Business Cycle

Business Cycle

An important aspect of a capitalist economy is the existence of alternating periods of prosperity and depression, commonly known as the business cycle (British economists call it the trade cycle).

The business cycle or trade cycle is a nation's economic activity pattern. In other words, the trade cycle is the accumulation of GDP through time.

It is based on the assumption that people will become wealthy or impoverished in the future when they make their choices. These choices have an impact on how enterprises and governments use natural resources and how technology is applied to improve human civilization. Understanding how economics and business cycles work is crucial to making wise decisions in these sectors.

The business cycle primarily concerns how customers react to changes in their income, such as whether they have additional money at particular periods of the year or during specific months of the year. The fluctuations in the money supply and the demand for goods and services are the key topics of discussion. Both are influenced by economic variables such as taxation and interest rates.

Typically, a boom comes before a recession, which triggers a business cycle decrease. A standard business cycle is characterized by five different phases - depression, recovery( or revival) prosperity ( or full employment), boom ( or overfull employment), and recession.

Short-run and long-run cycles are two ways to divide the business cycle. The time between peaks in one year and troughs in the following year is referred to as the short-run cycle. The term "long-run cycle" describes the interval between troughs over several years or decades. It contains both short-term and long-term cycles. The business cycle provides market entry and exit points for the investor. Because it has an impact on all parts of our life, including employment, inflation, interest rates, trade balances, etc., the business cycle is an essential

component of macroeconomics. A trade cycle is made up of good trade periods marked by increasing prices and low unemployment rates, which are followed by bad trade times marked by falling prices and high unemployment rates, according to Keynes' definition. According to Gordon, "business cycles consist of a periodic alternation of growth and contraction in aggregate economic activity, the alternating movements in either direction being self-reinforcing and permeating almost all sectors of the economy."

Causes of Business Cycle

Causes of the business cycle (Internal) 

Consumer demand can vary (over-saving or underconsumption) 

Different macroeconomic policies and changes in government spending may affect investment.

 The flow of money also affects the business cycle.

business cycle's root causes (External)

Conflict

War-related reconstruction

Technology astonishes

Natural phenomena

Human psychology 

Characteristics of Business Cycles:

Cyclical fluctuations are motions that resemble waves.

Natural fluctuations occur frequently.

They are inconsistent or non-periodic. In other words, there aren't predictable intervals between the peaks and troughs.

They can be found in such aggregation variables as prices, output, income, and employment.

These variables change at various rates while moving in the same direction roughly simultaneously.

Although prices fluctuate very modestly in the durable goods industry, output and employment are subject to relatively large swings. Contrarily, nondurable goods industries see quite large price variations but only modest shifts in employment and output.

Business cycles do not follow seasonal trends like increases in retail sales around the festival.

What are the signs that a business cycle is occurring or not?

• Leading Indicators

A measurable economic element is known as a leading indicator shift before the economy as a whole begins to exhibit a certain pattern or trend. In other terms, "Leading indicators" are variables that change before the actual output changes. Before significant economic changes, leading indicators frequently alter. For instance, Changes in stock prices, profit margins, and earnings, as well as other indices like housing, interest rates, and prices, are sometimes regarded as signs of upcoming upswings or downswings. The number of new orders for consumer products, new orders for machinery and equipment, building permits for private homes, the percentage of businesses reporting slower deliveries, the consumer confidence index, and the money growth rate are also used to measure and forecast changes in business cycles. even though they are frequently used to forecast economic changes, leading indicators are not always reliable. Even specialists can't agree on when to use these 'leading signs'. Before the economy starts to recover, it could take weeks or months after a stock market fall. However, it might never occur.

• Lagging Indicators

Lagging indicators are those that represent the economy's past performance, and changes to them are only apparent after an economic trend or pattern has already taken place. The term "Lagging indicators" refers to variables that change after the actual output changes. If business cycles are predicted by leading indicators, lagging indications confirm these predictions. Lagging indicators are measurements that alter once an economy enters a phase of volatility. Unemployment, corporate earnings, labor costs per unit of output, interest rates, the consumer price index, and commercial loan activities are a few examples of lagging indicators.

• Coincident Indicators

Economic indicators that overlap or take place at the same time as business-cycle events are known as coincident indicators. They describe the current stage of the business cycle because they closely correspond to changes in the economic activity cycle. In other words, these indicators more or less provide information on the rate of change of the expansion or contraction of an economy at the moment it occurs. The Gross Domestic Product, industrial production, inflation, personal income, retail sales, and financial market patterns like stock market prices are a few examples of coincident indicators.

Other Business Cycle Indicators

Production: The agricultural and production index will show an upward trend during the economic recovery and prosperity periods.

boom at its height

The rate falls during the recession.

