According to Parkin and Bade – “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. A business cycle is not a regular, predictable, or repeating phenomenon like the swing of the pendulum of a clock. Its timing is random and, to a large degree, unpredictable”.
A business Cycle has two expansion phases and two contraction phases. The expansion phase shows more rapid growth than the long run trend of growth rate. Similarly the contraction phase shows rapid decline in growth rate.
When the decline in growth rate reaches its lowest (lower) point expansion begins. Beginning from the lower turning point, the phase of recovery starts and after some time it reaches the upper turning point or peak. But this peak situation can’t remain forever, so now it starts to move downwards and the phase of contraction starts then phase of recession then the bottom, after hitting bottom it starts to move upwards, and this goes on forever.
Phases of business cycles –
1. Expansion (Boom, Upswing, Prosperity)
2. Peak (Upper turning point)
3. Recession (Contraction, Downswing)
5. Trough (Lower turning point)
1. Expansion –
The steady line shows the growth of the economy when there is no business Cycle. The line of cycle that moves above the steady growth line represents the expansion phase of a business cycle. In the expansion phase, there is an increase in all economic activities, such as production, employment, output, wages, profits etc.
2. Peak –
A peak is the top of a cycle. At peak, both the output and employment reaches at the highest possible level with the given resources. There is no involuntary unemployment and whatever unemployment prevails is only of frictional and structural types. So, at peak level the gap between potential GNP and actual GNP is zero. The level of production is at maximum level. The demand for durable consumer goods is high also the investment is at the high level in this phase. Prices also rise during the expansion phase but due to the high level of economic activity people enjoy a high standard of living.
Then something may happen, whether banks start reducing credit or profit expectations change adversely and businessmen become pessimistic about the future state of the economy that brings an end to the expansion phase.
3. Recession –
When the economy reaches its peak, it starts slowing down. The phase of recession starts when the decline in the growth rate becomes rapid and steady. Recession can be identified by reduced investments, fall in bank credits, decline in stock prices, increase in unemployment etc.
4. Depression –
When the growth rate falls below the steady growth rate the economy enters in the Depression Phase.
This phase is identified by the rapid decline in the national income and expenditures, prices of consumer goods decline, unemployment increases, bank credit decreases etc.
An important feature of the depression is the fall in interest rates. With lower interest rates people’s demand for money holding increases.
5. Trough –
When the economy reaches the depth of depression, then it is called Trough. This marks the end of the depression phase.
At this phase, even the expenditure incurred in maintenance is postponed, small firms goes bankrupt and thrown out of industries.
There is a limit to which level of economic activity can fall. The lowest level of the economic activity is called Trough.
6. Recovery –
In this phase, some firms plan to invest and renovate programs to come back into the market. The stimulation of investment brings the recovery of the economy. As the investment rises, this causes induced increase in consumption. As a result industries starts producing more, employment of the labour increases and rate of unemployment falls, with this cycle is complete.
Over a period of time, when factors of production are fully employed, the wages increases which causes the consumption to increase, with increase in consumption, demand increases, the price of the inputs rises, with the increase in the price of the inputs, the investments increases, which leads to more profits to the producers.
So, the business cycle is a non stop process, which goes on forever.