Relevance of Business Cycles - Business Cycles CA Foundation Notes | EduRev

Business Economics for CA Foundation

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CA Foundation : Relevance of Business Cycles - Business Cycles CA Foundation Notes | EduRev

The document Relevance of Business Cycles - Business Cycles CA Foundation Notes | EduRev is a part of the CA Foundation Course Business Economics for CA Foundation.
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RELEVANCE OF BUSINESS CYCLES IN BUSINESS DECISION MAKING 
Business cycles affect all aspects of an economy. Understanding the business cycle is important for businesses of all types as they affect the demand for their products and in turn their profits which ultimately determines whether a business is successful or not. Knowledge regarding business cycles and their inherent characteristics is important for a businessman to frame appropriate policies. For example, the period of prosperity opens up new and superior opportunities for investment, employment and production and thereby promotes business. In contrast, a period of recession or depression reduces business opportunities and profits. A profit maximising firm has to consider the nature of the economic environment while making business decisions, especially those related to forward planning.
Business cycles have tremendous influence on business decisions. The stage of the business cycle is crucial while making managerial decisions regarding expansion or down-sizing. Businesses have to advantageously respond to the need to alter production levels relative to demand. Different phases of the cycle require fluctuating levels of input use, especially labour input. Firms should exercise the capability to expand or rationalize production operations so as to suit the stage of the business cycle. Business managers need to work effectively to arrive at sound strategic decisions in complex times across the whole business cycle, managing through boom, downturn, recession and recovery.
Economy-wide trends can have significant impact on all types businesses. However, it should be kept in mind that business cycles do not affect all sectors uniformly. Some businesses are more vulnerable to changes in the business cycle than others. Businesses whose fortunes are closely linked to the rate of economic growth are referred to as "cyclical" businesses. These include fashion retailers, electrical goods, house-builders, restaurants, advertising, overseas tour operators, construction and other infrastructure firms. During a boom, such businesses see a strong demand for their products but during a slump, they usually suffer a sharp drop in demand. It may also happen that some businesses actually benefit from an economic down turn. This happens when their products are perceived by customers as representing good value for money, or a cheaper alternative compared to more expensive products.
Overcoming the effects of economic downturns and recessions is one of the major challenges of sustaining a business in the long-term. The phase of the business cycle is important for a new business to decide on entry into the market. The stage of business cycle is also an important determinant of the success of a new product launch. Surviving the sluggish business cycles require businesses to plan and set policies with respect to product, prices and promotion.
In general, economic forecasts are not perfectly reliable. Neither, of course, are the hunches and intuitions of entrepreneurs. Understanding what phase of the business cycle an economy is in and what implications the current economic conditions have for their current and future business activity, helps businesses to better anticipate the market and to respond with greater alertness. However, taken together and applied carefully, economic forecasts can help business firms to prepare for changes in the direction of the economy either prior to or soon after these changes occur.

SUMMARY
  • The rhythmic fluctuations in aggregate economic activity that an economy experiences over a period of time are called business cycles or trade cycles and are manifested in fluctuations in measures of aggregate economic activity such as gross national product, employment and income.
  • A typical business cycle has four distinct phases namely
    ⇒Expansion (also called boom or upswing) characterized by increase in national output and all other economic variables.
    ⇒Peak of boom or prosperity refers to the top or the highest point of the business cycle.
    ⇒Contraction (also called downs-wing or recession) when there is fall in the levels of investment, employment.
    ⇒Trough or depression occurs when the process of recession is complete and there is severe contraction in the economic activities.
  • Economists use changes in a variety of activities to measure the business cycle and to predict where the economy is headed towards. These are called indicators.
  • A leading indicator is a measurable economic factor that changes before the economy starts to follow a particular pattern or trend. i.e. they change before the real output changes.
  • Variables that change after real output changes are called ‘Lagging indicators’.
  • Coincident economic indicators, also called concurrent indicators, coincide or occur simultaneously with the business-cycle movements.
  • According to Keynes, fluctuations in economic activities are due to fluctuations in aggregate effective demand.
  • According to some economists, fluctuations in investments are the prime cause of business cycles. Investment spending is considered to be the most volatile component of the aggregate demand.
  • Fluctuations in government spending with its impact on aggregate economic activity result in business fluctuations.
  • Macroeconomic policies, (monetary and fiscal policies) also cause business cycles.
    According to Hawtrey, trade cycle is a purely monetary phenomenon. Unplanned changes in the supply of money may cause business fluctuation in an economy.
  • According to Pigou, modern business activities are based on the anticipations of business community and are affected by waves of optimism or pessimism.
  • According to Schumpeter, trade cycles occur as a result of innovations which take place in the system from time to time.
  • Understanding what phase of the business cycle an economy is in and what implications the current economic conditions have for their current and future business activity, helps businesses to better anticipate the market and to respond with greater alertness.

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