Contraction As the economy begins to contract, business begins to slow down for Normal Maintenance. This growth phase has its share of both issues and opportunities. However, as the profit cycle still lags behind the sales cycle, the profit level is not as high as sales. Apart from this, in recovery phase, some of the depreciated capital goods are replaced by producers and some are maintained by them. Inflation erodes the real incomes of the people and makes life miserable for the poor people. This also leads consumers to restructure their monthly budget.
Finally, the cash flow during the growth phase becomes positive, representing an excess cash inflow. In this way cycle is complete. An expansion is the period from a trough to a peak, and a recession as the period from a peak to a trough. The banks and the people try to get greater liquidity, so credit also contracts. Further, they assume that the rich have a large propensity to save, that is, they save a relatively large proportion of their income and therefore, consume a relatively smaller proportion of their income. But the climate theory does not adequately explain periodicity of the trade cycle. Changes in agricultural output through its demand and input-output relations affect industry.
Like other under-consumption theorists, Marx argues that driving force behind business cycles is ever increasing income inequalities and concentration of wealth and economic power in the hands of the few capitalists who own the means of production. This is because, in this age of globalisation, dependence of one country on other countries is great. It is clear from above that under-consumption theory contains some important elements, especially the emergence of the lack of consumption demand as the cause of recession but it is regarded as too simple. Business is expanding to such an extent that Normal Maintenance and its suppliers are starting to have trouble obtaining materials such as shingles and siding because the manufacturers have not kept pace with the economic expansion. This again gives boost to investment activity and as a result recession ends. Although business experts disagree on the number of distinct stages in a business life cycle, they typically agree on what occurs during each critical stage. And, they are tied predictably to calendar seasons or short-lived fads.
They made an attempt to explain how a free enterprise economy could enter a long-run economic slowdown. In this stage, interest rates can be rising rapidly, with a flattening yield curve. Firms cut their production resulting in recession or contraction in economic activity. In other words, peak phase refers to the phase in which the increase in growth rate of business cycle achieves its maximum limit. Although sales continue to increase, profit starts to decrease in the shake-out phase. They should use contractionary fiscal policy to keep the economy from overheating. Similar process is at work in the expansion phase, prosperity spreads through various linkages of input-output relations or demand relations between various industries, and sectors.
On the other hand, demand, price level, and cost of production will rise. Phase Five: Decline In the final stage of the business life cycle, sales, profit, and cash flow all decline. Business Cycle Phases Business cycles are identified as having four distinct phases: expansion, peak, contraction, and trough. Since economies in the olden world were heavily dependent on agriculture, changes in climatic conditions due to sun-spots produced fluctuations in agricultural output. When depression sets in, the inventories start accumulating beyond the desired level.
Once the prices begin to fall businessmen begin to expect that they will fall further. Other earlier economists also focused on changes in climatic or weather conditions in addition to those caused by sun-spots. The fall in prices also causes real value of money balances to rise which induce people to hold larger money holdings with them. Even by lowering down the interest rates, financial institutions do not find enough borrowers. The slowing ceases at the trough and at this point the economy has hit a bottom from which the next phase of expansion and contraction will emerge. In this phase, it becomes difficult for debtors to pay off their debts.
Theories of Business Cycles : We have explained above the various phases and common features of business cycles. The owner increases his advertising budget, hoping to capture any business that might be had. Generally, producers are unaware of decrease in the demand of products and they continue to produce goods and services. As a result, the poor workers lack income to purchase goods produced by the capitalist class resulting in under-consumption or over-production. The stock market is in a. In the years when due to lack of monsoon there are drought in the Indian agriculture, it affects the income of farmers and therefore reduce demand for the products of industries.
After the peak point is reached there is a declining phase of recession followed by a depression. Prosperity: Once the forces of revival get strengthened the level of economic activity tends to reach the highest point—the peak. The expansion in economic activity ceases when investment exceeds saving. Further, under-consumption theory rightly states that income redistribution schemes will reduce the amplitude of business cycles. Figure-2 shows the graphical representation of different phases of a business cycle: As shown in Figure-2, the steady growth line represents the growth of economy when there are no business cycles.