Q. What is a Business Cycle ? Describe various phases of a Business Cycle.
Ans. Meaning of Business Cycle: Every country witnesses boom and depression periodically. Depression is characterised by falling production, falling prices, and rise in unemployment. On the other hand, boom is characterised by rising production, rising prices and high employment percentage. These changes of boom and depression are cyclical in form. Hence, these are called Trade or Business Cycles. Rhythmic fluctuations taking place in an economy, at intervals, in the form of boom and depression are called Trade or Business Cycles.
In the words of Lord Keynes, “A business cycle is composed of periods of good trade characterised by rising prices and low unemployment percentage alternating with periods of bad trade characterised by falling prices and high unemployment percentage.”
According to Anatol Murad, “Business Cycles are alternations of prosperity and depression.”
Phases of Business Cycle: According to Prof. Schumpeter a business cycle can have four phases:
(1) Expansion or Boom,
(2) Recession,
(3) Depression or Trough or Contraction, and
(4) Recovery.
The following figure illustrate all the four phases or stages of business cycles:
● (1) Expansion or Boom: This phase of the business cycle represents the best stage of prosperity. The objective of the national economic policy of each country is to attain this stage. In this phase hectic economic activities go on and factors of production are put to optimum use. The main characteristics of this phase are:
(i) Income or production is maximum.
(ii) The economy reaches full employment by removing unemployment.
(iii) Prices rise very high.
(iv) Wages, rates of interest, rent and taxes increase. But increase in all these is less than increase in prices. Thus, real wages do not rise much.
(v) Because of relatively more increase in prices than cost of production, profits rise very high.
(vi) Rise in profits and possibility of their remaining high, lead to rise in the prices of shares. As a result, expectations of profits rise further.
(vii) Under condition of prosperity, today's an entrepreneurs become optimist. All kinds of products and speculative activities grow. As a result, there is more investment.
(viii) Bank banks pursue liberal credit policy leading to more investment in machines, factory buildings, etc. It results in more productivity.
(ix) Under condition of prosperity, producers expand economic activities by stimulating demand for consumption goods and rise in price level. Explain expenditure of the consumers rise and so also demand.
(x) Under condition of prosperity, the process of expansion continues to be cumulative and self-sustained till the economy reaches the highest level of production, called boom. It is the situation of over full employment and inflation.
● (2) Recession: Under the phase of prosperity, the entrepreneurs make investments in certain ventures which do not prove to be profitable. Their optimism gives way to pessimism. Investivment shows signs of decline. Many enterprises are closed down. Unemployment spreads and income of the people falls. As a matter of fact, beyond the stage of full employment, annie increase in investment is followed by increase in interest, wages and other costs. Consequently, prices rise sharply causing fall in demand. Falling demand obliges the firms to sell their stocks at reduced prices. This paves the way for the recession. In this phase there is decline in economic activities. The main to main features of this phase are under.
(i) There is fall in income and output.
(ii) Workers are rendered unemployed.
(iii) Prices begin to fall.
(iv) Wages fall.
(v) Profits fall. There is no new borrowing despite fall in the rate of interest.
(vi) There is contradiction of bank credit.
(vii) Fall in investment sets in motion the reverse action of the multiplier. Consequently, income falls many times more than the decline in investment.
(viii) Demand of the consumers for various goods fall.
(ix) There is a sharp decline in the stocks of goods.
(x) There is a feeling of doubt and fear among the people. They turn pessimistic. Share prices fall.
● (3) Depression or Contraction: Once the process of recession starts, it becomes almost difficult to stop the rot. It goes on gathering momentum and ends hopeless depression. Consequently, economic activities are faced with depression or contraction. Level of output and employment is extremely low. There is heavy fall in prices and wages. Prices of goods fall much more than wages and interest, resulting into heavy losses to the entrepreneurs and traders. Workers are the hit adversely because of widespread unemployment. Production and distribution systems of the economy go out of gear. Heavy fall in profits serves as a disincentive to any new investment. Although rate of interest falls, yet no new investment takes place as marginal efficiency of capital falls more than proportionate fall in rate of interest.
Under depression, prices of raw materials fall more than the prices of finished products. Economic condition of farmers and producers of raw material grows worse than that of the traders and producers of finished goods. Because of the reverse action of the multiplier and the accelerator, there is heavy fall in income. Share prices fall rapidly. Many indian industries are ruined. Eighth every mversously affects the entire economy. Thus, under depression, all economic factors like income, output, employment, prices, profit, interest, wages, demand etc. have a tendency to contract. Salient features of this phase are as follows:
(i) Level of output and income is low.
(ii) Unemployment increases.
(iii) Wages, interest and other costs decline.
(iv) Price level falls.
(v) Volume of the profits falls sharply. Hence, despite fall in the rate of interest, inducement to invest very low.
(vi) Cash reserves with the bank pile up and demand for credit falls.
(vii) Old and worn-out machines are not replaced. Hence, demand for capital gods falls.
(viii) Demand for consumer goods falls.
(ix) There is an all-round decline in investment , causing reverse action of multipliers and accelerator.
(x) People grow pessimist. It affects economy adversely.
● (4) Recovery: It is worth noting that depression phase cannot last for ever. During the phase of depression the entrepreneurs do not even replace machines and other capital goods. Production falls considerably. Stocks of goods are at their lowest. Even during the phase of depression a situation does arise wherein shortage of goods is experienced. Need for replacement of machines become so imperative that the entrepreneurs are obliged to buy new machines to replace old and worn out ones. It results into more demand for capital goods. Investment in capital goods industries increased. As a result of it, interaction of multiplier and the accelerator comes into play and there is increase in income. Demand for goods rises. There is increase in output and employment. Thus, the economy gradually moves from depression to recovery. The wave of recovery once initiated begins to feed up itself. The main features of this phase are as follows:
(i) Replacement investment results into increase and income output.
(ii) Employment increases.
(iii) Demand for consumption and production good rises.
(iv) Prices begin to look up.
(v) There are more profits.
(vi) Costs increase relatively less.
(vii) Investment increases.
(viii) Demand for bank loans and advances increases.
(ix) Pessimism gives place to optimism.
Table. Features of Different Phases of Business Cycles
| Feature | Expansion or Boom | Recession | Depression | Recovery |
|---|---|---|---|---|
| 1. Employment | Increases | Suddenly falls | Very Low | Slowly rises |
| 2. Output | Increases | Falls | Falls very low | Slowly rises |
| 3. Wages | Rise | Fall | Fall very low | Begin to rise |
| 4. Prices | Rise | Fall sharply | Fall very low | Begin to rise |
| 5. Interest | High | Begins to fall | Very low | Begins to rise |
| 6. Bank Credit | Expands | Suddenly falls | Falls low | Begins to expand |
| 7. Cost of Production | Rises | Falls | Falls very low | Begins to rise |
| 8. Stocks | Large | Fall | Fall very low | Begins to rise |
| 9. Feeling | Optimism | Doubt and Fear | Pessimism | Optimism |
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