Business Cycles - Phases & Features (CA Foundation)
Business Cycles – Phases & Features (CA Foundation)
What is Business Cycle
A business cycle refers to the natural expansion and contraction of production and output of products and services over time. Many analysts state that a business cycle involves an economic rise and fall of a firm. Therefore, business cycles are most significant to understand the economic conditions of a firm. Every firm can benefit from such analyses to form necessary changes to their policies. One thing to know is that business cycles are a phenomenon that happens over time. Every firm undergoes cycles as no firm can have a continuing growth or decline over its life cycle.
Write the names of different phases of the business cycle?
The 4 phases of the business cycle are as follows:
Expansion (Boom, Upswing or Prosperity)
Peak (Upper turning point)
Contraction (Downswing, Recession or Depression)
Trough (Lower turning point)
I – Expansion: The production output and employment increase significantly during this phase. Involuntary unemployment stays at a minimum low during this period.
II – Peak : The expansion phase ends here and reaches its peak. The business reaches its high point during this phase. The economy produces its maximum output but becomes overheated due to this. Cost and sale prices rise resulting in lower demand and higher cost of living.
III – Contraction : The business succumbs to the economic pressure and begins to downsize during this phase. Contrary to the expansion phase, the production output and employment begin falling. Involuntary unemployment starts increasing.
IV – Trough: The outputs and employment reach their lowest points during this time. So in order to expand, business owners increase capital investments which leads to higher output. The higher output at low prices begins to generate sales and business transitions into the expansion phase.
Example of Business Cycle – The Great Depression
The business cycle since the year 2000 is a classic example. The economy boomed during the early 2000s. The boom came due to the expansion of numerous firms that contributed to the global economy.
The boom came crashing down during the great recession of 2007 to 2009. So let us understand the series of events that led to the recession.
Back in the day, banks did not have a lot of stringent conditions for providing loans. Since new homebuyers could freely afford loans, they availed those loans. So homebuyers kept purchasing homes, and that increased the demand for homes. And increased demand led to a rise in housing prices.
In gist, Easy loans conditions -> Higher loans -> Increased purchasing of houses -> Higher demand of properties -> Increased housing prices.
The Federal Reserve continued to lower the interest rate, and the Federal Government put specific guarantees on mortgages, allowing banks to lend money even cheaper. Since the government promised guarantees to the funds of banks, they were absolutely safe! So banks started lending money to just about anyone. They allowed people to take two and three mortgages for a single home because the housing prices kept increasing. People used this money to buy boats and motors, thus increasing economic activity even more.
Since expansions and other phases in the economic cycle get measured in real GDP, this economic activity gave a false impression of inflation. The peak of such activities was in December 2007.
People started getting an understanding of this false bubble, and houses prices began to fall. Further, the federal funds rate increased to combat fake borrowings that caused higher interest payments on mortgages. The increased interest rates with declining home prices left homeowners with sub-prime loans.
The entire economy that once boomed contracted from late 2007 until 2009. It then bottomed out and began to rebound. Therefore, completing a complete business cycle.
Features of Business cycle
No business in any economy features a straight trajectory. The economy is dynamic and is ever-changing. Therefore, all industries have periods of economic expansion and periods of contraction. Such implications give all business cycles certain features as mentioned below –
1. Occur Periodically: Various phases in the business cycle occur from time to time. However, such occurrences vary consistent with the industries. Their duration may vary from anywhere between two to 10 or maybe twelve years. Even the intensity of the phases is different.
For instance, the firm may even see tremendous growth followed by a shallow short-lived depression phase.
2. Synchronic: Business cycles aren’t limited to at least one firm or one industry. They originate within the free economy and are pervasive. A disturbance in one industry disrupts other industries and eventually affects the entire economy.
3. Complex Phenomenon: Business cycles are complex and dynamic. They do not have any uniformity. Therefore, it is nearly impossible to predict or steer oneself against these business cycles.
4. International in Character: Business cycles are contagious. They do not limit themselves to just one country or one economy. As they affect any country, they spread to other countries like wildfire.