There are two approaches to the analysis of the
phases of a business cycle. The first attributable to burns and Mitchell
(1946), marks a business cycle from one peak in the level of economic activity
to another (peak), or from one trough in the level of economic activities to
another. A peak is the highest point in the level of economic activities
experienced in the course of a cycle while a trough shows the lowest point in
the level of economic activities recorded in a cycle. Thus, the peak is the
height of a cycle while the trough is the bottom of a business cycle. A very
high peak is called a boom. In Fig. 7-1, we present three business cycle marked
off from peak to peak.
phases of a business cycle. The first attributable to burns and Mitchell
(1946), marks a business cycle from one peak in the level of economic activity
to another (peak), or from one trough in the level of economic activities to
another. A peak is the highest point in the level of economic activities
experienced in the course of a cycle while a trough shows the lowest point in
the level of economic activities recorded in a cycle. Thus, the peak is the
height of a cycle while the trough is the bottom of a business cycle. A very
high peak is called a boom. In Fig. 7-1, we present three business cycle marked
off from peak to peak.
The second approach is attributable to
Schumpeter who disagreed with the burns Mitchell position and opined that
business cycles should be marked off from equilibrium to equilibrium. With this
approach, we can derive two broad phases of a business cycle: one in which
economic series (aggregates) are below the equilibrium level, and, the other in
which the level of economic activities is above the equilibrium level. The
former is divided into two parts; a period of depression and a period of
economic recovery.
Schumpeter who disagreed with the burns Mitchell position and opined that
business cycles should be marked off from equilibrium to equilibrium. With this
approach, we can derive two broad phases of a business cycle: one in which
economic series (aggregates) are below the equilibrium level, and, the other in
which the level of economic activities is above the equilibrium level. The
former is divided into two parts; a period of depression and a period of
economic recovery.
Similarly, the latter is subdivided into a
phrase of prosperity followed by a period of economic recession. Thus, a typical
business cycle will have four phases (which can follow from top to bottom or
vice versa).
phrase of prosperity followed by a period of economic recession. Thus, a typical
business cycle will have four phases (which can follow from top to bottom or
vice versa).
1.
A phase of economic depression
A phase of economic depression
2.
A recovery phase
A recovery phase
3.
A phase of economic prosperity and
A phase of economic prosperity and
4.
A recessionary phase.
A recessionary phase.
These four (4) phases are cumulative and are
presented in Fig. 7-2. On the whole, the Schumpeter approach to analyzing the
phases of a business cycle appears to be more popular, perhaps a result of the
integration of the national income (output) equilibrium in its analysis. In addition
while the burns-Mitchell approach reveal only two phases of a business cycle (a
period of expansion and a period of contraction),the Schumpeter approach breaks
down a business cycles into four phases from the view point of the equilibrium
level of income and output. We proceed to examine (in brief) the four phases of
a business cycle, following the Schumpeterian tradition.
presented in Fig. 7-2. On the whole, the Schumpeter approach to analyzing the
phases of a business cycle appears to be more popular, perhaps a result of the
integration of the national income (output) equilibrium in its analysis. In addition
while the burns-Mitchell approach reveal only two phases of a business cycle (a
period of expansion and a period of contraction),the Schumpeter approach breaks
down a business cycles into four phases from the view point of the equilibrium
level of income and output. We proceed to examine (in brief) the four phases of
a business cycle, following the Schumpeterian tradition.
Economic
depression
depression
A low and falling level of economic activities
characterizes a depression, aggregate demand in the economy is not only below
the equilibrium level, but is falling. Again, the relative price structure is
badly distorted such that the prices of finished products are lower than the
rewards of labor and other factor inputs. The combined effect of these is that
most business activities becomes unprofitable (profit becomes negative) and hence,
there is increasing unemployment of both human and capital (machineries). Idle
resources, capacity underutilization and falling prices are key features of a
depressed economy.
characterizes a depression, aggregate demand in the economy is not only below
the equilibrium level, but is falling. Again, the relative price structure is
badly distorted such that the prices of finished products are lower than the
rewards of labor and other factor inputs. The combined effect of these is that
most business activities becomes unprofitable (profit becomes negative) and hence,
there is increasing unemployment of both human and capital (machineries). Idle
resources, capacity underutilization and falling prices are key features of a
depressed economy.
