BUSINESS CYCLES – TYPES AND PHASES

BUSINESS CYCLES – TYPES AND PHASES

Definition of Business cycles

                        In the words of W.C. Mitchell, “Business cycles are a species of fluctuations in the economic activities of organized communities. The adjective ‘business’ restricts the concept of fluctuations in activities which are systematically conducted on a commercial basis. The noun ‘cycles’ bars out fluctuations which do not recur with a measure of regularity.” Prof. Mitchell, thus, insists upon a measure or regularity in cyclical fluctuations.

            The business cycle, in short, is an alternate expansion and contraction in overall business activity, as evidenced by fluctuations in measures of aggregate economic activity, such as, the gross product, the index of industrial production, and employment and income.

Characteristic of Business Cycle

            From the definitions given above we can gather the features of business cycle.

(i) It occurs periodically

            The business cycle occurs periodically in a regular fashion. This means the prosperity will be occurring alternatively.

(ii) It is all embracing

            The business cycle implies that the prosperity or depressionary effect of the phase will be affecting all industries in the entire economy and also affecting all industries in the entire economy and also affecting the economies of other countries. It is international in character. The Great Depression of 1929 is an example of this.

(iii) It is wave-like

            The business cycle will have a set pattern of movements which is analogous to waves. Rising prices, production, employment and prosperity will become the features of upward movement: Falling prices, employment will become the features of the downward movement.

(iv) The process is cumulative and self-reinforcing

            The upward movement and downward movement are cumulative in their process. When once the upward movement starts, it creates further movement in the same direction by feeding on itself. This momentum will persist till the forces accumulate to alter the direction and create the downward movement. When downward movement starts, it persists in the same direction leading to the worst depression and stagnation till it is retrieved to gain an upward movement.

(v) The cycles will be similar but not identical

            Different cycles and waves in the business cycles will be similar in general feature, but they are not identical in all respects. “A typical cycle constructed by making, as it is were, a composite photograph of all the recorded cycles would not materially differ in form very widely from any one of them. But this typical cycle is not an exact replica of any individual cycle. The rhythm is rough and imperfect. All the recorded cycles are members of the same family, about among them are no twins”.

Types of business cycles

            Prof. James Arthur Estey has classified business cycles under the following heads:

1. Major and Minor Cycles

            Major cycles may be defined as the fluctuations of business activity occurring between successive crises. The term “crisis” may be interpreted here to mean the major “breakdowns” or “downturns” that interrupt from time to time the relatively even tenor of economic activity. So the major cycles constitute the intervals between successive major downturns of business activity or between major recessions. On this basis, Prof. Hansen recognizes twelve major cycles in the U.S.A., during the period from 1837 to 1937, with an average duration of 8.33 years. The major cycles are sometimes referred to as Juglar Cycles, after the name of Clement Juglar, a French economist of the nineteenth century, who on the basis of his investigation, established the crystal nature of business fluctuations.

            It has been established from the records of business fluctuation s that each major cycle is made up of two or three minor cycles the upswing of business in the major cycle is often interrupted by minor downswings, likewise, the downswings of business in the major cycle may be interrupted by minor upswings. These shorter cycles in major cycles are sometimes referred to as minor cycles. The duration of the minor cycles averages close to 40 months. These minor cycles have actually operated both in Great Britain and the U.S.A. Since the distinction ‘between major and minor cycles was observed by    Prof. Joseph Kitchin, the minor cycles are sometimes referred to as Kitchin Cycles.

2. Building cycles

            This refers to the cycle of building construction. The duration of the building cycles is longer than that of the business cycle.

            It has been discovered the building industry is also subject to fluctuations of fairly regular duration. There are upswings and downswings in the building cycles is 18 years-just twice the length of business cycle. Between 1830 and 1934, there were six complex building cycles in the U.S.A.

3. Kondratieff Cycles (or Long Waves)

            They are sometimes referred to as “long waves” occurring in a 50 or 60-year cycle. The long waves in economic activity were discovered by the Russian economist, Kondratieff. Hence, these long waves are called Kondratieff Cycles. Kondratieff, on the basis of statistical data pertaining to the period 1780-1920, was able to establish 21/2 long cycles in England and France each full cycle being of the duration of 60 years.

