Understand Business Cycle– Upward-Boom, Downward-Bust– Economic Movements-Shifts: Critical for Good Decision-Making…

Business cycle is a fundamental, and yet elusive concept in macro-economics… it’s a pattern of economic booms-and-busts– economy-wide trends– that can have significant impact on businesses… The term business cycle (or economic cycle) refers to economy-wide fluctuations in production, trade… and economic activity, in general, over several months or years…

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The business cycle is the upward-and-downward movement of GDP (gross domestic product) with periods of expansions-contractions in the level of economic activities (i.e., business fluctuations) centered around its long term growth trend. The fluctuations typically involve shifts, over time, between periods of relatively rapid economic growth (expansion or boom), and periods of relative stagnation or decline (contraction or recession). 

The basic definition of the business cycle was developed by Arthur F. Burns and Wesley C. Mitchell in their book ‘Measuring Business Cycles’: Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions and revivals, which merge into the expansion phase of the next cycle.

Another definition by Parkin and Bade says; the business cycle is periodic, but irregular up-and-down movements in economic activity measured by fluctuations in real GDP and other macroeconomic variables. A business cycle is not a regular, predictable or repeating phenomenon like swing of the pendulum of a clock. Its timing is random and, large degree, unpredictable. However, many experts say that the term business cycle is misleading– ‘cycle’ implies that there is some regularity in timing and duration of upswings and downswings in economic activity–and most economists prefer the term ‘short-run economic fluctuations’ instead of business cycle

In the article What Is a Business Cycle– Why Is It Important? by Gregory Hamel writes: The rise and fall of economic conditions are part of the business cycle. Business planning usually revolves around decisions related to specific markets in which a company operates, but economy-wide trends can have significant impact on businesses. The business cycle is a pattern of economic booms-and-busts exhibited in the modern economy.

Understanding business cycle is important because it affects– sales, profitability… and they ultimately determine whether a business succeeds-fails. Business cycles have four phases: booms, downturns, recessions, and recoveries. During booms; economic output increases quickly and businesses tend to prosper. Eventually, a booming economy reaches a peak point where economic growth rates start to fall, leading to an economic downturn. Downturns lead to periods of economic stagnation or decline called recessions.

Also, the point at which economic growth rates begin to increase again is called the trough of the business cycle; a period of economic recovery follows the trough and leads back into an economic boom. The business cycle can have major effect on total level of employment in the economy: During periods of economic growth-prosperity, employment tends to be high because businesses need more workers to meet demand and expand their companies. Whereas, economic downturns-recessions are characterized by cuts in worker hours, cuts in worker pay, rising unemployment…

Also, business cycle can have significant influence on consumer demand: High levels of unemployment and under-employment mean consumers have less money to spend on products and services and that can lead to lower sales… Overcoming economic downturns-recessions is one of the biggest challenges for sustaining business: During economic recovery-boom, conditions are ripe for businesses to enter markets, but during downturns-recessions the result can be the failure of many weak businesses. Surviving sluggish business cycle typically revolves around cutting costs, improving efficiency, drawing on resources saved during periods of prosperity.

In the article Economic Business Cycle Indicators by Shane Hall writes: Business cycles are difficult to predict but certain indicators can provide signals to corporate leaders, investors, economists, government officials… about the onset-progress of business cycles. The ‘Conference Board’, global business research association, identifies three main classes of business cycle indicators, based on timing: leading, lagging and coincident indicators.

The Conference Board website states that all the indicators are designed to predict– peaks-troughs of business cycles in several nations-regions around the world including; U.S., Britain, Australia, China, Japan, Euro area of Europe, Germany, France, Mexico… Leading indicators are measures of economic activity in which shifts may predict the onset of a business cycle. For examples, leading indicators include; average weekly work hours in manufacture, factory orders for goods, housing permits… Increases-decreases in these measures could signal beginning of a business cycle.

The ‘Conference Board’ reports that leading indicators receive the most attention because of their tendency to shift in advance of business cycles. Other leading indicators include; index of consumer expectations, average weekly claims for unemployment insurance, interest rate spread… If leading indicators signal the onset of business cycles, lagging indicators confirm these trends. Lagging indicators consist of measures that change after an economy has entered a period of fluctuation. Lagging indicators include; average length of unemployment, labor cost per unit of manufacturing output, prime rate, consumer price index, commercial lending activity… Because lagging indicators change direction after the economy enters a business cycle, they are sometimes dismissed as unimportant.

