Business Cycle: Meaning and Various Phases of it

Business cycle is an important feature of capitalist economy. It means alternating periods of prosperity and depression in the country. It has been defined as an alternative expansion and contraction in overall business activity as evidenced by fluctuations in measures of aggregate economic activity, such as, the gross product, the index of industrial production and
employment and income. Generally speaking, the cyclical fluctuations have a tendency towards simultaneous appearance in all the branches of national economy. But, sometimes, they may be confined only to an individual industry of individual sectors of the economy. Cyclical fluctuations in such cases are referred to as specific cycles.

Phases of a Typical Business Cycle

A typical business cycle is characterized by five different phases or stages- depression, recovery (or revival), prosperity (or full employment), boom (or overfull employment) and recession.

i) Depression

The depression is the first stage of trade cycle. It is a protracted period in which business activity in a country is far below the normal. It is characterized by a sharp reduction of production, mass unemployment, falling prices, falling profits, low wages, contraction of credit, a rate of business failures and an atmosphere of all-round pessimism and despair. A decline in output or production is accompanied by a reduction in the volume of employment. A construction activity comes to a more or less complete standstill during a depression. The consumer goods industries, such as food and clothing, are not so much affected by unemployment as the basic capital goods industries. The prices of manufactured goods fall to low levels. Since the costs are ‘sticky’, and do not fall as rapidly as prices, the manufacturing suffer huge losses. Many of the firms have to close down on account of accumulated losses. The two longest depressions in the US history were those of 1873-1879 (65 months) and 1929-1933 (44 months).

ii) Recovery

It implies increase in business activities after the lowest point of the depression has been reached. During this phase, there is a slight improvement in economic activity, to start with. The entrepreneurs begin to feel that the economic situation is, after all, not so bad as it is in the preceding stage. This leads to further improvement in business activity. The industrial production picks up slowly and gradually. The volume of employment also increases steadily. There is slow but sure rise in prices accompanied by a small rise in profits. The wages also rise, though they do not rise in the same proportion in which the prices rise. Attracted by rising profits, new investments take place in capital goods industries. The banks expand credit. The business inventories also start rising slowly. The recovery continues until business activity reaches approximately the same level that it had achieved before the decline set in. the rate of recovery is generally related directly to that of the preceding depression. The more severe the depression, the more rapid will the recovery be.

iii) Prosperity

This stage is characterized by increased production, high capital investment in basic industries, expansion of bank credit, high prices, high profits, high rate of formation of new business enterprises and full employment. There is a general feeling of optimism among businessmen and industrialists. The longest sustained period of prosperity occurred in the USA between 1923 and 1929 with some minor interruptions in 1924.

iv) Boom

It is the stage of rapid expansion in business activity to new heights, resulting in high stocks and commodity prices, high profits and overall employment. The prosperity phase of the trade cycle does not end up with a stable state of full employment; it leads to the emergence of boom. The continuance of investment even after the stage of full employment results in a sharp inflationary rise of prices. This causes undue optimism among businessmen and industrialists who make additional investment in the various branches of the economy. This put additional pressures on the factors of production which are already fully employed, causing a sharp rise in their prices. Soon, the situation develops in which the number of jobs exceeds the over full employment. Attracted by rising profits, the businessmen further increase their capital investments. Runaway inflation raises its head in all its ugliness. Prices rise sky-high. There is an atmosphere of over-optimism all round.

But the developing boom carries within it the seeds of self-destruction. Factors of production become scarce causing spurt in their prices. The costs of calculations are upset. Some new hastily set up firms collapse. This makes the businessmen over-cautious. They now begin to stay away from new projects and even stop the expansion of existing units. This prepares the ground for the succeeding stage. A boom is inevitably followed by a bust.

v) Recession

A feeling of over-optimism of the earlier period is replaced now by over-pessimism characterized by fear and hesitation on the part of the businessmen. The failure of some among businessmen. The banks also get panicky and begin to withdraw loans from business enterprises. More business enterprises fail. Prices collapse and confidence is rudely shaken. The initial unemployment spreads to other industries. Unemployment leads to a fall in income, expenditure, prices and profits. Once a recession starts, it goes on gathering momentum and finally assumes the shape of full-fledged depression- the first stage of the trade cycle is complete. The 1957-58 recession in the USA was a severe one.

The various phases of the business cycle can be illustrated in the diagram as below.
Phases of Business Cycle
In this diagram, PM is the full employment line. Above this line, we have two stages of the trade cycle, a boom in the upswing and a recession in the downswing. Below this line again we have two stages of the trade cycle, a recovery in the upswing and depression in the downswing. The business cycle as shown in the diagram passes through five stages. It starts with depression to be followed by recovery, prosperity, boom, recession, and ultimately ends up again with depression.

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