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Business Cycles

Business Cycle- Phases and Features

After going through this lesson, you shall be able to understand the following concepts:

  • Meaning of Business Cycle
  • Phases of Business Cycle
  • Features of Business Cycle
We earlier discussed that economics deals with the fluctuations in the economic activities of a country. But, the important questions that arise are: What are these fluctuations? How do we identify them? How do they occur? And so on. So let’s answer these questions one by one.
Consider the following cases:
1. Due to rapid growth during 1920s, UK saw a gradual growth in the GDP, living standards and production levels of the country. Not only this, the growth was also fuelled by new technologies and production processes like the assembly line production along with a rise in the value of stock market.
2. During 1990s, Japan experienced a fall in its growth rate following the asset price bubble. In fact, it went through stagnancy with a continuous fall in GDP, real wages and stagnant price levels.
These cases portray the business cycles in two countries. The first example shows how the UK economy experienced a boom period during 1920s while the second example indicates the recession period in Japan.
Through research, we can find many more examples of boom and recession in the economic history of the world which indicates that at some time or the other, nearly all the countries have gone through periods of prosperity alternating with periods of economic downturns. Such rhythmic fluctuations in economic activities of an economy over a period of time are called business cycles or trade cycles.
Important Note: According to Keynes, a trade cycle is composed of periods of good trade characterised by rising prices and low unemployment percentage, altering with periods of bad trade characterised by falling prices and high unemployment percentages.
So in a nutshell we can say, that business cycle refers to the fluctuations in the form of expansion or contraction of overall economic activities, such as, GDP, employment and income levels of a country. However, these fluctuations are recurrent and occur periodically. That is, they reoccur after certain time periods, but their intervals or length are never the same. For example, some business cycles may be long, lasting for several years while others may end after two to three years.
Phases of Business Cycle
A business cycle consists of four different phases. These are:

These phases can be understood with the help of the following figure:

In Figure 1, the trend line represents the steady growth line of an economy when there are no business cycles. However, in the presence of business cycles, the economic growth line follows a different pattern. In figure 1, the line depicting the Real GDP begins with ‘trough’ when the overall economic activities are at the lowest levels, but, with expansion of production and employment, the economy revives, and moves onto the expansion path. Now, since expansion cannot be indefinite, the economy tends to contract after reaching the ‘peak’. Such contraction continues till it again reaches the lowest turning point i.e. ‘trough’. Once the economy reaches trough, it again revives after a certain time period, and thus, leading to a new business cycle which goes on and on.
Let’s discuss the phases of business cycle in detail.

1. Expansion (also called Boom/Upswing): It refers to a period where a country experiences an increase in output, employment, aggregate demand, capital, profit levels, etc. During this phase, constant efforts are made to ensure full employment of resources and maximum level of production by using the available resources productively. Not only this, the expansionary phase is also characterized by increasing prices, low unemployment levels, increase in consumption and spending and high investment. Such changes altogether increase the prosperity of the country and add to the standard of living of people. Eventually, following an expansionary phase, the growth levels slow down and reach its peak.

2. Peak or Prosperity: It refers to the top or the highest point of the business cycle, where after the economic growth stabilizes for some time and then starts declining. In other words it is the time period before the economic indicators start to show a fall. During this phase of business cycle, the input prices increase due to shortage of their supply. Moreover, the output prices increase leading to a high cost of living, following which, the consumers often tend to reduce consumption expenditure on different goods and services. As a result, the demand stagnates and the economic growth starts moving in reverse direction.

3. Contraction (also called Recession/Downswing): It refers to the period where the levels of investment and employment begin …

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