NGFL WALES BUSINESS STUDIES A LEVEL 2008 Spec Issue 2 Sept 2009 Page 1

RESOURCES.

The Business or Trade Cycle

Specification—The impact of the Business 7 year period. But we did have a much longer
Cycle on business activity. than average period of uninterrupted growth
between 1993 and 2008. Within this cycle
The Business Cycle, also called the Economic there are four distinct phases.
or Trade Cycle, has been studied by
economists for over 100 years.. We all know Note. The business cycle measures
of its effects. Sometimes the economy is fluctuations in GDP over time. GDP ( Gross
booming are other times when economy is in Domestic Product), is a measure of the value
recession. During times of boom of all outputs in the economy over time. The
unemployment is relatively low, wages are current value of UK GDP (2009) is around
rising and inflation is also likely to be rising. £1400 Billion, and over the last 40 years GDP
During times of recession unemployment is has increased on average by around 2.25% per
relatively high, wages may be stagnant and year in real terms (i.e. allowing for inflation)
inflation is likely to be low.
The Four Phases of the Business
Within A Level Business Studies we need to Cycle
examine the parts of the business cycle,
what causes the fluctuations in the cycle and Boom
the implications of the business cycle for This phase is marked by low unemployment or
businesses. even full employment in certain sectors of the
economy, increasing interest rates, increasing
The parts or phases of the Business inflation, high consumer demand, a balance of
Cycle. payments deficit and often a budget surplus
Within the UK economy the business cycle for the government caused by high tax
typically moves from boom to bust over a 4 to revenues and lower expenditure on Social
Security.
The Business Cycle
Recession
Following boom comes
the recession. During
this phase we see
i n c r e a s i n g
unemployment, falling
demand from consumers,
falling investment by
firms and a decline in
the levels of inflation
and interest rates.
Technically a recession
Title Business Cycle Page 2

happens when gross domestic product falls Consumers and the Business Cycle
for two consecutive quarters.
The activities of consumers are often quite
Bust predictable. During the bust phase consumer
The third phase is bust, the bottom of the spending is low, people do not have the
business cycle. In this stage unemployment is confidence to spend on large consumer items
relatively high, inflation is low, demand from or other luxury goods. They may feel insecure
consumers is low especially in regard to about their position in work, they may be
consumer durables (cars, fridges, washing unemployed, or they may just be waiting for
machines etc.) and luxuries such as foreign signs of recovery in the economy. Instead of
holidays , there is very little investment by buying consumer durables such as TVs, washing
firms. machines or cars, they will defer the purchase
of these goods and continue to use their
Recovery existing consumer durables. This pattern of
The final phase is recovery, during this phase behaviour will of course mean less expenditure
investment increases unemployment falls and in the economy, lower demand, and so lower
consumers start to spend again. Doing the production by firms.
first part of recovery there is little inflation
or pressure for increased wages but as we A time will be reached where interest rates
progress through recovery there will be and inflation are so low, and that the rate of
inflation when there are shortages of labour, increase in unemployment slows, so that some
housing, capital etc, confidence returns, this will encourage
borrowing and spending. Demand will increase,
Causes of Fluctuations in the and so output by firms will increase. As this
increase in demand grows in momentum then
Business Cycle
the recovery phase of the business cycle
starts. As more people will be employed, more
Over the past 30 years, the UK business people will have greater confidence in the
cycle has in the main fluctuated over a 4 to 7 future, so again demand will increase. This
year period, moving from boom to bust and increase in demand will be especially evident in
back again. The causes of this cycle in markets such as housing and luxury goods.
economic and business activity are well
understood. It is worth noting that the activities of
consumers are not always predictable. During
There are four main contributors to the the period 92-94 all the conditions were ripe
pattern of fluctuation. The first contributors for an economic recovery, but consumers
are consumers, the second businesses, the refused to spend, they still remembered the
third government, and fourth external boom and bust of the late 80's and were
factors such as world economic conditions. lacking confidence in the future. It will be
What economists are less sure about is how interesting to see if consumers in 2010 will be
to manage these causes, and so reduce the willing to spend again, and jump back into the
fluctuations! housing market after the recent fall in housing
Title Business Cycle Page 3

prices and the problems in the banking

system. Because of the higher levels of spare capacity
and lower cost of factors of production such
As the economy moves through the recovery as borrowing money, employing land and labour,
phase, interest rates and inflation will start a point will be reached where businesses can
to rise. These increases will eventually put a employ extra resources at a relatively low
limit on the growth in consumer spending . cost, so profits can be made by selling at
Expensive borrowing will discourage long term relatively low prices. This will encourage
financial commitments. There will be a point investment and output. This increased
where consumer's spending will start to investment in stock for sale is often a
decline, or the rate of increase in spending response to increasing consumer demand, or
will fall. At this point we reach the top of the the increased investment may be caused by
boom phase and perhaps start to move into increasing levels of exports, this is especially
recession. likely the if the value of the pound is low
making British goods cheap to foreign
Although levels of demand are still high, purchases.
people will now feel less secure about the
future and start limiting demand especially As the recovery phase gathers momentum ,
where long-term commitments are involved, investment in capital goods increases, (as spare
such as buying a car or purchasing houses. As capacity is used up) along with consumer
the recession gathers momentum, demand, this encourages further investment,
redundancies start to mount, often reported which can still be achieved at relatively low
on the news every night, people feel even less cost. At this stage in the business cycle
secure about the future and so again demand demand might outstrip supply, so firms can
starts to fall. This continued fall in demand increase prices, maximising profits, but this in
causes an increase in recession, and so self turn may lead to inflation.
perpetuates the business cycle effect, until
we move into the bust phase and the cycle As the recovery phase progress there will
(hopefully!) starts again. appear shortages of land and labour in specific
areas and industries. There may be shortages
Business and Industry of specialist skills required or shortages of
land in such regions as the southeast. This will
In regard to business, in the bust phase lead to inflationary pressure on wages, the
firms have often suffer from cash flow cost of land and on the cost of borrowing,
problems and lack of working capital. Banks causing interest rates is to increase.
are unwilling to lend to what they see as risky
businesses, but their unwillingness to lend It is worth noting that some regions of the
increases the risk of the firms failure. There country might be booming, whilst others still
is plenty of spare capacity in industry, this have a long way to go before recovery fully
leads to lack of return on previous sets in.
investment and unemployment levels of all
factors of production are high. As inflationary pressure builds this
Title Business Cycle Page 4

