Business Cycles

The business cycle is the periodic but irregular up-and-down movement in economic activity, measured by fluctuations in real gross domestic product (GDP) and other macroeconomic variables. A business cycle is typically characterized by four phases recession, recovery, growth, and declinethat repeat themselves over time. Economists note, however, that complete business cycles vary in length. The duration of business cycles can be anywhere from about two to twelve years, with most cycles averaging six years in length. Some business analysts use the business cycle model and terminology to study and explain fluctuations in business inventory and other individual elements of corporate operations. But the term "business cycle" is still primarily associated with larger (industry-wide, regional, national, or even international) business trends.

STAGES/PHASES OF A BUSINESS CYCLE

1. Recession A recession is a period of reduced economic activity in which levels of buying, selling, production, and employment typically diminish. This is the most unwelcome stage of the business cycle for business owners and consumers alike. A particularly severe recession is known as a depression. A decline in the real GDP that occurs for at least two or more quarters. Recessions feed on themselves. During a recession, business people spend less than they once did. Because sales are failing, businesses do what they can to reduce their spending. They lay off workers, buy less merchandise, and postpone plans to expand. When this happens, business suppliers do what they can to protect themselves. They too lay off workers and reduce spending. As workers earn less, they spend less, and business income and profits decline still more. Businesses spend even less than before and lay off still more workers. The economy continues to slide. 2. Recovery Also known as an upturn, the recovery stage of the business cycle is the point at which the economy starts working its way up to better financial footing. A period in which the real GDP grows; recovery from a recession. When business begins to improve a bit, firms will hire a few more workers and increase their orders of materials from their suppliers. Increased orders lead other firms to increase production and rehire workers. More employment leads to more consumer spending, further business activity, and still more jobs. Economists describe this upturn in the business cycle as a period of expansion and recovery. 3. Growth Economic growth is in essence a period of sustained expansion. Hallmarks of this part of the business cycle include increased consumer confidence, which translates into higher levels of business activity. Because the economy tends to operate at or near full capacity during periods of prosperity, growth periods are generally accompanied by inflationary pressures. In this phase, the business is continually gaining regular customers. Sales should be increasing every week and cash flow is almost always positive. In the case of a small business; there is likely to be between 10 and 15 employees working on a consistent roster.

With growth comes complexity, responsibility and a need for long term planning. Advertisement is important during both establishment and growth, as is the need to make investments in relevant equipment or employees to ensure a good reputation. Owners must be careful not to expand faster than their business can adapt to the changes. 4. Decline Also referred to as a contraction or downturn, a decline basically marks the end of the period of growth in the business cycle. Declines are characterized by decreased levels of consumer purchases (especially of durable goods) and, subsequently, reduced production by businesses. During the declining stage of business income continues to drop as do profits. Slowly, they slide away as a competitor is able to entice away customers with better service and lower prices or more modern products. To succeed in this stage: Introduce new products or services and market aggressively. If you can't reduce your price in line with your competition, find some other way to differentiation yourself. If you have to, sell your business at this stage and let someone else take it to new heights while you go create another business.

FACTORS THAT SHAPE BUSINESS CYCLES

For centuries, economists around the world regarded economic downturns as "diseases" that had to be treated; it followed, then, that economies characterized by growth and affluence were regarded as "healthy" economies. By the end of the 19th century, however, many economists had begun to recognize that economies were cyclical by their very nature, and studies increasingly turned to determining which factors were primarily responsible for shaping the direction and disposition of national, regional, and industry-specific economies. Today, economists, corporate executives, and business owners cite several factors as particularly important in shaping the complexion of business environments. Volatility of Investment Spending Variations in investment spending is one of the important factors in business cycles. Investment spending is considered the most volatile component of the aggregate or total demand (it varies much more from year to year than the largest component of the aggregate demand, the consumption spending), and empirical studies by economists have revealed that the volatility of the investment component is an important factor in explaining business cycles. According to these studies, increases in investment spur a subsequent increase in aggregate demand, leading to economic expansion. Decreases in investment have the opposite effect. Indeed, economists can point to several points in history in which the importance of investment spending was made quite evident. The Great Depression, for instance, was caused by a collapse in investment spending in the aftermath of the stock market crash of 2009. Similarly, the prosperity of the late 2012s was attributed to a capital goods boom.

