2.01 –Understand economic indicators to recognize economic

trends and conditions

Determine the impact of business cycles on business activities

Objectives

• Define the following terms; business cycles, expansion, peak, contraction, and trough.

• Identify the phases of a business cycle.• Describe the peak phase of a business cycle.• Describe the contraction phase of a business cycle.• Describe the trough phases of a business cycle.• Explain how knowledge of business cycles benefits

businesspeople.• Describe internal causes of business cycles.• Explain external causes of business cycles.

Business Cycles

• The business cycle describes the phases of growth and decline in an economy.

• The goal of economic policy is to keep the economy in a healthy growth rate -- fast enough to create jobs for everyone who wants one, but slow enough to avoid inflation.

Expansion• An expansion, which is a period of increasing economic activity• The second of the two primary business-cycle phases is an expansion. • An expansion, which is a period of increasing economic activity. Clearly real GDP

increases over this segment. • An expansion generally takes the economy from below the long-run trend to at or

above the long-run trend.– The early part of an expansion is usually termed a recovery because the economy is

"recovering" from the contraction– An expansion typically lasts about three to four years, but could be as short as one year or

as long as a decade. – The longest expansion on record, occurring during the 1990s, lasted ten years.

• The inflation rate tends to increase during an expansion.

• The unemployment rate, is almost guaranteed to decrease during an expansion and

Peak

• The transition from expansion to contraction is a peak.

• An expansion, like a contraction, eventually comes to an end. The end of an expansion, and the onset of a contraction is a peak.

• While a peak, the highest level of the business cycle, might seem like a good thing, it really has a down side.

• A peak means that the expansion has ended and that a contraction is about to begin.

Contraction

• A contraction, which is a period of declining economic activity

• A period of decline in which economic • activity decreases for at least six months is termed a contraction.

– Contractions, also termed recessions.

– The inflation rate, tends to decrease during a contraction

– The unemployment rate, for example, is almost guaranteed to increase during a contraction.

Contraction (Continued)• One of the two primary business-cycle phases is a contraction. • A contraction, which is a period of declining economic activity.• A contraction generally takes the economy from at or above the

long-run trend to below the long-run trend.– Because the long-run trend represents full employment, unemployment

results when real GDP is below the long-run trend, or when actual real GDP is less than potential real GDP.

– Moreover, the lower real GDP dips below the long-run trend, then the greater is unemployment.

• A contraction typically lasts about a year, but could be as short as six months or as long as eighteen months. – The longest contraction on record, occurring during the Great

Depression, lasted almost four years.

Trough

• The transition from contraction to expansion• is a trough .• A contraction does not last forever, at least none have so far.

The end of a contraction, and the onset of an expansion is a trough.

• The trough in the previous exhibit is indicated by point B. It is the end of the previous contraction that took the economy from point A to point B.

• While a trough, the lowest level of the business cycle, might not seem like a good thing, it really is.

• A trough means that the contraction has ended and that an expansion is about to begin.

Four Phases of a Business Cycle

• Recession• Recovery• Growth (Prosperity) • Decline. (Depression)

Prosperity PhaseWhen there is an expansion of output, income, employment, prices and profits, there is also a rise in the standard of living. This period is termed as Prosperity phase.• 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.• A high level of MEC (Marginal efficiency of capital) and investment.

Due to full employment of resources, the level of production is Maximum and there is a rise in GNP (Gross National Product). Due to a high level of economic activity, it causes a rise in prices and profits. There is an upswing in the economic activity and economy reaches its Peak. This is also called as a Boom Period.

Recession Phase

The turning point from prosperity to depression is termed as Recession Phase.• During a recession period, the economic activities slow down. When

demand starts falling, the overproduction and future investment plans are also given up.

• There is a steady decline in the output, income, employment, prices and profits. – The businessmen lose confidence and become pessimistic (Negative). It

reduces investment. – The banks and the people try to get greater liquidity, so credit also contracts. – Expansion of business stops, stock market falls. Orders are cancelled and

people start losing their jobs. – The increase in unemployment causes a sharp decline in income and

aggregate demand. Generally, recession lasts for a short period.

Depression PhaseWhen there is a continuous decrease of output, income, employment, prices and profits, there is a fall in the standard of living and depression sets in.• 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.• Overall business pessimism.• Fall in MEC (Marginal efficiency of capital) and investment.In depression, there is under-utilization of resources and fall in GNP (Gross National Product). The aggregate economic activity is at the lowest, causing a decline in prices and profits until the economy reaches its Trough (low point).

Recovery PhaseThe 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. When demand starts rising, production increases and this causes an increase in investment.

• There is a steady rise in output, income, employment, prices and profits.– The businessmen gain confidence and become optimistic (Positive). This increases

investments. The stimulation of investment brings about the revival or recovery of the economy.

– The banks expand credit, business expansion takes place and stock markets are activated.

– There is an increase in employment, production, income and aggregate demand, prices and profits start rising, and business expands. Revival slowly emerges into prosperity, and the business cycle is repeated.

• Thus we see that, during the expansionary or prosperity phase, there is inflation and during the contraction or depression phase, there is a deflation.

Explain how knowledge of business cycles benefits businesspeople.

• First, on the academic side, business cycles are an inherent part of the macroeconomy, they are part of the mechanism of the economy.– Understanding the ups and downs of business cycles means a better understanding of the

macroeconomy. – Through this understanding, key macroeconomic problems, especially unemployment and

inflation, can be addressed.• Second, on the selfish side, human lives are seriously affected by the ups and downs

of business cycles. – The unemployed take a serious hit to their living standards during recessionary downturns. – Those with fixed incomes or financial wealth take a serious hit to their living standards

during inflationary upturns.• The study of business cycles makes it possible to anticipate and prepare for these

problems.– Knowing that the economy is on the verge of higher inflation, gives people the opportunity

to convert financial wealth into something less affected, or even helped, by inflation.– Knowing a downturn is imminent, lets people plan for an extended period of

unemployment.

