During the past hundred years if we study conditions of trade, we find ups and downs in the level of economic activity. These ups and downs in the economic activity are called trade cycles or business cycles.
According to Keynes a business cycle is composed of good trade as well as bad trade. During the time of good trade, output, level of employment, prices and incomes of the people rises. During the time of bad trade output, level of employment, prices and incomes of the people fall. In other words, economic activity rises and falls in regular manner.
Characteristics of Business cycle
A business cycle has two characteristics namely periodicity and synchronization.
1. Periodicity : It is cyclical in nature. A business cycle must occur at fairly regular intervals.
2. Synchronization : A business cycle pass on from one sector to another and spread the entire economy. It also spreads from one country to another.
Phases of Business Cycle :
A business cycle has five different phases
1) Expansion, 2) Prosperity, 3) Recession, 4) Contraction, 5) Revival. These phases of business cycles are shown in the following:
1. Expansion : Business cycle starts with depression. In this situation suppose production is stimulated by one reason or other. Hope begins to appear in the business. Favorable conditions appear for the expansion of business. Producers begin to increase production. Income will increase. The demand will increase because of increased incomes. Prices begin to go up. Profits will begin to increase. In this way business expansion starts. This is the expansion phase of a business cycle.
2. Prosperity : The above cumulative process reaches a stage where there is full employment. In this stage all the factors of production are fully employed. There will not be involuntary unemployment. At this stage economic activity reaches its optimum level. Stability of output, wages, prices and incomes are obtained. Business people keep more stocks to have advantage of rising prices. Banks increase credit. There will be business prosperity and there will be full employment. This is called the prosperity phase of a business cycle.
3. Recession : After same period of prosperity, trade recession begins. Higher wage rates, high interest rates and higher prices of raw-materials increase the cost of production considerably. Profit margin begins to decline. With this they stop further expansion of business. They also try to cut down present production. Banks call the business people to repay the loans. Thus, the forces of depression set into economy. This is called the Recession phase of a business cycle.
4. Contraction : When business recession begins, production, employment, incomes, demand etc. will fall, prices fall. Some firms become insolvent. This gloom pass on from one industry to the other and spreads the entire economy. There will be large scale of unemployment. Thus, again contraction or depression takes place.
5. Revival: After sometime setting of depression hope begins to appear in business. Favorable conditions appear for the improvement of economic situation. Low wages, cheap credit facilities, low prices of factor and raw-materials induce the entrepreneurs to increase production. Income of the people increases. Demand increases and prices begin to rise. Rising prices and falling costs increase profit margins. In this stage, Banks also begin to give more credit on liberal terms. Investment will increase. Thus production, incomes, and employment will move towards
upward direction. In this way, this cumulative process sets into economy. Due to this cumulative effect, the economy improve and recover from contraction or depression. This is the revival phase of a business cycle.
Thus, a business cycle passes through these five phases.