At the least, during the depression

High labor demand during the stages of recovery and prosperity;

high unemployment rate

lowest employment rate during the boom

The rate falls during the recession.

During the Great Depression, unemployment skyrocketed.

Income level and consumption: As employment rises throughout the recovery and prosperous eras, an increasing trend in per capita income level and consumption will be observed.

When there is a recession or depression, the rate falls.

A manageable increase in the rate of inflation during the recovery and prosperous periods.

During the boom time, inflation will reach unacceptable levels.

The recessionary phase will see a declining trend in inflation.

Investment: Optimism is prevalent during moments of recovery and growth.

When there is a recession or depression, investment decreases.

Budgetary policy:

The government creates fiscal policy (expenditure and taxation policy) measures to combat the negative consequences of various phases.

Theories of Business Cycle

1. Sunspot Theory: One of the earliest theories of the business cycle is the one based on the sunspot phenomenon and climate theory. In 1875, Stanley Jevons presented it. A sunspot is a hypothesized weather-influencing stone on the sun's surface. Agriculture was the primary source of production in ancient times. According to this notion, climate changes determine the creation of agricultural products. The nation's economic activities are impacted by the climate.

2. Psychological theory: This is related to professor A.C. Pigue, who popularized it in his investigation of industrial volatility. This idea contends that variations in business are caused by the waves of businesspeople and manufacturers who are both optimistic and pessimistic. This will benefit the entire company.

The entire business community adopts an upbeat mindset as a result. Its entire structure is based on the entrepreneur's mentality of whether or not the company can be revived or shut down during a business depression or crisis. According to monetary theory, the underlying reason for an economy's ups and downs is the supply and demand for money.

4. The excessive investment supposition: The competitiveness theory of business cycles is another name for this hypothesis. It was proposed by economists with socialistic views. This indicates that there will be an excess commodity and the market will be overstocked. Such an overproduction situation will result in a decrease in the commodity's price. In the case of other commodities, the same thing occurs.

If organizations and people If organizations and individuals save more money and make far bigger investments than they had planned, their payments will increase.

5. Underconsumption theory: It is referred to as the business cycle underconsumption theory. Additionally, socialist-leaning economists like Major Douglas and J.A. Hobson advanced it. This hypothesis contends that the predominant income inequality in a capitalist society. According to this idea, the reason for the business depression is that too much saving and too little consumption will decrease the market's demand for goods.

6. The assertion about innovation: This hypothesis states that more inventions result in inventive businesses and new technology, which

advance the health of the economy, Joseph Schumpeter, an economist from the United States, is primarily responsible for the innovation hypothesis. He refers to the introduction of anything new that modifies the current mode of production as the "innovation hypothesis. The introduction of a unique production technique, opening a new market, releasing a new product, or using an alternative raw material source are examples of innovations.

Phases of Business Cycle

The gap between the peak and growth trend line is known as inflation. The growth trend line represents the full employment level.

Recovery or Revival Phase

A business cycle's initial or growth phase. There is an increase in several economic variables, including sales, production, employment, output, wages, and profits. Organizations continue to concentrate on raising consumer demand for their goods and services. People are confident and make purchases. heightened product demand. It is easy to obtain a bank loan.

Businesses are successful, and stock values are rising.

Demand growth, wealth expansion, heightened competition, and increased advertising established new regulations.

Increasing brand loyalty Creditors lend money at higher interest rates since borrowers are typically in a position to pay back their loans.

As a result, the flow of money increases. As investment opportunities have increased, idle money from individuals or organizations is invested in a variety

of reasons.

Boom/ Peak

The era after the expansion is called  Peak. The condition of the economy is at its maximum, and profits remain steady. Plans are made by organizations for future growth.

Features of  Boom

• High supply and demand
• A large market share and revenue
• Diminished advertising
• A powerful brand image
• GDP reaches its peak

Economic elements including employment, output, profit, and sales are increasing but remain stable.

The economy no longer expands (reached the top)Businesses are unable to increase production or employee numbers.

Recession or contraction

Usually, a natural recession or fall in activity marks the beginning of the economic cycle. This occurs when an excessive number of companies

and customers opt to conserve money instead of making immediate purchases. When fewer people have work and businesses aren't making as much money as they once were, this is referred to as an "economic slowdown" or " economic depression."

After reaching its peak for a while, an organization starts to deteriorate and enter the phase of contraction. A recession is another name for this stage. A company may be in this phase for several reasons, including a shift in government policy,

an increase in competition, unfavorable economic conditions, and labor issues.

The organization starts to lose market share as a result of these issues.

The following are crucial aspects of the contraction phase:

Decreased demand, decreased sales and revenue, and diminished market share

Increasing competition/Declining employment

People cease spending money because they are pessimistic (negative).

Banks cease making loans.