Explain how knowledge of business cycles benefits businesspeople.

• Small business owners can take several steps to help ensure that their establishments weather business cycles with a minimum of uncertainty and damage.

• "The concept of cycle management may be relatively new," wrote Matthew Gallagher in Chemical Marketing Reporter, "but it already has many adherents who agree that strategies that work at the bottom of a cycle need to be adopted as much as ones that work at the top of a cycle.

• While there will be no definitive formula for every company, the approaches generally stress a long-term view which focuses on a firm's key strengths and encourages it to plan with greater discretion at all times.

• Essentially, businesses are operating toward operating on a more even keel."

Specific tips for managing business cycle downturns include the following:

– Flexibility—According to Gallagher, "part of growth management is a flexible business plan that allows for development times that span the entire cycle and includes alternative recession-resistant funding structures."

– Long-Term Planning—Consultants encourage small businesses to adopt a moderate stance in their long-range forecasting.

– Attention to Customers—This can be an especially important factor for businesses seeking to emerge from an economic downturn. "Staying close to the customers is a tough discipline to maintain in good times, but it is especially crucial coming out of bad times," stated Arthur Daltas in Industry Week. "Your customer is the best test of when your own upturn will arrive. Customers, especially industrial and commercial ones, can give you early indications of their interest in placing large orders in coming months."

– Objectivity—Small business owners need to maintain a high level of objectivity when riding business cycles. Operational decisions based on hopes and desires rather than a sober examination of the facts can devastate a business, especially in economic down periods.

– Study—"Timing any action for an upturn is tricky, and the consequences of being early or late are serious," said Daltas. "For example, expanding a sales force when the markets don't materialize not only places big demands on working capital, but also makes it hard to sustain the motivation of the sales-people. If the force is improved too late, the cost is decreased market share or decreased quality of the customer base. How does the company strike the right balance between being early or late? Listening to economists, politicians, and media to get a sense of what is happening is useful, but it is unwise to rely solely on their sources. The best route is to avoid trying to predict the upturn. Instead, listen to your customers and know your own response-time requirements."

Internal Causes of Business Cycles• Psychological Factors-Optimistic and pessimistic mood of the

entrepreneur. When entrepreneurs are optimistic about future market conditions they take up investiment.

• Money Supply – if there is expansion in money and credit supply, there will be raise in economic activity. If there is contractions there will be down fall in economic activity.

• Over investment – excessive investment in capital goods industries brings upswing and downswing when there is a fall in investment.

• Marginal Efficiency of capital- When the rate of marginal efficiency of capital gets higher the expansion phase of trade cycle commences. There is a contraction phase when the rate of marginal efficiency of capital I lower.

External Causes of Business Cycles• Wars-available resources are utilized for the production of weapons which greatly

affect the product of both capital and consumer goods. This fall in production decreases income, profits which further create unemployment. These create contraction in the economic activity.

• Postwar Period-the level of consumption and investment goes upward. Bothe the government and individuals involve the construction (houses, roads, bridges, etc. All these activities increase the effective due to which the economics variable, output, income and employment goes upward.

• Scientific Development-Every day new products come to the markets like mobile phones, laptops, etc. These products require huge amount of investment through which new technology of products is adopted. All this increases income, employment and profit etc. and plays an important part in the revival of economy.

• Gold Discoveries – and mines stimulate the volume of international trade and help in adjusting trade deficit, loans etc. the rising income lead to expansion in economic activity.

External Causes of Business Cycles

• Surplus, Exports and Foreign Aid- raises the level of consumption and investment spending which helps in increasing output, income and employment level.

• Weather-is an important factor which can cause economic activities. If in any year, weather is good the ouptu of agricultural sector will go upward.

• Population Growth Rate- when it is higher than the economic growth rate, income level and consumption expenditure and savings will be low.

Sources• Amadeo, K. (n.d.). Business cycle. Retrieved May 15, 2012, from

http://useconomy.about.com/od/glossary/g/business_cycle.htm • AmosWEB. (2000-2012). Business cycle phases. Retrieved May 15, 2012, from

http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=business+cycle+phases• AmosWEB. (2000-2012). Business cycles. Retrieved May 15, 2012, from

http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=business+cycles• AmosWEB. (2000-2012). Contraction. Retrieved May 15, 2012, from

http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=contraction• Basu, C. (n.d.). Four stages of business cycle recovery. Retrieved May 15, 2012, from

http://smallbusiness.chron.com/four-stages-business-cycle-recovery-20837.html • MBA Research and Curriculum Center. (2011). Boom or bust (Business cycles) [LAP: EC-

009: Presentation Software]. Columbus, OH: Author. • Roberts, S. (n.d.). What are the characteristics of each stage of the business cycle?

Retrieved May 15, 2012, from http://smallbusiness.chron.com/characteristics-stage-business-cycle-18492.html

• Trading Online Markets. (2005-2012). Business cycle phases. Retrieved May 15, 2012, from http://www.tradingonlinemarkets.com/Beat_the_Market/The_Business_Cycle_Phases.htm

2.01 Performance Activity

• read two business articles about the current economic conditions and draw conclusions from those articles about the phase of the existing business cycle.

• Write a two-paragraph page that includes the following: – Identify causes of the phase and businesses’ reactions. – Tell whether changes are taking place that would indicate a

new phase is beginning. – Turn in when completed – label this assignment 2.01

Performance Activity.