The Conference Board points out, however, that lagging indicators are costs of doing business, and can provide valuable insight into structural issues of an economy. Coincident indicators consist of aggregate measures of economic activity that change as business cycle progresses. Therefore, according to the ‘Conference Board’; these indicators help define business cycles, and examples of coincident indicators include; personal income levels, industrial production, unemployment… Although leading indicators receive the most attention, the ‘Conference Board’ emphasizes the importance of all three classes of indicators when observing business cycles. Leading indicators are most meaning, when they are included as part of a framework that includes coincident and lagging indicators that help define and describe fluctuations in economic activity…

In the article 4 Phases of Business Cycle in Economics by Gaurav Akrani writes: Business cycle (or trade cycle) is divided into four phases:

  • Prosperity Phase: Expansion-Boom-Upswing of economy. When there is an expansion of output, income, employment, prices and profits, there is also a rise in the standard of living. The features of Prosperity are: High level of output and trade. High level of effective demand. High level of income and employment. Rising interest rates. Inflation. Large expansion of bank credit. Overall business optimism… There is an upswing in the economic activity and economy reaches its Peak.
  • Recession Phase: The turning point from Prosperity to Depression is termed as Recession Phase. During a Recession  period, the economic activities slow down. There is a steady decline in the output, income, employment, prices and profits. Business loses confidence and become pessimistic… reduces investment, business expansion stops, stock market falls. Typically, an increase in unemployment that causes a sharp decline in income and aggregate demand. Recession, generally, lasts for a short period.
  • Depression Phase: There is a continuous decrease of output, employment, income, prices, profits, and fall in standard of living… The features of Depression are: Fall in volume of output and trade. Fall in income and rise in unemployment. Decline in consumption and demand. Fall in interest rate. Deflation. Contraction of bank credit…The aggregate economic activity is at the lowest, causing a decline in prices and profits until the economy reaches its Trough (low point).
  • Recovery Phase: The turning point from Depression to Expansion is termed as Recovery or Revival Phase. During the period of revival or recovery, there are expansions and rise in economic activities. Steady rise in output, employment, income, prices and profits. Business gains confidence and optimistic… increases investments, banks expand credit, business expansion takes place, increase in employment, production, income and aggregate demand, prices and profits start rising,  and business expands. Revival slowly emerges into Prosperity, and business cycle is repeated.

business cycle

The ‘media’ often likes to refer to the business cycle model, since it can use terms, such as; ‘boom’ and ‘bust’. It’s a model that can communicate several important pieces of information about a nation’s economy. Basically, the business cycle is a graph which shows the level of real GDP over time. The ‘vertical axis’ shows– level of GDP, and ‘horizontal axis’ shows– time frame.

A typical nation’s business cycle will most likely look like a wave, showing how GDP ‘rises and falls’ over time. Assuming that a country is achieving economic growth over the long-term, the business cycle’s ‘line of best fit’ or ‘trend line’ will slope upwards, indicating that over the span of years or decades, a nation’s economy will produce more output. But over shorter periods of time, output may fluctuate, as the economy experiences those ‘boom’ and ‘busts’ that the media is so fond of.

According to Jim Riley; the business cycle is crucial for businesses because it directly affects demand for products. Every business is affected by the stage of the business cycle, but some businesses are more vulnerable to change than others. For example, a business that relies on consumer spending for its revenues will find that demand is closely related to movements in GDP. During a boom, such businesses should enjoy strong demand for their products… But during a slump, a business can suffer a sharp drop in demand…

Businesses whose fortunes are closely linked to the ‘rate of economic growth’ are referred to as ‘cyclical’ businesses. By contrast, however, some businesses actually benefit from an economic downturn. If their products are perceived by customers as representing good value or it’s a cheaper alternative, then consumers are likely to switch.

According to Noah Smith; modern business cycle models used by mainstream macro-economists are, for the post part, not actually models of cycles. When we think of a ‘cycle’, most of us think of something like a wave– it’s a harmonic motion such as; snapping rope or whip, ocean waves, bouncing ball… also, it may be natural to think of business cycles in this same way. When a recession comes on the heels of boom or economic bust– we can easily conclude that booms cause busts. However, very few macro-economists think like this! And very few macro-economic models actually have this property. In modern macro-economic models, since ‘cycles’ are nothing like waves.

A ‘boom’ does not make a ‘bust’ more likely, or vice versa. Modern macro-economic models assume that what may looks like ‘cycle’ is actually ‘trend’… Some economists argue that the business cycle is an essential part of an economy.

Even downturns have their role to play– they tends to ‘shakeup’ the economy and weed-out weak firms– creating greater incentives to cut costs and more efficiency. However, this view is controversial and other economists argue that in recession, even ‘good’ firms can fail– leading to permanent loss of productive capacity…