V A business cycle can be defined as a

wavelike fluctuations of business activity

characterized recurring phases of
expansion & contraction in periods varying
from 3 to 4 years.
V Business activity never takes place in a
steady manner. It implies that the period of
business expansion comes to an end sooner
or later. After turning point the business
activity passes through the phase of
contraction which also terminates in a few
years & once again the business activity
finds itself on the expansion path.
i. Recurring Fluctuations
ii. Period of Business Cycle is longer than a
year
iii. Presence of the alternating forces of
expansion & contraction
iv. Phenomenon of the crisis
V jvery business cycle has the critical mark off
points of peak & trough.
V From trough to peak there is the expansion
phase & from peak to trough the
contraction phase.
V Apart from these two relatively longer
phases there are two other phases
characterized by the turning points.
V The upper turning point located at the peak
marks the beginning of recession, while the
lower turning point located at the trough
mark the beginning of revival.
V The prosperity phase begins from an equilibrium
position under the stimulus of certain forces. These
forces create expectation of rising profits which in
turn induce entrepreneurs to increase the scope of
their activities, they employ more people in their
industries & order more raw material.
V The demand for raw material leads to larger
employment in other industries as does the
demand for consumption goods when worker
spend their additional earning received from the
entrepreneurs.
V Since the wages increase rapidly the demand for
consumption goods also increase rapidly. The
supply of these goods, however in the later stages
increases with a lag & this leads to a rise in prices.
Thus the prosperity phase is accompanied by a rise
in prices which gathers momentum towards the
later stages.
V This delay in price rise is mainly due to fact that there
is some unutilized plant capacity available in the
early stages of expansion & production can be
increased without proportionate increase in costs.
But in the later stages unutilized plant capacity is not
there & thus plants have to be expanded. Further,
some other bottlenecks may appear. Also. With
growing employment, workers may succeed in
forcing employer to play higher wages. Under these
condition both production cost & prices rise.
V Distortion of price relation ² Prices do not rise
uniformly during this phase. Wholesale prices rise
more than retail prices. Changes occur not only in
the relative prices of goods but also in the various
cost structure. Raw Material costs increase rapidly
whereas rent, wages, salaries, interest rate, etc.
increases slowly.
V jxpansion reaching its heights ²jntrepreneurs,
observing that their profits are growing rapidly make
further investments. The increasing investment
activity during this phase results in growth of fixed
assets. It also makes substantial increase in wages
which add to increase in consumption of goods &
strengthen the general price level. This waves of
optimistic sentiments is exhibited in the form of real
estate & stock market booms. The economy is
brought to a relatively high pitch of production,
where the activity of producers increases at a pace
much faster than the consumption. However the
rate of activity eventually begins to be slowed down
& by gradual change or abrupt transition, the phase
of prosperity eventually ends & turns into the phase
of recession. The turn of the cycle has thus been
reached.
V In this period while the forces of expansion are
weakened, the forces that makes for contraction
get strengthened. The recession is normally
characterized by liquidation in the stock market,
strains in the banking system, fall in prices, a sharp
reduction in demand for capital equipment &
abandoning of relatively new projects.
V During recession production of consumer goods
does not decline immediately, even when the
income of the people fall, they persist for sometime
with their consumption standard which they have
achieved in good times. Hence, the demand for
consumption goods fall with a lag. In contrast, the
fall in the production of capital goods is dramatic.
Since entrepreneurs abandon their investment
program
V The sign of recession are not immediately
noticed in the industrial sector. The most
noticeable signal of recession is the weakening
of the stock markets which is the pulse of the
industrial sentiments. Its weakening is caused by
the realization that profits can no longer be
maintained. The speculators in order to avoid
future losses start selling securities. The
beginning, however is made usually by the
insiders who are anxious to get out early.
V The liquidation of securities as well as inventories
together with suspension of investment
programs is a prelude to a prolonged phase of
declining business activity.
V Whether the depression will be reached by a
orderly less trying transition or it will be
accompanied by an explosive financial panic
depends on the nature of previous booms, existing
state of minds of the people & the policies
adopted.
V Recession can pass without any problem. Provided
people do not panic & make impossible demands
for liquidity from banks.
