Monday, August 24, 2009

Phases of the Business Cycle

The phases of the business cycle are discussed as under:

1. Depression

We might start at a point when business is at the lowest ebb and the economy is engulfed in depression. The lucky ones, who are employed, get distressingly low wages. The purchasing power of money is high but that of man is low. The general purchasing power of the community being very low, the productive activity both in production of consumer’s goods and producer’s goods, especially the latter, is at a very low level. Business settles down at a new equilibrium at a low level of prices, costs and profits. This new adjustment or equilibrium may last for a number of years.

2. Recovery

But the things are not going to continue to be in a depressed stage forever. After the depression has lasted for some time, rays of hope appear on the business horizon. Pessimism give place to optimism. The depression contains with in itself the germs of recovery. After the depression has lasted for some time, the situation is found favourable for a business venture. Wages are low even for efficient workers, sufficient number of whom is now available. Money is cheap and so are other materials and factors of production. Prices may by low but costs too are low. This induces an entrepreneur, who may have sufficient financial backing, to take the risk. He orders repairs, renewals and replacements and perhaps a new plant. Constructional and allied industries receive orders and re-employ workers who spend their newly-acquired purchasing power on consumer’s goods. This stimulated further investment and production in several other industries. Thus business turns the corner.

3. Boom

Recovery once started gathers momentum. The slander stream of recovery, when it has started flowing is strengthened by numerous tributaries on its way. The revival of investment in one industry leads to a revival in an other. The wages paid to workers in one industry create demand for goods produced by another. With the general revival of demand, prices show an upward trend. The businessmen’s income takes a forward jump while wages, interest and other costs lag behind. Profit margins are thus widened. Optimism grows and spreads far and wide. The banks know that profits are being made and they do not mind in giving advances. Credit expands; businessmen borrow and plunge deeper into business so long as the expected rate of profit exceeds the prevailing rate of interest. Exceptional business prosperity turns their head, and they indulge in overtrading. Every body is feverishly busy in making money. This phase of the trade cycle is known as boom and it may, like the depression last for a number of years.


But just as depression created the conditions of recovery, similarly the boom conditions generate their own checks. All the idle factors have been employed and further demand must raise their prices, but the quality available now is inferior. Less efficiency workers have to be taken on higher wages. Rate of interest rises and so also of the necessary materials. The costs have after all started the upward swing. They overtake prices ultimately and the profit margins are first narrowed and then begin to disappear. The boom conditions are almost at the end. The bankers feel uneasy over their advances. They throw sinister hints that the loans may be recalled. The out look is no longer optimistic.


Then starts the downward course fearing that the era of profits has come to a close, businessmen stop ordering further equipment and materials. The prudent businessman wants to get out altogether and cuts down his establishment ruthlessly. The Government applies the axe mercilessly. The bankers insist on repayment. The ‘bottle necks’ appear, stocks accumulate. Desire for liquidity increases all around. This accentuates the depression just as the recovery is self-reinforcing; the forces of depression are also self accumulating. Every body is shifting for himself. A scramble for liquidity ensues. Some firms are forced into bankruptcy. The failure of one firm creates difficulties for those with whom it has business connections. Gloom spreads. There is general distress. This phase of trade cycle is known as crisis.

The crisis is the period of utmost suffering for a businessman. But they recover in a course of time from stunning blow. Their commitments are liquidated some how and business enters into the stage of what has already been described as depression or slump or a state of stagnation. Lord over stone describes the course of trade cycle thus “state of quiescence – next improvement – growing confidence – prosperity – excitement – over trading – convulsion – pressure – distress – ending again in quiescence”.

In Mitchell’s terminology we can depict the phases of a business cycle. Viz expansion (upward movement) recession, contraction (downward course) and recovery.


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