Cycle Basically, there are two phases of business cycles namely, prosperity or expansion phase and depression or contraction phase. But these two phases are interconnected by other two phases known as recession and recovery phase. These four phases have distinct characters and also affect economy in different ways. It is also necessary to note that there is no any starting point as such of this cycle, neither there is any standard time duration of these phases. These four phases of business cycle can be described as follows:
Depression (Contraction)
Depression is the most critical and fearful stage of a business cycle. This can be regarded as the first phase of business cycle. In this phase, all economic activities are far below the normal rate of growth. The level of price, credit, wages, profit, production, employment, etc. are at low level. There are also business failures.
Hence, the weak firms are compelled to leave the business. In the state of depression, there will be unfavourable situations every where in the economy. Since the prices of goods and services are in a decreasing state, the investors are discouraged to invest. Due to the less investment, output and employment will decrease. So in this phase of business cycle, the business will be in very poor condition. The wages of labour also decreases as a result of decrease in investment. Due to fall in price level, the purchasing power of moneywill increase. Despite increase in purchasing power of money, purchasing power of people will be very low due to high degree of unemployment. During depression, industries producing capital goods are affected more than the industries producing consumer goods. Due to decrease in price of raw materials used by manufacturing industries, farmers are also affected.
There is also great decline in construction and construction industries. Because of all these reasons, there is pessimism all round. The different forces become self reinforcing and depression reaches to trough in extreme. Trough is the lowest point of business cycle or business activity. It is also called lower turning point of business cycle. Such depression was experienced by the world during 1929-1933. During this period, about one forth of labour force was unemployed and economies affected by depression were producing far below their potential level.
Features of Depression
1. Decrease in output (production),
2. High degree of unemployment and low level of income,
3. Decrease in demand and fall in price level,
4. Excessive decrease in price of raw materials and agricultural output,
5. Decrease in credit demand due to decrease in investment,
6. Decrease in rate of interest and increase in bank liquidity,
7. Decrease in construction works, and
8. State of hopelessness or pessimism everywhere in the economy
Recovery (Revival)
Recovery is another phase of business cycle. This phase can be regarded as the second phase. In this phase, all economic activities slowly improve and move towards the state of prosperity. Revival may be caused due to new expectations and political changes or government intervention. The economy suffering from depression, many attempts are carried out by government and private business firms such as banks to increase economic activities.
These types of interventions may create opportunities to invest at the lower cost. During such period, bank may reduce interest rates, credit availability may increase and there may be other incentives for investment. Due to these incentives, new investment may be profitable. Optimistic feelings slowly grow and new investments start. When new investments start, new employment will be generated. These employments will bring forth new consumption which will revive consumption industries or industries producing consumer goods. So, demand for basic raw materials for industries also starts. Due to these changes, output increases; employment also increase and income will start rising, which will cause the end of depression and recovery will start. Recovery which refers to lower turning stage begins with the improvement in demand for capital goods. In order to meet this increased demand, investment in the capital goods industries increases.
This leads to increase in income and employment. The increased income pushes up the level of effective demand, which in turn leads to rise in prices, profits, further investment, employment, output and income starts rising slowly and steadily. Such recovery may start with the investment of government on infrastructure development or other development activities. When such government investment starts, it may trigger new economic institutions raising investment and consumption process.
Features of Recovery
1. Increase in output and employment,
2. Increase in income and demand,
3. Increase in price level,
4. Increase in wages and interest rate,
5. Improvement in financial market, and
6. Increases in marginal efficiency of capital and profit.
Prosperity
Prosperity phase emerges after recovery. This phase can also be regarded as the third phase of business cycle as the best phase of business cycle. During this phase of business cycle, all macroeconomic variables increase rapidly. The macroeconomic variables like national income, employment and price level rise at a high level. The factors of production also remain employed or there are no idle resources. This means that full employment of labour force and full utilization of productive capacity are realised in the prosperity phase. As a result, business parties and entrepreneurs will earn maximum profit.
More labours will be required for higher level of production. This will bring about the state of full employment. Keynes has said that in such a situation voluntary unemploymentremains but the number will be very small. The purchasing power of people will increase as well as new and improved machineries will be used in the industries. In this stage, profit margin increases because price level rises faster than the cost of production. Because of high profit margin, producers will produce excessive quantity. This will cause scarcity of labour and raw materials leading to the rise in cost of production. This ultimately leads to rise in price. Due to rising price, real wages of labour will decline. Their consumption will also decline slowly due to decline in real income. So the business firms will reduce to start their production. This will result fall in income, employment and investment. In this way, period of prosperity moves towards the period of recession.
Features of Prosperity
1. Excessive increase in the output and employment,
2. Increase in demand, price, wages and interest rates,
3. Increase in profit margin due to excessive increase in price relative to the increase in cost of production,
4. Excessive increase in investment and production,
5. State of optimism every where in the economy,
6. Full utilization of all factors of production, and
7. Increases in loans and bank credit.
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