V If banks continue making advances to all those
who have a good name in the market(goodwill) &
security & honor all demands for cash promptly,
the crisis might be adverted. Normally, during
recessions banks & other financial institutions do
not reach the stage of bankruptcy. This situation
develops when depressions sets in.
V Recession ultimately merges into depression which is
the phase of relatively low economic activity. When
an economy moves from recession to depression,
there is a notable fall in production of goods and
services & in employment. This decline in production
is general & is visible throughout the economy.
Usually agricultural activity usually considered to be
necessary for subsistence is not much affected in
terms of both output & employment. Retail business
is also little affected. In contrast, the output
reduction is substantial in manufacturing, mining &
construction. In the industrial sector, the worst
affected industries are those which produce
machines, tools, plants, equipment & steel. In these
industries, employment falls rapidly.
During depression there is a substantial reduction in the
incomes of the people & thus the demand for
consumer goods also declines. Nonetheless, it is far less
than fall in demand for machines & equipment. It has
been observed that during depression when incomes
of most of the household drastically fall, they make
substantial reduction in their expenditure on durable
goods. This explains why the output & employment in
industries producing these goods fall rapidly. Most of
the households even when their incomes fall during the
depression find it difficult to reduce the consumption of
non-durable goods. Therefore, production &
employment are little affected in the sectors producing
these goods. During depression the general price level
falls despite the reduction in output of goods & services.
In the earlier stages when the producers & wholesalers
realize that the demand is falling, they liquidate
inventories piled up during the prosperity phase
This causes an increase in the supply of goods which in
turn leads to fall in prices. As the contraction proceeds
the purchasing power of the people steadily falls & this
causes further decline in prices. Steadily declining
prices of commodities continuously erode the profit of
producers & traders. In the later stages of depression
some firm incur losses & in an atmosphere of pessimism
have little hopes for the revival of economic activity.
These are the conditions in which the most adverse
affected firms decide to close down. Those of the firms
which survive see no reason why they should make
investments. Deteriorating business prospects &
abandoning of the investment activity results in
substantial reduction in bank lending. In this phase
distortion in cost ² price relations occur. These cost
rigidities while prices continue to fall during the
depression wipe out the profit margins in many cases.
The recovery starts when forces that work to restore the
normal price relations & cost price factors start
operating effectively. The recovery is gradual, it starts
when the prices stop falling. When inventories are
exhausted with the slowing down of production,
supplies reach scarcity levels & further downward
movement of prices is arrested. This is the stage where
producers see no risk in undertaking production. This
stage reaches faster in those fields where production
can be controlled easily. During depressions demand
for durable goods is reduced drastically & production
is correspondingly cut down. But the demand for even
these goods cannot be postponed indefinitely.
Therefore, once the stock of these goods are
exhausted, the pressure for increasing their production
is created. To begin with, firms use idle capacity to
increase production. This naturally generates both
employment & income which creates additional
demand for goods & services. The firms begin making
investment t replace depreciated equipment. With
business prospects improving, some firms opt for larger
investments.
Along with restoration of the normal price relations. There
is correction of distortion in cost-price relations. The
lagging costs which had eroded profits margins during
depressions start falling. Since financial institutions do
not find attractive outlets for their funds, interest rates
fall in the later phase of depression. Rent, insurance
rate & taxes are also adjusted downwards. Wages are
reduced under the hard reality of unemployment.
Since the relatively inefficient workers lose jobs, less
efficient plants are left idle & less efficient managerial
executives are dropped, the general level of
efficiency rises during the later phase of depression,
which in turn lowers down average cost of production.
Under the influence of these changes in cost structure,
losses are replaced by profit. Obviously together with
upwards movement of prices, rational adjustment in
cost-price relations induce investment activity. In
course of time, the recovery process gathers
momentum due to multiplier effect coming into
operations.
Another sign of recovery, is the revival of stock market
activities manifested in the rising prices of securities.
The upward movement of prices of the securities is
taken to be a good indicator of the recovery of profits.
Increase of stock prices provide inducement to
construction & other capital projects. With the
expectation of growing profits entrepreneurs undertake
construction of factory building & shopping complexes.