The burns-Michelle approach marks a business
cycle form one peak in the level of economic activity to another, or form one
trough to another. A peak is the highest point in a business cycle, while a
trough is the lowest point in a circle.
cycle form one peak in the level of economic activity to another, or form one
trough to another. A peak is the highest point in a business cycle, while a
trough is the lowest point in a circle.
The consequent loss in business confidence that
accompanies a depression generates a fall in the demand for loan able funds.
Banks reserves piles up and the structure of interest rates falls in line with
the general fall in the price level. Investment in capital goods practically
ceases and aggregate demand (at its chronically low level) is concentrated on
consumer goods: food, clothing and other basic needs of life. Thus, while the
construction goods industry (such as building steel, machineries etc.) are the
worse hit during the period of economic depression, the core consumer goods
industry are the least affected. The lowest point of a depression is called a
trough. At this level, all things reach their lowest ebb. The trough is the
lower turning point in a business cycle.
accompanies a depression generates a fall in the demand for loan able funds.
Banks reserves piles up and the structure of interest rates falls in line with
the general fall in the price level. Investment in capital goods practically
ceases and aggregate demand (at its chronically low level) is concentrated on
consumer goods: food, clothing and other basic needs of life. Thus, while the
construction goods industry (such as building steel, machineries etc.) are the
worse hit during the period of economic depression, the core consumer goods
industry are the least affected. The lowest point of a depression is called a
trough. At this level, all things reach their lowest ebb. The trough is the
lower turning point in a business cycle.
The
recovery or revival phase
recovery or revival phase
At the recovery phase, the economy begins to
pick up. A aggregate demands begins to rise, generating increases in employment
and income. Prices remain fairly stable in the early phase of the recovery while
business profits begin to rise. Business expectation increases due to the
increases in sales and profits. Worn-out machines are replaced and the demand
for loan able funds begins to rise again. This leads to increases in bank
lending and profits.
pick up. A aggregate demands begins to rise, generating increases in employment
and income. Prices remain fairly stable in the early phase of the recovery while
business profits begin to rise. Business expectation increases due to the
increases in sales and profits. Worn-out machines are replaced and the demand
for loan able funds begins to rise again. This leads to increases in bank
lending and profits.
For the recovery phase to set in, however, the
process of recovery has to be initiated. This could be done by the business
sector through innovation or exploitation of new avenue of investment (either
in new region, new product or new methods) or by the sheer need to replace
capital that has been used up during the period of depression. Thus, even
without government intervention, business cycles tend to be cumulative (self
adjusting). On the other hand, the recovery process could be set in motion by
government undertaking a fresh expenditure. Whatever the case, an injection,
(either in the form of new investment or fresh government expenditure), is
needed to lift the economy out of a depression and set in motion a process of
recovery. Once the recovery process has been initiated however, it feeds upon
itself. The increase (new) investment or fresh government expenditure results
in a multiplied increase in the level of economic activities and this generate
a cumulative effect on the recovery process.
process of recovery has to be initiated. This could be done by the business
sector through innovation or exploitation of new avenue of investment (either
in new region, new product or new methods) or by the sheer need to replace
capital that has been used up during the period of depression. Thus, even
without government intervention, business cycles tend to be cumulative (self
adjusting). On the other hand, the recovery process could be set in motion by
government undertaking a fresh expenditure. Whatever the case, an injection,
(either in the form of new investment or fresh government expenditure), is
needed to lift the economy out of a depression and set in motion a process of
recovery. Once the recovery process has been initiated however, it feeds upon
itself. The increase (new) investment or fresh government expenditure results
in a multiplied increase in the level of economic activities and this generate
a cumulative effect on the recovery process.
The
prosperity phase
prosperity phase
Recovery soon gives way to economic prosperity.
