Business Cycles& the British Economy - What are business cycles?

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Business Cycles

& the British Economy

What are business cycles?

Business cycles, economic cycles or trade cycles as they are sometimes called, are defined by the Longman Dictionary of Business English, as "a cycle in time during which trade moves from a state of high activity (boom, prosperity) through a running-down period (contraction, downsizing, recession, slump, downturn) to a state of low activity (depression, stagnation, trough), then upward again when business improves (expansion, recovery, revival) until there is a return to high activity once more. The whole cycle then begins again." (Adam 1982 p.138)

But what does this actually mean? In Fig. 1 below you can see a theoretical business cycle, which shows the trending and actual output or aggregate demand, of a country, over time.

Fig.1

Aggregate demand is the sum of Consumer spending (C), Government spending (G), Investment (I) and Exports (X) (minus Imports (Z)); represented as

C + G + I + (X-Z); and is a major indicator in the financial stability of a country.

As you can see in Fig.1 the trending output increases steadily year on year, whilst the actual output fluctuates around it. The actual output curve reflects the business cycle at which point A marks a slump, B shows the economy in the recovery phase, C indicates the top of the boom period, D is the start of a recession and E shows another slump, after which the recovery starts again.

The Implication to Businesses

For businesses to survive it is imperative that they understand the nature of business cycles and the causal chains or knock-on effects that each stage creates. For example, when the economy enters a slump the following occurs:

Fig.2

In a boom period the opposite happens and rises in aggregate demand fuel growth in the economy. To a business which is considering expanding, understanding this can mean the difference between prospering and going bankrupt.

What causes business cycles?

There are several theories for what causes a business cycle and they are split into two categories:

* External (Exogenous) Theories - these follow the ideology that business cycles are influenced by changes in external factors such as war, revolution, elections, gold discoveries, oil shortages, technology and scientific breakthroughs etc.

* Internal (Endogenous) Theories - these look for triggers within the economic system itself, such as the massive consumer and business borrowing of the mid 1980's or stock market crashes.
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Some of the main theories include:

Monetary Theories - these argue that when the supply of money increases faster than output and interest rates are low, spending increases and the economy moves into a boom period, such as during the dot com era when wages skyrocketed. However the higher demand increases demand for money, interest rates rise and investment and consumption fall causing a downturn in the economy.

The Multiplier-Accelerator Theory - this says that if there is a rise in one sector of the economy it will impact another sector. For example, a rise in ...

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