The Business Cycle
Murad Rattani
Oxford College of London
Murad Rattani
What is Business Cycle?
According to Parkin and Bade’s
‘The business cycle is the periodic but irregular up and
down movements in economic activity, measured by
fluctuations in real GDP and other macroeconomic
variables.’
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Phases of Business Cycle
A business cycle is not a regular, predictable or repeating phenomena like
the swing of the pendulum of a clock. It’s timing is random and to a
large extent unpredictable. A business cycle is identified as a
sequence of four phases:
Contraction: A slowdown in the pace of economic activity.
Trough: the lower turning point of a business cycle, where a contraction
turns into an expansion.
Expansion: A speed up in the pace of economic activity.
Peak: the upper turning of a business cycle.
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Phases of Business Cycle
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Recession
According to standard newspaper
definition
‘recession is decline in Gross
Domestic Product (GDP) for two or
more consecutive quarters.’
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Recession (BCDC Definition)
According to Business Cycle Dating Committee at the
National Bureau of Economic Research (NBER)
‘A recession is the time when business activity has
reached its peak and starts to fall until the time when
business activity bottoms out. When the business activity
starts to rise again it is called an expansionary period. By
this definition, the average recession lasts about a year.’
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Depression
Before the Great Depression of the 1930s any downturn in
economic activity was referred to as a depression. The
term recession was developed in this period to
differentiate periods like the 1930s from smaller economic
declines that occurred in 1910 and 1913. This leads to
the simple definition of a depression as a recession
that lasts longer and has a larger decline in business
activity.
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Depression
According to the rule of thumb,
A depression is any economic downturn
where real GDP declines by more than 10
percent. A recession is an economic
downturn that is less severe.
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Characteristics of recession
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Businesses complaining of falling demand.
Cuts in output.
Rising unemployment.
Few job opportunities.
Gloomy expectations.
Low levels of capacity utilisation.
Falling levels of investment.
Businesses making losses.
Businesses closing down.
Falling sales.
Customers may seem price conscious.
Investments in increased capacity is postponed.
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Recovery
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Recovery is rather halting.
Businesses are unsure that improvement in demand is
sustained.
Businesses are unenthusiastic about taking risk for investment.
They are unwilling to take on new employees unless they are
sure, so unemployment is still high.
Lack of business confidence persists.
Output can increase sharply as long as there is spare capacity.
Businesses use their under-utilised capital equipment to
increase output.
When they are running at full capacity, they put expansion
plans in motion, investing in new buildings, plant and
machinery.
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Characteristics of Boom
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Investment increases.
Businesses experience shortage of skilled staff.
In order to attract the skilled people, businesses bid
against each other so that wages begin to rise faster than
inflation.
Prices are increased.
High levels of demand mean that higher prices have little
effect on the growth of sales.
Inflation, i.e. a general rise in the level of prices,
increases.
Boom is also mainly characterized by supply constraints,
full order book, full capacity output.
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Characteristics of boom
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When recovery turns into boom, it overheats.
The economy is growing too fast a rate to be
sustainable in the medium term. The reason is
that growth requires resources. At any given
time, there could be limit of the resources
available. There could be shortage of skilled
staff so the companies start poaching and
provide them with higher wages or train
inexperienced staff. According to
economists, it is called supply constraints.
Businesses call it bottlenecks.
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Characteristics of boom
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A full order book can occur. If capital equipment
producers are working flat out, orders for labour-saving
equipment will go on the order books, but will not be
produced for some time. This is good for the supplier but
indicates shortage of capacity.
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Full capacity output in the economy is the maximum
production level possible when all resources are working
flat out. The closer the economy gets to full capacity
output, the greater the supply constraints. Therefore
costs tend to rise. As cost rise, inflation accelerates.
Government responds by increasing the interest rate.
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Downturn
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The rising costs associated with boom discourages continuing
growth.
It reduces profitability and the attractiveness of further
investment.
Rising interest rates reduces consumers’ spending.
Cost of production goes up as businesses have to pay higher
interest rates.
Demand for products goes down.
Consumers have to pay higher mortgage rates which means
lower demand for housing.
Builders abandon their plans for housing construction and start
laying off.
People get unemployed and their purchasing power goes down.
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Downturn
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Because of higher interest rates and
higher cost of production, demand goes
down.
Not all industries are affected. The most
to be affected are consumer durables.
People depend upon savings and
benefits.
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Indicators of the Business Cycle
As according to financial media, two consecutive quarters of
negative GDP is recession, therefore GDP is a quick
and simple indicator for economic contraction.
The NBER (National Bureau of Economic Research)
considers primarily other economic indicators as well
which are
1.
2.
3.
Employment
Personal Income
Industrial Production
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References
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http://economics.about.com/cs/businesscycles/a/depressi
ons_2.htm
http://economics.about.com/cs/businesscycles/a/depressi
ons.htm
Ian Marcouse, The Business Studies Teachers’ Book (ISBN:
0340-73763-8), 1999
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