At this most desirable phase of a business cycle, real income, output,
employment and aggregate demand are not only high but also rising, and the
economy tend to be operating towards (or on)) its production possibilities
curve. Unemployment of resources (both human and capital) is very limited
except for voluntary or frictional unemployment (in the case of labor).
Business confidence sores high and business failure becomes rare occurrences.
Hence, the demand and supply of loanable funds, as well as interest rates, are
high. Investment in durable capital goods is also high and growing. The same is
true for the levels of commerce and trading.
At this most desirable phase of a business cycle, real income, output,
employment and aggregate demand are not only high but also rising, and the
economy tend to be operating towards (or on)) its production possibilities
curve. Unemployment of resources (both human and capital) is very limited
except for voluntary or frictional unemployment (in the case of labor).
Business confidence sores high and business failure becomes rare occurrences.
Hence, the demand and supply of loanable funds, as well as interest rates, are
high. Investment in durable capital goods is also high and growing. The same is
true for the levels of commerce and trading.
The expansion in the level of economic
activities associated with the prosperity phase of a business cycle continues
until a peak (an optimum point is reached. As aggregate demand and economic
activities expands beyond this peak however, bottlenecks are created. Factor
inputs including labor (especially the skilled type), raw materials and capital
etc. become scare leading to increases in factor prices as business firm complete
with each other for factor services. The relative price relationships in the
economy are again distorted as some factors begin to earn pure economic rent
(i.e. abnormally high profit).
activities associated with the prosperity phase of a business cycle continues
until a peak (an optimum point is reached. As aggregate demand and economic
activities expands beyond this peak however, bottlenecks are created. Factor
inputs including labor (especially the skilled type), raw materials and capital
etc. become scare leading to increases in factor prices as business firm complete
with each other for factor services. The relative price relationships in the
economy are again distorted as some factors begin to earn pure economic rent
(i.e. abnormally high profit).
In addition, the excessive demand for loan able
funds creates a shortage of funds leading to increases in the interest rates.
This in turn affects the price of goods and services. Inflationary pressures
are created and sustained from both cost and demand sides, since the growth in
output is not able to match the growth in aggregate demand. The booms (a peak
that exceed the level of potential output) soon give way to economic recession
as the forces of contraction take over from the forces of expansion.
funds creates a shortage of funds leading to increases in the interest rates.
This in turn affects the price of goods and services. Inflationary pressures
are created and sustained from both cost and demand sides, since the growth in
output is not able to match the growth in aggregate demand. The booms (a peak
that exceed the level of potential output) soon give way to economic recession
as the forces of contraction take over from the forces of expansion.
The
phase of economic recession
phase of economic recession
The rising cost of production soon leads to a
fall in output and employment. Households’ income and aggregate demand also
falls. This eventually leads to a fall in prices. Many business ventures that
had appeared profitable suddenly become unprofitable. Cases of business failure
begin to emerge and there is a general loss of business confidence. All of
these would lead to fall in investment spending. The fall in the demand for
loan able funds soon affects the banking sector. Interest rates and profits
from financial investment begin to fall. The uncertainties created by falling
prices and the fear of business failure would cause banks to begin to recall
loans.
fall in output and employment. Households’ income and aggregate demand also
falls. This eventually leads to a fall in prices. Many business ventures that
had appeared profitable suddenly become unprofitable. Cases of business failure
begin to emerge and there is a general loss of business confidence. All of
these would lead to fall in investment spending. The fall in the demand for
loan able funds soon affects the banking sector. Interest rates and profits
from financial investment begin to fall. The uncertainties created by falling
prices and the fear of business failure would cause banks to begin to recall
loans.
When such a general fall in the level of
economic activities continues and worse the economy is brought to another phase
of depression and the cycle repeats itself. In Table 7-1, we present the
characteristics of the different phases of a business cycle.
economic activities continues and worse the economy is brought to another phase
of depression and the cycle repeats itself. In Table 7-1, we present the
characteristics of the different phases of a business cycle.