There are several reasons for the volatility that can often be seen in investment spending. One generic reason is the pace at which investment accelerates in response to upward trends in sales. This linkage, which is called the acceleration principle by economists, can be briefly explained as follows. Suppose a firm is operating at full capacity. When sales of its goods increase, output will have to be increased by increasing plant capacity through further investment. As a result, changes in sales result in magnified percentage changes in investment expenditures. This accelerates the pace of economic expansion, which generates greater income in the economy, leading to further increases in sales. Thus, once the expansion starts, the pace of investment spending accelerates. In more concrete terms, the response of the investment spending is related to the rate at which sales are increasing. In general, if an increase in sales is expanding, spending on investment rises, and if an increase in sales has peaked and is beginning to slow, investment spending falls. Thus, the pace of investment spending is influenced by changes in the rate of sales. Momentum Many economists cite a certain "follow-the-leader" mentality in consumer spending. In situations where consumer confidence is high and people adopt more free-spending habits, other customers are deemed to be more likely to increase their spending as well. Conversely, downturns in spending tend to be imitated as well. Technological Innovations Technological innovations can have an acute impact on business cycles. Indeed, technological breakthroughs in communication, transportation, manufacturing, and other operational areas can have a ripple effect throughout an industry or an economy. Technological innovations may relate to production and use of a new product or production of an existing product using a new process. The video imaging and personal computer industries, for instance, have undergone immense technological innovations in recent years, and the latter industry in particular has had a pronounced impact on the business operations of countless organizations. However, technological innovations and consequent increases in investmenttake place at irregular intervals. Fluctuating investments, due to variations in the pace of technological innovations, lead to business fluctuations in the economy. Variations in Inventories Variations in inventoriesexpansion and contraction in the level of inventories of goods kept by businessesalso contribute to business cycles. Inventories are the stocks of goods firms keep on hand to meet demand for their products. How do variations in the level of inventories trigger changes in a business cycle? Usually, during a business downturn, firms let their inventories decline. As inventories dwindle, businesses eventually use down their inventories to the point where they are short. This, in turn, starts an increase in inventory levels as companies begin to produce more than is sold, leading to an economic expansion. This expansion continues as long as the rate of increase in sales holds up and producers continue to increase inventories at the preceding rate. However, as the rate of increase in sales slows, firms begin to cut back on their inventory accumulation. The subsequent reduction in inventory investment dampens the economic expansion, and eventually causes an economic downturn. The process then repeats itself all over again. It should be noted that while variations in

inventory levels impact overall rates of economic growth, the resulting business cycles are not really long. The business cycles generated by fluctuations in inventories are called minor or short business cycles. These periods, which usually last about two to four years, are sometimes also called inventory cycles. Fluctuations in Government Spending Variations in government spending are yet another source of business fluctuations. This may appear to be an unlikely source, as the government is widely considered to be a stabilizing force in the economy rather than a source of economic fluctuations or instability. Government spending not only contributes to economic expansions, but economic contractions as well. In fact, the recession of 195354 was caused by the reduction in government spending after the Korean War ended. More recently, the end of the Cold War resulted in a reduction in defence spending by the United States that had a pronounced impact on certain defence-dependent industries and geographic regions. Politically Generated Business Cycles Many economists have hypothesized that business cycles are the result of the politically motivated use of macroeconomic policies (monetary and fiscal policies) that are designed to serve the interest of politicians running for re-election. The theory of political business cycles is predicated on the belief that elected officials (the president, members of Congress, governors, etc.) have a tendency to engineer expansionary macroeconomic policies in order to aid their re-election efforts. Monetary Policies Variations in the nation's monetary policies, independent of changes induced by political pressures, are an important influence in business cycles as well. Use of fiscal policy increased government spending and/or tax cutsis the most common way of boosting aggregate demand, causing an economic expansion. The Central Bank, in the case of the India, The Reserve Bank of India, has two legislated goalsprice stability and to operate currency and credit system. Its role in monetary policy is a key to managing business cycles and has an important impact on consumer and investor confidence as well. Fluctuations in Exports and Imports The difference between exports and imports is the net foreign demand for goods and services, also called net exports. Because net exports are a component of the aggregate demand in the economy, variations in exports and imports can lead to business fluctuations as well. There are many reasons for variations in exports and imports over time. Growth in the gross domestic product of an economy is the most important determinant of its demand for imported goodsas people's incomes grow, their appetite for additional goods and services, including goods produced abroad, increases. The opposite holds when foreign economies are growing growth in incomes in foreign countries also leads to an increased demand for imported goods by the residents of these countries. This, in turn, causes Indian exports to grow. Currency exchange rates can also have a dramatic impact on international trade and hence, domestic business cyclesas well.