Cyclical Fluctuations
Businesses that are running in a capitalist economy are likely to have ups and downs in their financial and production-related activities. If we see these fluctuations in a graph, we can witness that these fluctuations are making a wave in the graph. This wave in the graph is termed as the business cycle or trade cycle or economic fluctuations. A general trade cycle or business cycle has four stages which are classified as prosperity, recession, depression and recovery. These four stages that are present in the business cycle are termed as economic fluctuations in economical terms.
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Prosperity
For a business to survive the one thing that is required is profit, without profit it is impossible for a business to run its operations. Thus profit is considered as the oxygen of the business or in other terms the prosperity of the business. In a capitalist economy like India, a businessman gets his/her incentives or benefits only if the business he/she has invested in generates some profit. In a capitalist economy, only an increase in the profit of the business can guarantee a businessman to get some incentives.
When the businessman receives these incentives they get motivated to invest more and more in the business, thus, aiming to increase the production of the business to new higher levels. This results in expansion of the company's operations giving a boost to the employment opportunities in the country. This is because a company has to expand its workforce along with the expansion of its operations so as to be efficient and effective.
More employment means a generation of more income among the masses which gives a rise to the demand for some products. Thus, we can witness from here that everything is interrelated in this type of economy. This is how a business performs during the prosperity stage of economic fluctuations.
Recession
With the expansion of companies, the cost of managing different operations also increases thus giving rise to diseconomy. Diseconomy is the result of the large scale production of different business houses. Large scale production gives rise to higher wages, rising cost and shortage of various resources. This is the second stage of economic fluctuations.
This stage is considered to be the recession stage in the cyclical fluctuations. The interest rate of loans provided by banks increases at an alarming rate during this stage because of the rise in demand of the bank loans. This increase in interest rates affects the profits of the business. The resultant profit at this stage is lower than the prosperity stage.
Depression
This is the third stage in cyclical fluctuations and during this stage, businesses suffer a lot. The income generation and production of output decrease at an alarming rate at this stage. This decline leads to an increased rate of unemployment in the country. Investments during depression are very low, thus, discouraging the business houses to continue with their operation. Many businesses get shut down at this stage due to low revenue and investments. This situation leads to the pessimism that in turn give rise to deflation.
Recovery
Depression stage doesn't continue forever. It tends to level down after a certain period of time. During this time, new developments and improvements in trade are witnessed. At this time, businesses clear out their debts, liquidate the units that are weak and cant be used. At this stage, businesses aim to reorganize their operations. Thus this stage is known as the recovery stage. With the development in business, the unemployment rate of the country also decreases gradually. Also during this time, business houses again start generating income from trading.
Control of Business Cycle
Government of many countries try to take many steps in order to control the business cycle so that the businesses will suffer less. The central bank plays a major role in controlling the business cycle by introducing contractionary or expansionary credit policies. A government should cut the taxes and try to spend more in order to control the business cycle.
The main objective of the government should be to increase the effective demand for some products and services by increasing the buying power of the people with new policies. The government should take more taxes during prosperity time and try to spend less. All these cyclical fluctuations are due to the capitalist economy. We can avoid the cyclical fluctuations if we shift our economy from capitalist to socialist. By shifting these, the business houses will no longer have the main objective of earning more and more profit but despite they will be more interested in giving back to society through their different operations.
FAQs on Economic Fluctuations: Causes and Effects
1. What are economic fluctuations and how do they relate to the business cycle?
Economic fluctuations refer to the recurring, yet irregular, ups and downs in the level of economic activity, such as production and employment. These movements do not follow a fixed pattern but form a wavelike pattern over time. This pattern of expansion (growth) and contraction (recession) in the economy is known as the business cycle or trade cycle.
2. What are the main causes of economic fluctuations in a modern economy?
Economic fluctuations are primarily caused by shifts in aggregate demand and aggregate supply. Key factors include:
- Changes in Investment: Fluctuations in business spending on new capital, driven by profit expectations and interest rates.
- Shifts in Aggregate Demand: Changes in overall spending by consumers, businesses, and the government.
- Technological Shocks: Major innovations can boost productivity and lead to expansion, while their absence can slow growth.
- Monetary Policy: Actions by the central bank to change interest rates and the money supply can either stimulate or slow down the economy.
- Fiscal Policy: Changes in government spending and taxation directly impact aggregate demand.
3. What are the four primary phases of a business cycle?
The business cycle is typically characterised by four distinct phases that occur in succession:
- Prosperity (or Peak): A phase of high economic growth, low unemployment, and rising incomes. Business confidence and investment are high.
- Recession: A period of economic slowdown where growth falls, unemployment starts to rise, and consumer demand weakens.
- Depression (or Trough): The lowest point of the cycle, marked by high unemployment, low production, and significant decline in economic activity.
- Recovery: The phase where the economy starts to rebound from the depression. Employment, income, and production begin to rise, leading back towards prosperity.
4. What is the main difference between economic fluctuations and economic growth?
The key difference lies in the time frame and direction. Economic growth refers to the long-term, sustained increase in a country's real Gross Domestic Product (GDP) over many years, representing an expansion of the economy's productive capacity. In contrast, economic fluctuations are the short-term, cyclical movements (expansions and contractions) of GDP around this long-term growth trend.
5. How do economic fluctuations directly affect employment and household income?
Economic fluctuations have a direct and significant impact on households. During an expansion (prosperity), businesses increase production, leading to more hiring and lower unemployment rates. This results in higher average household incomes and increased consumer spending. Conversely, during a contraction (recession), businesses cut back on production, leading to layoffs and higher unemployment. This reduces household income, decreases consumer confidence, and lowers overall spending, further deepening the economic downturn.
6. Why can't a government completely prevent economic fluctuations?
While governments can moderate the severity of economic fluctuations using fiscal and monetary policies, they cannot eliminate them entirely. This is because:
- Time Lags: It takes time to recognise an economic problem, implement a policy, and for that policy to have an effect.
- External Shocks: Unpredictable events like global financial crises, pandemics, or wars can disrupt the economy regardless of domestic policy.
- Imperfect Information: Policymakers work with incomplete data and economic forecasts that are not always accurate.
- Political Constraints: Policy decisions can be influenced by political goals rather than purely economic needs.
7. Can you provide a real-world example of an economic fluctuation?
A prominent example is the Global Financial Crisis of 2008. It began with a downturn in the US housing market, leading to a major banking crisis. This triggered a severe recession, which is a phase of the business cycle. Production fell, unemployment rates soared across the world, and global trade declined sharply. The subsequent years saw a slow and uneven recovery phase as governments and central banks implemented stimulus measures.
8. How do changes in interest rates contribute to the business cycle?
Changes in interest rates are a key mechanism driving the business cycle. When the central bank lowers interest rates, borrowing becomes cheaper for businesses and consumers. This encourages investment and spending on big-ticket items, stimulating economic expansion. Conversely, when the central bank raises interest rates to control inflation, borrowing becomes more expensive. This discourages investment and spending, which can slow down the economy and potentially trigger a recessionary phase.