            Summing up, the fundamental changes in economic activity include three kinds of cycles-the short or minor or the Kitchen cycles of the duration of 40 months or so, the major or the Juglar cycles, composed of three minor cycles and of the duration of 10 years or so, and finally, the Kondratieff cycles (or, long waves), made up of 6 Juglar cycles and of the duration of 60 years.

Phases of Business Cycle

            A typical or standard business cycle is characterized by five different phases or stages-depression, recovery (or, revival), prosperity (or, full employment), boom (or, overfull employment), and recession.

Depression

            This constitutes the first stage of a business cycle. It is a protracted period in which business activity in the country is far below the normal. It is characterized by a sharp reduction of production, mass unemployment, low employment, falling prices, falling profits, low wages, contraction of credit, a high rate of business failures and an atmosphere of all-round pessimism and despair. A decline in output or production is accompanied by a reduction in the volume of employment. All construction activities come to a more or less complete standstill during a depression. The consumer-goods industries, such as, food, clothing, etc. are not so much affected by unemployment as the basic capital goods industries. The prices of manufactured goods fall to low levels. Since the costs are “sticky” and do not fall as rapidly as prices, the manufacturers suffer huge financial losses. Many of these firms have to close down on account of accumulated losses.

Recovery (or, Revival)

            It implies increase in business activity after the lowest point of the depression has been reached. During this phase, there is a slight improvement in economic activity, to start with. The entrepreneurs being to feel that the economic situation was, after all, not so bad as it was in the preceding stage. This leads to further improvement in business activity. The industrial production picks up slowly and gradually. The volume of employment also steadily increases. There is a sow, but sure, rise in prices, accompanied by a small rise in profits. The wages also rise, though do not rise in same proportion in which the prices rise. Attracted by rising profits, new investments take place in capital goods industries. The banks expand credit. The business inventories also start rising slowly. The pessimism and despair of the preceding period is replaced by an atmosphere of all-round cautious hope.

Prosperity (or, Full Employment)

            This stage is characterized by increased production, high capital investment in basic industries, expansion of bank credit, high process, high profits, a high rate of formation of new business enterprises and full employment. There is a general feeling of optimism among businessmen and industrialists.

The longest sustained period of prosperity occurred in U.S.A. between 1923 and 1929 with some minor interruptions in 1924.

Boom (or, Overall Employment)

            It is the stage of rapid expansion in business activity to new high marks, resulting in high stocks and community prices, high profits and overall employment.

            The prosperity phase of the business cycle does not end up with a stable state of full employment; it leads to the emergence of boom. The continuance of investment even after the stage of full employment results in a sharp inflationary rise of prices. This causes undue optimism among businessmen and industrialists who make additional investments in the various branches of the economy.

Recession

            The feeling of over-optimism of the earlier period is replaced now by over-pessimism characterized by fear and hesitation on the part of the businessmen. The failure of some business creates panic among businessmen. The banks also get panicky and begin to withdraw loans from business enterprises. More business enterprises fail. Prices collapse and confidence is rudely shaken. Building construction slows down and unemployment appears in basic, capital goods industries. This capital unemployment then spreads to other industries. Unemployment leads to fall in income, expenditure, prices and profits. The recession, it should be remembered, has cumulative effect. Once a recession starts, it goes on gathering momentum and finally assumes the shape of depression-the first phase of the business cycle complete.

            In this Diagram, PM is the full employment i.e, Above this line, we have two stages of the business cycle-a boom in the upswing and precession in the downswing. Below this line, again, we have two stages of business cycle-recovery in the upswing and depression in the downswing. The business cycle, as shown in the diagram, passes through five stages. It starts with depression to be followed by recovery, prosperity, boom, recession and ultimately ends up again with depression.

Fig 7.1

These are the five phases or stages of a typical business cycle. It does not, however, imply that every business cycle passes through these five stages in the same order. It is possible tat the recovery stage may be followed by the recession stage without the business cycle entering into the prosperity and boom stages, as it actually happened at U.S.A., in 1937.