Phases of Business Macroeconomics - TU Note

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 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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