A businessman in a recession won't have any choice but to cut back on production and sales. As a result, profits will decline, and capital will subsequently be lost.

Trough

An organization experiences severe losses and reaches its lowest point during the trough phase. Both profitability and demand are declining at this point. Additionally, the company's competitive edge is lost. This phase's key characteristics are:

• Smallest income
• Loss of clients
• Adoption of cost-cutting and reduction measures
• The significant market share decline

An economy's growth rate turns negative at this stage. Additionally, there is a sharp decrease in national income and spending during the trough phase.

Business cycle management

• Monetary policy

(operate by the central bank of a country)

Contrary to popular belief, government policies do not directly affect economic cycles. Governments can influence economic cycles through their monetary policies, including interest rate management and tax levying or subsiding, although these elements are not the root drivers of economic cycles. Instead, they influence both individual and business decision-making. These decisions cause economic issues that put pressure on firms and start a boom-and-bust cycle.

1. Bank Rate Policy

A change in the bank rate is the monetary policy tool used to control the trade cycle. The bank rate is the central bank's lowest lending rate.

When the business cycle reaches extremes, management of the cycle is required. Both boom and depression are

the extremes.

Boom: Increases bank rates to reduce the money supply

Depression: Lower rate to boost the supply of money

2. Trading on the open market

Boom: Sells securities and deprives individuals of their disposable money.

Depression: Purchases securities to put more money in people's pockets

3. Alteration in the cash reserve ratio

Boom: Increase CRR to lower lending capacity

Depression: Reduce CRR to increase lending

The statutory liquidity ratio has changed.

(Statutory Liquidity Ratio, or SLR, is the term used to describe the minimum portion of deposits

that a commercial bank must keep in the form of readily available cash, gold, or other assets. In essence, it is the minimum amount of reserves that banks must have to extend credit to clients.

Boom: Increase in SLR to cut back on credit-granting

Depression: Lower SLR to allow the bank to raise credit

Limitations of Monetary Policy:

If the boom is the result of cost-push forces, it might not be successful in reducing inflation, total demand, production, income, and employment. In terms of depression, the Great Depression of the 1930s teaches us that when businessmen are pessimistic, monetary

policy's chances of success are essentially zero.

They do not desire to borrow under such circumstances, even if the interest rate is cheap. Similarly to this, consumers who experience unemployment and lower incomes limit their spending on goods and services. Businesspeople and consumers cannot be persuaded to increase aggregate demand by either the central or commercial banks. This seriously

undermines the ability of monetary policy to control economic swings.

2. Business cycle management Fiscal policy (taxation strategy, Government spending)

A taxation strategy

Increased tax rates and other taxes are implemented to reduce excessive purchasing power.

Tax rates are lowered during a recession to raise purchasing power and boost demand.

B Government spending

Boom: The government cuts back on public spending

Depression: More money spent on government work

Business cycle management Direct control (Direct Actions for Control, Export taxes)

Direct Controls:

Direct control's main objective is to make sure that scarce resources are allocated properly to stabilize prices. They have an impact on specific producers and consumers. These regulations include licensing, rationing, price and wage controls, export tariffs, exchange controls, quotas, and anti-hoarding measures. Their success is dependent on having an effective and trustworthy administration. If not, they result in illegal marketing, fraud, long lines, etc. Ensure that resources are allocated properly to maintain price stability for certain producers and consumers.

Direct Actions for Control

• Rations (controlled distribution of scarce resources)

• Control of prices and wages

Export taxes

• Exchange management

• Monopolies in power

• Policies against hoarding.

Success hinges on having a trustworthy and effective administration.

If not, it could result in illegal marketing, corruption, long lines, speculation, etc. As a result, they should only be used in dire situations like war, crop failures, and hyperinflation. A single stabilization policy strategy is not sufficient to reduce cyclical swings. As a result, all techniques ought to be applied simultaneously. This is because monetary policy is simple to implement but less effective, whereas fiscal policies and direct controls are challenging to implement but more effective.

It is impossible to completely eliminate cyclical oscillations from the capitalist system. While certain changes may be helpful for economic expansion, others may be unfavorable. Therefore, unwelcome fluctuations should be under control via a stabilization policy.

Conclusion: 

The scarcity of jobs will increase if the economy is contracting. You might not be able to find another employment if you leave!

However, if the economy is expanding, plenty of jobs are available. The timing may be right to change careers.

Only if you're certain that a contraction won't result in your job being lost. So, purchase your home while it is expanding.

However, interest rates will fall if the economy begins to slow down (shrink). 

If you are certain that you won't lose your work, wait to buy a house until the rates reach a low point.

As a business tycoon, never be overconfident in a boom and never give up hope during a depression. Control your emotion and continue to normalize the harsh situation arising from COVID-19.