Learn about the phases of the trade cycle and how they impact the economy. Understand the characteristics of each phase to anticipate economic trends and make informed decisions.
The World has registered remarkable economic progress especially during the last 150 years. But it would be wrong to think that this economic progress has been a steady upward swing and a continuous movement forward. On the other hand, every businessman knows that, after ten or twelve years, the production machinery receives a rude shock, which throws it out of gear for a number of years. There are upward swings and then downward swings in business.
The periods of business prosperity alternate with periods of adversity. Every boom is followed by a slump, and vice versa. This is a trade cycle. The trade cycle simply means the whole course of trade or business activity vyhich passes through all phases of prosperity and adversity.
Understanding the Phases of Trade Cycle
Depression: Let us briefly trace the course of a trade cycle. We might start at a point when business is at the lowest ebb and the economy is engulfed in depression. The lucky ones, who are employed, get distressingly low wages. The purchasing power of money is high but that of man low. The general purchasing power of the community being very low, the productive activity, both in the production of consumer’s goods and producer’s goods, especially the latter, is at a very low level. Business settles down at a new equilibrium at a low level of prices, costs and profits. This new adjustment or equilibrium may last for a number of years.
ecovery: But the things are not going to continue to be in a depressed state for ever. After the depression has lasted for some time, rays of hope appear on the business horizon. Pessimism gives place to optimism. The depression contains within itself the germs of recovery. After the depression has lasted for some time, the situation is found favourable for a business venture. Wages are low even for efficient workers, sufficient number of whom is now available.
Money is cheap and so are the other materials and the factors of production. Prices may be low but the costs too are low. This induces an entrepreneur, who may have sufficient financial backing, to take the risk. He orders repairs, renewals and replacements and perhaps, a new plant. Constructional and allied industries receive orders and re-employ workers who spend their newly – acquired purchasing power on consumers goods. This stimulates further investment and production in several other industries Lo! The business has turned the corner.
Boom: Recovery once started gathers momentum. The slender stream of recovery, when it has started flowing is strengthened by numerious tributaries on its way. The revival of investment in one industry leads to a revival in another. With the general revival of demand, prices show an upward trend. The businessman’s income takes a forward jump while wages, interest and other costs lag behind.
Profit margins are thus widened. Optimism grows and spreads for and wide. Exceptional business prosperity turns businessman’s head and they indulge in over – trading. This phase of the trade cycle is known as boom.
End of Boom: But just as depression created the conditions for recovery, similarly the boom conditions generate their own checks. All idle factors have been employed and further demand for them must raise their prices, but the quality available now inferior. Less efficient workers have to be taken on higher wages. Rate of interest rises and so, also the prices of the essential materials. As a consequence, costs take an upward swing. They overtake prices and the profit margins are first narrowed and then again to disappear. The boom conditions are thus almost at an end.
Crisis: Then starts the downward course. Fearing that the era of profits has come to a close, businessmen stop
ordering further equipment and materials. The government applies the axe mercilessly. The bankers insists on repayment. The bottlenecks appear and stocks accumulate. Desire for liquidity increases all round. This accentuates the depression. Just as the recovery is self – reinforcing, the forces of depression are also self – accumulating. There is general distress. This phase of the trade cycle is known as, the crisis – a point of qritical convulsions.
Slump: The crisis is the period of utmost suffering for businessmen. But they recover in course of time from the stunning below. Their commitments are liquidated somehow and business enters into the stage of what has already been described as depression or slump or a state of stagnation.
Lord Overstone describes the course of a trade cycle thus: “state of quiescene – next improvement – growing – confidence – prosperity – excitement – over trading – convulsion – pressure – distress – ending again in quiescence.” To use Mitchell’s terminology, we can mark four distinct phases of a business cycle, viz., Expansion (upward movement). Recession. Contraction (downward course) and recovery. The above figure represents these four phases. Characteristics of a Trade Cycle:
A study of trade cycle has revealed to important characteristics: (I) its cyclical nature, i.e., periodicity, (2) its general nature or synchronism.
In the first place, it has been found that trade cycles occur periodically at fairly regular intervals. The interval is not a precise one but the degree of regularity is sufficient to demonstrate the periodicity of a trade cycle. There is a general consensus of opinion that the cycle takes seven to ten years nearly to complete itself.
The second characteristic is synchronism or its all – embracing character. The business world is one economic unit, like a living organism. An attack on one part of the business organism is bound to send a shock to the other parts. If one firm is in grief, those who deal with it cannot remain unaffected, and they in turn, will affect others with whom they may be jn commercial intercourse. Thus, depression passes from one industry to another. A time comes when all industries in all districts and all firms in the country are engulfed. Few can escape the deluge.