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Business Cycle, term used by economists to designate a periodic increase and decrease in an economy’s production and employment. Ever since the Industrial Revolution of the 1800s, the overall level of production in industrialized capitalist countries has varied from high output and employment to low output and employment. Economists started to study business cycles because they have a significant impact on all aspects of an economy.
Furthermore, the preparation of this report aims to look at the Business Cycle in general, history of business cycle and examples of long waves, phases of business cycle: recession, depression, expansion and recovery and peak and how to keep track on business cycles in order to to understand why there are ups & downs in that nation’s economy and to learn what can be done to prevent recessions and maintain prosperity
Business Cycle: a predictable long-term pattern of alternating periods of economic growth (recovery) and decline (recession), characterized by changing employment, industrial productivity, and interest rates. Also called economic cycle.
History of Business Cycle:
Many people believe that business cycles exist according to the theories. This has not been a permanent belief. In the 19th century, business cycles weren’t mentioned at all and it was spells of “crises” which is interrupting the smooth development of the economy. In later years, both economists and non- economists began to believe in the regularity of such crises, analyzing how they were spaced apart and associated with changing economic structures.
Obviously, not every economic cycle operates on the same yardstick. The following classification, originally conjured up by Schumpeter (1939), defines a few of them by their duration (trough to trough or peak to peak) for examples:
Seasonal cycles – within a year
Kitchin cycles – 3 years
Juglar cycles – 9-10 years
Kuznets cycles – 15-20 years
Kondratiev cycles – 48-60 years
Also, Schumpeter labeled the “four-phases” of a cycle which are: boom, recession, depression and recovery. Boom, is a rise which lasts until the peak is reached; a recession is the drop from the peak back to the mean; a depression is the slide from the mean down to the trough and a recovery is the rise from the trough back up to the mean. Despite the meanings, these phases cycle are moved up into another boom and thus the beginning of another four-phase cycle. Additionally, if any cycle of whatever duration can be described as going through these four phases, the fluctuations cannot really be described as “cycles”.
Theorists of business cycle believe that the economy goes through like waves of economic activity. However, it causes the economy to exhibit this type of activity has been a source of many disruptive, as a result it become far imaginative and exercises.
There are many empirical facts that all business cycle theorists should be acquainted. To begin with, empirical evidence shows that throughout the 19th Century, the price level oscillated heavily while output was much less subject to fluctuations. Thus, the early analysis of “cycles” was based precisely on their definition as swings in price levels and not output. Nevertheless, during the 20th Century there has normally been a constant upward trend in prices by saving few exceptions. Prices varied, of course, but only around this upward trend. Output, however, oscillated heavily in the 20th century – thus what were defined as “cyclical” were movements in output like: in recessions and depressions. Also, output would increase in the recovery and boom. That means the “cycle” or even a “crisis” as a movement in output is a rather recent phenomenon.
Lastly, Wesley C.Mitchell dedicated much of his life to measuring and analyzing business cycles, thus it is no surprise that Mitchell’s NBER has maintained the most widely accepted historical record of business cycles in the United States.
The NBER does not record Kondratiev Cycles (or “long waves”) and they don’t believe these cycles exist. Even so, these four Kondratiev waves have been identified by going through four phases of boom, recession, depression and recovery (the dates and labels are from Kuznets, 1940) such as:
(1) The Industrial Revolution (1787-1842) is the most famous Kondratiev wave: the boom began in about 1787 and turned into a recession at the beginning of the Napoleonic age in 1801 and, in 1814, deepened into a depression. The depression lasted until about 1827 after which there was a recovery until 1842. As is obvious, this Kondratiev rode on the development of textile, iron and other steam-powered industries.
(2) The Bourgeois Kondratiev (1843-1897): After 1842, the boom reemerged and a new Kondratiev wave began this one as a result of the railroadization in Northern Europe and America and the accompanying expansion in the coal and iron industries. The boom ended approximately in 1857 when it turned into a recession. The recession turned into a depression into 1870, which lasted until about 1885. The recovery began after that and lasted until 1897.
(3) The Neo-Mercantilist Kondratiev (1898-1950?): The boom began about 1898 with the expansion of electric power and the automobile industry and lasted until about 1911. The recession which followed turned into depression in about 1925 which lasted until around 1935. We can assume that this third wave entered into a recovery immediately afterwards which one might suspect lasted until around 1950.
