5 Different Phases of Business Cycle with Diagram

The business cycle is associated with sweeping fluctuations in economic activities such as production, employment, prices, etc.

A trade or business cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages that are altered with periods of bad trade characterized by falling prices and high unemployment percentages.

different phases of business cycle with diagram
different phases of business cycle with diagram

A business cycle may be defined as a period of prosperity followed by a period of depression.

It is not surprising that the economic process should be irregular, with trade being good at some times and bad at others.

We can say that the business cycles are an alternative expansion and contraction in overall business activity.

What are the Phases of the Business Cycle with Diagram?

There are phases or stages of the business cycle with the diagram given under:

1. Depression

This is one of the phases of a business cycle. Under this stage business activity in an economy is far below normal.

There is a sharp reduction of production, mass unemployment, low employment, falling prices, falling profit, low wages, contraction of credit, a high rate of business failures, and an atmosphere of all-around pessimism and despair.

A decline in production is accompanied by a reduction in the volume of employment.

All Construction activities come to a complete standstill during the depression.

The consumer goods industries such as food, and clothing. Area not so much affected by unemployment as the basic capital goods industries.

The prices of manufactured goods fall to a low level. The manufacturers suffer huge financial losses.

Many of these firms have to close down on account of accumulated losses.

The Fall in prices distorts the relative price structure. The prices of agricultural commodities and raw materials fall to a great extent than the prices of finished manufactured goods.

The agricultural are hit more than the manufacturing classes.

The Example of depression is the two longest depressions in USA history during 1875-1879 (65 months) and 1929-1933 (44 months).

2. Recovery or Revival

It implies the increase in business activity after the lowest point of the depression has been reached.

There is a slight improvement in economic activity during this phase of the business cycle to start with.

The entrepreneurs start to feel the economic situation was not as bad as it was in the first phase. This leads to further improvement in business activity.

Industrial production picks up slowly. The volume of employment also steadily increases.

There is a slow rise in prices accompanied by small rice in-proof profits.

The wages also rise less than in proportion to the rise in prices. With rising profits, new investment takes place in capital goods industries.

The banks expand credit. Business inventories are also started rising slowly.

The pessimism and despair of the previous phase are replaced by an atmosphere of all-around cautious hope.

The recovery was continuous. The most severe depression, The more rapid will be the recovery. The duration of the recovery period cannot be definitely said.

The recovery could be initiated by new innovations, government expenditure, changes in production techniques, investment in new regions, and exploitation of new sources of energy.

3. Prosperity or Full Employment

This phase is characterized by increased production high capital investment in basic industries, expansion of bank credit, high prices, high profits, a high rate offer nation of new business enterprises, and full employment.

There is an environment of optimism felt by businessmen and industrialists.

An example of this stage is the longest sustained period of prosperity that occurred in the USA between 1923 and 1929.

4. Boom or Overfull Employment

This face is on rapid expansion in business activity to new high marks, resulting in high stocks and commodities prices, high profits, and over-full employment.

The prosperity phase does not end up with a stable state of full employment and it leads to the emergence of the boom. After the stage of full employment inflationary rise in prices starts.

This results in undue optimism among industrialists and businessmen resulting in additional investments in different sectors of the economy.

It puts pressure on the demand for a variable factor of production who are already fully employed, and their prices increase at a higher spread.

The number of jobs exceeds the number of workers available in the market. The situation is called Overfull Employment.

Profits touch new heights with rising profits. Businessman and industrialists increase their capital investments. This leads to an inflationary rise in prices.

Prices are skyrocketing and there is an atmosphere of over-optimism around.

But after some time bottlenecks begin to appear in the various sectors of the economy.

Factors of production become scared leading to a further rise in their prices. The cost calculations of businessmen and industrialists are adversely affected.

New projects are not undertaken and expansion of the exciting unit is stopped.

5. Recession

The atmosphere of over-optimization of the previous phase is replaced by over-pessimism. The failure of some businesses creates panic among businessmen.

The banks withdraw loans from business Enterprises more business Enterprises fail. Prices collapse and confidence is shaken.

Building construction slows down and unemployment appears in the basic, capital goods industries.

This unemployment spreads to the other sectors of the economy, Unemployment leads to falling in income, expenditure, prices, and profit.

The Recession has a cumulative effect.

The recession goes on gathering Momentum and finally gets the shape of a depression and thus, the first phase of the business cycle is complete.

The Example of the 1957-58 recession in the USA was a severe recession.

Business Cycle Diagram

The various phases of the business cycle can be seen in the following diagram:

business cycle diagram
business cycle diagram

The diagram shows the different phases of the Business Cycle.

FE is the full employment line. A boom in the upswing and a recession in the down-swing.

Below this line, we have two phases of the business cycle- recovery on the upswing and depression on the downswing.

It starts with depression to be followed by recovery, prosperity, boom, and recession and ultimately ends up again with depression.

Measures of Business Cycle

The business cycles create cyclical fluctuations in economic activity.

The long waves of business cycles are inevitable in a capitalist economy. But short business cycles should be checked.

The following measures can be used to control the business cycles:

1. Monetary Measures

In order to control such upswings and downswings of the business cycles government may evolve a suitable monetary policy to deal with the situation.

The undue expansion of the money supply could be checked by insisting upon a proper and adequate cover against no issue.

As regards bank credit, the central bank of the country could use various quantitative and qualitative methods of credit control.

Such as bank rate, open market operations, cash reserve ratio, statutory liquidity ratio, fixation of margin requirements, regulation of consumer credit, rationing of credit, morals suasion, publicity, and direct action.

2. Fiscal Measures

Monetary policy may not suffice to check cyclical business fluctuations.

When business activities show signs of slackening down, the government should use these three instruments(taxation, public spending, and public borrowing) of fiscal policy to check the downtrend and ensure stability in the economy.

The government should not levy new taxes and existing texas should be substantially reduced.

It will increase the purchasing power of people thereby more goods and services will be purchased by the people.

It will check the decline in demand and business activity.

When the economy is set, The government should raise the rates of existing taxes and may levy new taxes to check private spending.

Thus, the various instruments of fiscal policy should be followed by the government in such a manner that it may attain stabilization in the economy.

3. Automatic Stabilizers

Economist has suggested the introduction of a number of automatic stabilizers to deal with business cycles.

An automatic stabilizer in an economic shock absorber that helps smoothes the cyclical business fluctuations of its own accord.

Of its own accord, without requiring deliberate action on the part of the government, one such device is the progressive income tax. 

Progressive income tax and unemployment insurance were the two built-in stabilizers used in the USA to control the fluctuations in business activity.

Automatic stabilizers are superior to other monetary and fiscal measures as they go into action immediately whenever the economy is confronted with economic fluctuations.

Theories of Business Cycle

  1. Hawtrey’s Theory of Business Cycle.
  2. Hayek’s Over Investment theory.
  3. Keynesian theory of business cycles.
  4. Professor Hick’s theory of the business cycle.
  5. Sunspot theory of the business cycle.
  6. Psychological theory.
  7. Overproduction theory.
  8. Over Saving theory.
  9. Innovation theory.
  10. Cobweb theorem.

Thus, these are the phases of a business cycle.

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