Business cycle

A business cycle is also known as a trade cycle or an economic cycle because the business cycle is a representation of the short-run fluctuations in a growing trend of the country’s economic activity over a period of time.

It is a series of alternate expansion and contraction in the economic activity depending on the demand and cost of capital, business cycles are recurring, periodic, and synchronic.

Representor of business cycle:

  • Resource utilization,
  • Housing sector activity,
  • External Trade activity.

Relationship between the Business cycle, Unemployment and Inflation:

The economic growth trend of a country is non-linear as there are numerous factors defining the phases of the economy, Employment, Interest rates, Investments, Labor productivity, efficient use of capital, inflation, spending and money demand. A country experiencing a trade deficit will face unemployment, which causes economic slowdown (the contrary to this is not relevant here).

The business cycle depends on the circular flow of money between the households and the businesses. The government and private businesses have the authority to make decisions regarding investments and the employees are considered as the general public. The cost of capital and the interest rates are higher when the economy is at its peak. Businesses expand the production at higher cost and at the same time, as the interest rates move in tandem with inflation, the production will fall again the demand from the public is limited and the shift from luxuries to needs, as there is a cutoff in salary. Now that the standard of living has fallen due to diminished economic activity, which will require an increase in loan disbursement from banks to normalize the economy.

Business cycle graph

Stages of Business cycle or economic cycle.

Trough:

  • During this period, the economy is in an uncertain state with high unemployment rate, the country is in the utmost depressed state.
  • Inflation is low to nil as people don’t have the money to spend on discretionary basic goods are traded at acceptable prices if supply is not affected.
  • The economy experiences low production, investment and therefore a decrease in employment. As there is a need of capital for the economy to expand, banks will extend the credit limit and lower the interest rates to encourage investment activity.
  • As the country is reviving from the depressed state, the trough is also called as lower turning point.
  • GDP growth rate from negative to positive.

Recovery (Expansion):

  • The recovery stage is ahead with great prosperity.
  • Increase in Investments, Consumption level increases, Productivity increases as businesses are funded with less cost, Increase in the employment. Along with the business activities, inflation also increases.
  • The period of expansion exists till the growth reaches peak. The growth of a country is regulated by controlling the interest rates.
  • Companies don’t expand rapidly, instead the capacity is utilized to the fullest. If the demand is still unfed companies try to expand.
  • Banks reduce the credit limit and increases the lending rate due to which the businesses will experience increased cost of capital and thus production costs. This is a cost push inflation and passed on to the consumer.
  • Imports increase as domestic income growth accelerates.

Peak:

  • The inflection point of the optimistic part of the curve. The economy in full employment, We can conclude the GDP is at its maximum. Even after attaining full employment, the GDP heads north only due to increase in price, this is not sustainable for the long term.
  • The economy is restricted to grow as inflation grew with it. The recovery was successful coupled with high inflation and now its time to treat economy to have lower inflation.
  • The production, investments and employment level are more than sufficient.
  • The economy is heading towards a contraction.


Contraction (recession):

  • The growth declines slowly, as the cost of borrowing was higher at peak the businesses contemplate on further expansion even though the demand increases, so it is hard to expand beyond a certain stage.
  • The consumption of the households declines due to inflation. As the demand falls the production is narrowed and run at the minimum maintenance cost.
  • Companies don’t sell the Property, Plant and equipments because of economic contraction.
  • The unemployment increases due to which the consumption, production, and business investments fall.
  • Imports decrease as domestic income growth slows.

The aspect of the business cycle is, it cannot be defined by duration or the intensity of fall or peak and they recur at irregular intervals.