discourages investment as firms are now less basic supermarkets (aldi and Lidl) and even
likely to gain an adequate return on the cost holiday companies concentrating on holidays in
of investment. During the recovery stage, the UK. These firms have reverse trading
firms often build large stocks in the cycles i.e. their sales boom during recessions,
expectation of later sale and to meet but suffer during booms!
increasing demand. But towards the end of
the recovery phase these stocks are Other companies can suffer more than others
rundown, this happens because management from the fluctuations in the trade cycle. These
believe that it may soon be hard dispose of are industries that suffer from an
these high levels of stocks. This is running exaggerated trade cycles. A good example are
down of inventories is known as de-stocking. manufacturers of haulage vehicles, such as
trucks, lorries and vans e.g. LDV. In a boom,
This combination of falling investments and new businesses are demanding these products
running down of stocks leads to the end of like they are the only thing to be seen with,
growth and the beginning of a recessionary but once recession hits, and firms start going
period. During this period of the business out of business, the market can be flooded
cycle, firms will have to start cutting prices with second hand vehicles at bargain prices,
to dispose of their goods and also start and demand for new evaporates.
reducing their costs. This reduction in costs
often requires large numbers of Effects of Trade Cycle on Business
redundancies, short-time working or pay cuts.
Throughout the trade cycle businesses will
Firms can also suffer from cash flow suffer from a range of benefits and pressures.
problems. Firms who have over extended These can have a major impact upon the
themselves by borrowing heavily during the operation of firms, and the awareness of these
recovery or boom phase may find that they impacts can often dictate business planning.
have liquidity problems and therefore have to
cease trading. It is in this recessionary phase Recovery.
that most business failures occur. Improved demand will benefit businesses,
turnover increases and so do profits. As the
Eventually the point is reached where recovery progresses prices can be increased
investments levels are falling no more but and profits maximised. There is often pressure
there is very little new investment. Firms to invest, and management of expansion is one
concentrate on trying to sell through lower difficulty faced by management. During the
prices and minimising their costs. This is later stages of recovery, firms will find that
typical of the situation in the bust phase. pressure on wages mounts, increasing costs.
Often firms focus on profitable home markets,
It is worth noting that some businesses look and do not try to win export markets.
forward to recessionary and bust periods, as
this is when demand for their goods and Boom.
services are most buoyant. These businesses Firms must balance maximising profits with the
include low cost clothing shops, low price risks of overextending themselves should
Title Business Cycle Page 5

recession come. Should prices be pushed to focused on reducing interest rates to

the limit, or should firms concentrate on stimulate demand, and borrowing to fund
providing customer value? Profits will be lost government spending. Increased taxes can
if stocks are not built and sold, but high directly impact firms, increasing their costs,
stock levels can sow the seeds of cash flow and indirectly by leaving consumers with less
and liquidity problems during the recession money to spend.
which is likely to follow.
Slump or Bust.
Recession. Many firms believe that this is the time for
This is the time for shedding labour. retrenchment, concentrating on core business
Redundancies can be expensive, and can cause strengths. Others may look for the
resentment and de-motivation amongst those opportunity to buy and employ resources
employees who feel their jobs might be the cheap, taking advantage of low costs. Other
next to go. Also further HRM problems can firms will look for overseas markets, where
be caused by lack of opportunity for demand may still be buoyant.
overtime, short time working, and the
likelihood of reduced wages. To prevent Many of the problems of the recessionary
these problems occurring firms should have a period still exist, and for those whose
strategy of natural wastage that starts to be reserves and resources are low, survival may
used when recovery is at its peak. be the best that they can hope for. Firms must
Performance and productivity improvements be ready to use spare capacity when recovery
can come through efficiency improvements. comes, and be first into the new expanding
markets as consumer demand recovers.
Firms sometimes temporarily close down
entire plants (e.g. Corus Steel), mothballing Exaggerated Business or Trading Cycles.
the facility, so it is ready to be used when As already noted some industries suffer from
demand picks up again. exaggerated business cycles. This means that
as the economy moves from boom to bust and
Liquidity and cash flow problems can also back again, there will be very large
occur at this time. Firms that have over fluctuations in demand levels. Examples of
borrowed during recovery and boom may have these type of industries are Aircraft
problems meeting debt repayments and cash manufacturers and commercial vehicle
flow can be affected by the likely increase in manufacturers. The key to success in these
bad debts (as other businesses fail) and industries is size, gaining from economies of
problems in disposing of existing stocks. scale, and a presence in the multi national
market, which will hopefully even out over-all
In a recession the government is likely be sales, (sales fall in one country but rise in
forced to increase taxes or borrow heavily in another).
an attempt to balance its books. These Fiscal
policies can have the effect of further Notes
reducing total demand in the economy.
Current macro economic policy (2009-10) is