Business Cycles, Meaning, Causes

Business cycle refers to the recurring fluctuations in economic activity that occur over time in an economy. These cycles are characterised by periods of expansion, where economic growth, production, and employment increase, followed by periods of contraction, where economic activity slows down, leading to reduced production and employment. Business cycles typically consist of four phases: expansion, peak, contraction (recession), and trough.

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What is a Business Cycle?

Causes of Business Cycles

External causes

1. Wars: During conflict and unrest, economic resources are redirected towards producing specialised goods such as weapons and military equipment. This shift reduces focus on consumer and capital goods, leading to income, employment, and overall economic activity declines. However, post-war periods often stimulate economic recovery through infrastructure rebuilding efforts, including homes, roads, and bridges. This reconstruction boosts economic activity and effective demand.
2. Technology Shocks: Innovative and transformative technologies have a profound positive effect on economies. Introducing new technologies stimulates investment, increases employment opportunities, and raises incomes and profits. For instance, modern mobile phones significantly boosted the telecommunications industry.
3. Natural Factors: Natural disasters like floods, droughts, and hurricanes can devastate crops and inflict substantial losses on the agricultural sector. Food shortages resulting from these disasters drive up prices, causing inflation, while demand for capital goods may decrease.
4. Population Expansion: Uncontrolled population growth can strain an economy. When population growth outpaces economic expansion, total savings diminish, leading to reduced investments and economic slowdowns or depressions.

Internal Cause

1. Changes in Demand : Keynesian economists believe that fluctuations in demand directly impact economic activities. When demand in an economy increases, firms ramp up production to meet the higher demand. This leads to more output, increased employment, higher incomes, and greater profits, potentially resulting in an economic boom. However, excessive demand can also lead to inflation. Conversely, a decrease in demand reduces economic activity, which can lead to a downturn or even a depression if prolonged.
2. Fluctuations in Investments : Like demand, fluctuations in investment significantly influence business cycles . Investment levels can vary due to interest rates, entrepreneurial interest, and profit expectations. An increase in investment stimulates economic activities and fosters expansion. On the other hand, a decline in investment reduces economic activities, potentially causing a recession or even a depression.
3. Macroeconomic Policies : National monetary and economic policies also play a crucial role in the business cycle phases. If monetary policies promote investment and expand economic activities, the economy experiences growth. Conversely, increasing taxes or interest rates can slow economic activities, leading to a recession.
4. Supply of Money: An increased money supply encourages spending, which drives economic growth and expansion. However, excessive money supply can lead to inflation, adversely affecting individuals whose incomes do not keep pace with rising prices. Some theories suggest that business cycles are purely monetary phenomena, where changes in the money supply trigger trade cycles. An increased money supply leads to growth, while a decrease can initiate a recession. Excessive money supply can cause inflation, while a reduced money supply can slow down economic activities, leading to a downturn.

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