic conditions.
Consumer spending: Consumer confidence declines in a recession, leading to lower spending levels. Households often reduce their purchases of non-essential goods and services and focus on saving or paying down debt.
Rising Loan Default: As businesses and individuals struggle to maintain cash flow, loan defaults may increase. This can lead to stress in the banking sector and tighten credit availability.
Stock Market Decline: Financial markets often react to recessions with falling stock prices. Investor confidence weakens, and stock values can decline as corporate earnings expectations are revised downward.
Causes of Recession
When inflation rises too quickly, it erodes purchasing power and increases the cost of living. Central banks may respond by raising interest rates, which can reduce consumer spending and business investment, eventually slowing down the economy. In response to inflation or overheating economies, central banks may raise interest rates to curb demand. Higher interest rates make borrowing more expensive, reducing spending and investment, and this can push the economy into a recession.
Recessions are often triggered by financial crises, such as the collapse of major banks, stock market crashes, or widespread defaults in the credit market. For example, the 2008 global financial crisis was triggered by the collapse of the housing market and excessive risk-taking in the financial sector.
Natural disasters, wars, pandemics, or sudden changes in global trade policies can shock the economy and trigger recessions. For example, the COVID-19 pandemic in 2020 caused a sharp and sudden global economy.
While technological innovations generally boost productivity, technological disruptions can lead to temporary dislocations in the labor market or specific industries, leading to localized recessions or economic slowdowns.
Trough
It is the fourth stage of the business cycle in which the economy begins a transition from the contraction phase to the expansion phase. The entrepreneurs try to find new customers and keep up their sales revenue. Many companies are closed because not have enough money to run their functions.
Characteristics of Trough
Economic Indicators: Many industries, especially cyclical ones like manufacturing and construction, operate at reduced capacity or even shut down some operations. Unemployment rates are often high, as companies have cut down on hiring and may have conducted layoffs to survive the downturn.
Investment and Business Activity: Business investments are low due to poor economic conditions. Companies may refrain from spending on new projects or expansion, preferring to preserve cash. Business activity is generally sluggish as consumer confidence is down, leading to lower demand for goods and services.
Financial Conditions: Interest rates might be lower as central banks attempt to stimulate the economy. However, lower rates do not immediately translate into borrowing and investment, as businesses and consumers are cautious. Inflation is often low or may even turn negative (deflation), as the demand for goods and services is minimal.
Transition to Recovery: The trough can be a turning point, even if initially it's hard to recognize. Subtle signs of recovery might include slight improvement in hiring, consumer spending, or industrial production. Businesses start seeing value in new investments, often supported by government intervention, such as fiscal policies or monetary policies.
What is the Benefit of a Business Cycle
Knowledge of a business cycle is important to economic agents for
decision-making and planning purposes. For instance, during
periods of economic growth and prosperity, employment tends to
be high; therefore, employees have options and can negotiate
better. Firms can expand and go into new markets during a contraction, and economic agents would typically cut costs and
draw on resources saved during the boom.
Factor Influence on Business Cycle
A business cycle is a short-term variation. There are some external and internal factors that influence on business cycle. External factors include wars, revolutions, commodity price changes, new discoveries, and technological innovations. Internal factors consist of policy inconsistency, elections, outbreaks of diseases, and changing demographics.
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