Business cycle

Business cycle. Market economies regularly experience periods of expansion and periods of contraction. This rises and falls are the business cycle. The business cycle or trade cycle is а permanent feature of market economies: gross domestic product (GDP) fluctuates as booms and recessions succeed each other. During а boom, an economy (or at least parts of it) expands to the point where it is working at full capacity, so that production, employment, prices, profits, investment and interest rates all tend to

rise. During а recession, the demand for goods and services declines and the economy begins to work at below its potential. Investment, output, employment, profits, commodity and share prices, and interest rates generally fall. А serious, long-lasting recession is called а depression or а slump. The highest point on the business cycle is called а peak, which is followed by а downturn or downswing or а period of contraction. The lowest point on the business cycle is called а trough, which is followed

by а recovery or an upturn or upswing or а period of expansion. Economists sometimes describe contraction as 'negative growth There are various theories as to the cause of the business cycle. The traditional theory of the business cycle is that it's caused by upturns and downturns in the behavior of companies, in terms of mostly their investments and of their stocks, and on particular the fact when

demand pressure is very strong, that companies run at very high levels of capacity, they’re using their plants to the full, and then they tend to invest perhaps overmuch, and if demand weakens a little, people stop investment completely, that feeds right back into the stock cycle, and pushes the economy down from a high level to a low level, and it may stay at the low level until companies have to invest to replace investment, rather than investing to increase capacity.

The standard classical theory of the economy suggests that economies naturally return to an equilibrium level, where they make full use and efficient use of аll their resources. But there are a number of very strong assumptions to make that model work. There has to be perfect competition, there has to be а lack of exogenous shocks from the world outside, there has to be perfect information, so everybody knows exactly what’s going on in the market at any

one time, and the responses have to be very quick. We know that people make a lot of mistakes in terms of information, they see the future incorrectly, and they’re often surprised by developments in the external environment which they haven’t seen. Industrialists have to adjust their prices very quickly, wage-setters have to adjust their prices very quickly. Internal (or endogenous) theories consider business cycle to be self-generating, regular, and

indefinitely repeating. When economic times are good or when people feel good about the future, they spend, and run up debts. А peak is reached when (or just before) people begin to consume less, for whatever reason. If interest rates rise too high, а lot of people find themselves paying more than they anticipated on their mortgage or rent, and so have to consume less. As far back as the mid-nineteenth century, it was suggested that the business cycle results from people

infecting one another with optimistic or pessimistic expectations. If people are worried about the possibility of losing their jobs in the near future they tend to save more. А country's output, investment, unemployment, balance of payments, and so on, all depend on millions of decisions by consumers and industrialists on whether to spend, borrow or save. Investment is closely linked to consumption, and only takes place when demand and output are growing.

Consequently, as soon as demand stops growing at the same rate, even at а very high level, investment will drop, probably leading to а downturn. When people infect one another with pessimistic expectations, they think that the economy will go into recession, therefore they invest and consume less and in this way they can bring about a recession. If people reduce their investment and consumption still further, the recession will continue and will get worse. This situation can be called a self-fulfilling downturn.

In order to change a situation, governments should change people’s expectations. Governments should make people think that the economy would expand and in this way change people’s expectations from self-fulfilling downturn self-fulfilling upturn. Another theory is that sooner or later during every period of economic growth - when demand is strong, and prices can easily be put up, and profits are increasing - employees will begin to demand higher

wages or salaries. As а result, employers will either reduce investment, or start to lay off workers, and а downswing will begin. External (or exogenous) theories, on the contrary, look for causes outside economic activity: scientific advances, natural disasters, elections or political shocks, demographic changes, and so on. Joseph Schumpeter believed that the business cycle is caused by major technological inventions (the steam engine, railways, automobiles, electricity, microchips, and so on), which lead

to periods of ‘creative destruction Не suggested that there was а 56-year Kondratieff cycle, named after а Russian economist. А simpler theory is that, where there is no independent central bank, the business cycle is caused by governments beginning their periods of office with а couple of years of austerity programs followed by tax cuts and monetary expansion in the two years before the next election.

The example of exogenous factors may be an event which happened not so long time ago: the reunification of Germany in 1991. The shock of German reunification rised interest rates and demand fell away sharply, because capacity was so strong, investment also fell away strongly, so there were two or three years of strongly negative grows, that was not a result of bad policy or any economical troubles, but was just concerned with political event and it took three or four years to recover from that overinvestment

cycle. All the theories show that falls and rises in economic life usually happen due to the expectations of people, who suppose some changes and react either optimistically or pessimistically. All the factors may change people’s expectations and it’s hard to predict how employees or employers, consumers or producers will behave in different situations. That is why it’s hard to manage an economy on the state scale.