(4) The Fourth Kondratiev (1950 – 2010?). There has been much debate among believers on the dating the Fourth Wave – largely because of the confusions generated by the low fluctuation in price levels and the issue of Keynesian policies and hence this debate is yet to be resolved. Perhaps the most acceptable set of dates is that the boom began around 1950 and lasted until about 1974 wherein recession set in. When (and if) this recession fell into its depression phase may be more difficult to ascertain (c.1981?), but what has been more or less agreed upon is that 1992 (or thereabouts) the recovery began and has been projected to give way to a boom and thus a new Kondratiev wave around 2010 or so.
The Phases Of The Business Cycle
Economists have many different ways of labeling the business cycle. The business cycle may be defined as the changes that occur to the real GDP because of alternating periods of expansion and contraction. The phases are:
1. Recession. A decline in the real GDP occurs for at least two or more quarters. During a recession, business people spend less than they once did. As a result, 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. Since 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. Low Point or Depression. State of the economy where there are large unemployment rates, a decline in annual income, and overproduction. The time of the the real GDP stops there decline and starts expanding to the lowest point. Sooner or later, the recession will reach the bottom of the business cycle. How long the cycle will remain at this low point varies from a matter of weeks to many months. During some depressions, such as the one in the 1930s, the low point has lasted for years.
3. Expansion and Recovery. 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.
4. Peak. The point of real GDP stops increasing and begins its decline; the highest point. At the top, or peak, of the business cycle, business expansion ends its upward climb. Employment, consumer spending, and production hit their highest levels. A peak, like a depression, can last for a short or long period of time. When the peak lasts for a long time, we are in a period of prosperity.
One of the dangers of peak periods is that of inflation. During periods of inflation, prices rise and the value of money declines. Inflation is more of a threat during peak periods because employment and earnings are at high levels. With more money in their pockets, people are willing to spend more than before. In this way, demand is increased and prices rise.
Graphically the phases would look like so:
How Do Economists Keep Track Of The Business Cycle?
For many years, economists have tried to identify why there are ups and downs in that nation’s economy. They want to learn what can be done to prevent recessions and maintain prosperity. Therefore, they ask the following questions which are: (1) in what phase of the business cycle is our economy at the present time? And (2) Where is the business cycle heading?
On the other hand, economists believe that there are five causes of the business cycle.
The first cause is changes in capital expenditures. Businesses have expectations of sales growth, when the economy is strong. They invest heavily in capital goods. Although, businesses may decide that they have expanded to their limit, so they begin to pull back on their capital investments and cause an eventual recession.
The second cause of the business cycle is inventory adjustments. At the first sign of an economy reaching its peak, there are some businesses that cut back their inventories and then build them back up again at the first sign of a trough. Both actions cause the real GDP to fluctuate. Innovation and imitation are the third causes of the business cycle. Innovations include new products, new inventions, or a new way of performing a task. When a business innovates, it often gains an edge on its competitors because its costs decrease or its sales increase. Whatever the case, profits increase and the business grows. If other business in the same industry wants to keep up, they then copy what the innovator has done (imitation) or they come up with something better. While, Imitation companies usually invest heavily and an investment boom follows, the innovation spreads to another industry and the situation changes. Additional investments are unnecessary and economic activity may slow.
The fourth causes of the business cycle are the credit and loan policies of commercial banking. When “easy money” policies are in effect, interest rates are low and loans are easy to get. They encourage the private sector to borrow and invest, thus stimulating the economy. Eventually the increased demand for loans causes the interest rates to rise, which discourage new borrowers. The economy keeps declining until interest rates fall and the business cycle begins over again. So it won’t be slow down and decline.
The final cause of the business cycle is external shocks. Shocks such as increases in oil prices, wars, and international conflict, have the potential to either drive the economy up, or down. The economy may benefit when a new supply of natural resources is discovered. Such was the case with Great Britain in the 1970’s when an oil field was discovered off its coast in the North Sea. The British economy of course profited seeing that world oil prices were at an all time high, but the high prices hurt the United States at the same time.
The central idea of business-cycle, that the economy has regular and periodic waves–a cycle–lasting for several years, has few adherents today. Perhaps such cycles never existed, or perhaps they once did but no longer do because the government now plays a large and active role in the economy. However, the business-cycle approach remains useful because it is an easy way to introduce a number of macroeconomic topics, including the adjustment process that remains central in macroeconomics. It also provides a transition from our examination of monetary theories to an introduction to Keynesian economics, a very different way of viewing the macroeconomic.
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