Business Cycles: Expansion, Peak, Contraction

• Business cycles or trade cycles refer to rhythmic fluctuations in aggregate economic activity that an economy experiences over time.
• These fluctuations are evident in measures like gross national product, employment, and income.

Phases of Business Cycle

• Expansion, also termed Boom or Upswing, features a rise in national output and overall economic variables.
• Peak, also termed Boom or Prosperity, signifies the upper turning point or the summit of the business cycle.
• Contraction, known as Downswing or Recession, denotes a fall in the levels of investment and employment.
• Trough or Depression marks the conclusion of the recession, characterized by severe contraction in economic activities.

Economic Indicators

• Changes in various activities are used to measure the business cycle and predict economic direction, known as indicators.
• Leading indicators change before the economy follows a trend and are used to predict economic shifts.
• Lagging indicators change after real output changes.
• Coincident indicators, also called concurrent indicators, occur simultaneously and indicates the current state of the business cycle.

Examples of Business Cycles

• Great Depression of 1930 caused global GDP to fall by 15% between 1929 and 1932, resulting in widespread economic distress.
• The recovery from the Great Depression was aided by increased money supply and government spending.
• Information Technology bubble covered 1997-2000 and led to failing companies once the bubble burst in 1999-2001.
• The recent global economic crisis owes its origin to US financial markets in 2008-09 which started with the US housing market.

Features of Business Cycles

• No economy follows a perfectly timed cycle and that the business cycles are anything but regular.
• Business cycles occur periodically but lack regularity in duration and intensity.
• Phases seldom display smoothness or regularity.
• Length of each phase is not definite.
• Generally originates in free market economies.
• Affect most sectors.
• Affect some sectors such as capital goods industries, durable consumer goods industry disproportionately.
• They do not have uniform characteristics and causes.
• They are caused by varying factors.
• They are hard to predict.
• Cause repercussions felt on nearly all economic variables, viz. output, employment, investment, consumption, interest, trade, and price levels.
• Contagious and international in character.

Causes of Business Cycles

• Fluctuations in aggregate effective demand are a cause with higher demand induces more production and more income and employment.
• High aggregate demand can cause inflation which will trigger a low output and income.
• Fluctuations in investments are considered the prime cause of business cycles.
• Variations in government spending can cause business fluctuations.
• Macroeconomic policies, both monetary and fiscal, also cause business cycles.
• Changes in money supply cause business fluctuation.
• Psychological factors can cause business cycle, according to business community's optimism or pessimism.
• Trade cycles occur due to innovations which take place in the system from time to time.

External (Exogenous) Factors

• Wars divert resources to war goods, decreasing production of other goods and causing economic contraction.
• Post-War Reconstruction leads to increased economic activity.
• Technology Shocks occur through production of new and better products
• Causes big investments in new technology and leads to expansion of production output.
• Weather cycles cause fluctuations and cause instability in agricultural output.
• Higher rates cause less saving and less income and employment, slowing economic activity.

The relevance of business cycles in business decision-making

• Understanding the business cycle and economic conditions and forecasts helps businesses anticipate the market.
• Affects the demand for their products and in turn their profits which ultimately determines whether a business is successful or not.
• Knowledge regarding business cycles and their inherent characteristics is important for a businessman to frame appropriate policies.