A business cycle, also known as the trade cycle, marks different stages of a product/service in the economy.
Typically, the series of stages keeps on repeating itself after some time. However, not every set needs to be the same for a business whenever the cycle starts over again.
Consider business cycles as tides or a never-ending rise and fall graph.
Nonetheless, it is possible to identify the business’s different stages, or better said – phases within any cycle.
But, before we get to the different stages of the business cycle, it is important to understand why is it important?
Why Do We Need To Study Business Cycle?
Business cycles are universal to capitalist economies, and sometimes, communist and socialist economies too.
With globalization, these natural cycles are penetrating more economies than before.
Perhaps, understanding these cycles can help business owners plan their future strategies.
For instance, during expansion, businesses can plan for the contraction and vice-versa. It would help ensure the survival of the company and help it grow during tough times.
Likewise, the investors may use the cycle to predict when to buy and sell their assets. And, as a result, they may create their hedge against inflation and recession.
You must be wondering what expansion and contraction have to do with the business cycle?
Keep reading to find out.
Different Stages Of Business Cycle
As already mentioned, it is possible to identify the different stages in a business’s life cycle. However, it is noteworthy that the business cycle must not be confused with the product cycle. The two are quite different from each other. For example, the product life cycle is terminal whereas the economic cycle or business cycle is not.
Nonetheless, here are the four stages of a business cycle.
Often called the “normal”- expansion is the most desirable state in the economy or trade cycle. It is marked by the upward growth of the business or trade.
During expansion, businesses witness steady growth in production and profits. Unemployment also remains low, and the stock market performs progressively.
It means consumers are spending money, and currency flow in the market is improving.
After expansion, a state in the economy comes when investors buy assets with significantly lower underlying value. This is when the market grows out of control, eventually increasing the cost of everything.
The state or phase is regarded as the peak of the economy. Marketers often use a strategic market research tool to predict a peak in the economy. It helps identify and prepare for the upcoming contraction in the economy.
Besides, the peak also indicates that expansion has reached its maximum limit. Subsequently, the production and profits also stop increasing any further.
Once the economy reaches its peak, it also marks the arrival of a decline, as mentioned already. This declining phase in the economy is referred to as contraction.
Typically, rising unemployment, falling stock prices, and shrinking GDP characterize the contraction phase.
Eventually, the businesses cut back their activities. Or better said, they start pulling their investments from the market.
As the peak marks the highest point in the trade cycle, the trough marks the lowest. This is essentially what most people recognize as the recession in the market.
Most economic activities either cease to exist or hit rock bottom in the trade during this phase. Not to mention, the living costs far exceed the median income of the citizens in the economy.
However, the trough also brings merrier times in the economy. It marks the beginning of the new expansion in the economy and helps restore financial status.
Business Cycle Vs. Market Cycle
Although both the terms are often used interchangeably, technically speaking, they are quite different.
You already know the business cycle represents the rise and fall, and then again the rise of an economy. In contrast, the market cycle is precisely used for the stocks market.
The latter is more concerned with the trading of the stocks and assets, and how it affects the pricing and valuation.
However, it is also noteworthy that despite being different these two cycles are related for sure.
For instance, the stock market is generally affected by the performance of the economy and vice versa. Meaning, if the stocks decline, the economy may also decline, followed by a recession period.
Consider this, during expansion, investors purchase more stocks- creating a bull market. On the other hand, during contraction, investors generally dump their stocks- creating a bear market.
What Factors Affect Business Cycle?
Generally speaking, there is no single factor that affects the business cycle. From wars to natural disasters and calamities, everything can affect the economic cycle.
Nonetheless, there are a few influencers that drive the performance of an economy, and ultimately the trade cycle.
1. Supply and Demand
This one is the easiest to understand. Initially, when the demand is high, it marks the expansion period in the trade. It is then followed by a peak, which is reached when demand increases more than supply.
Once the peak is reached, it creates inflation in the market, leading to increased costs of living and reduced expenditure. People start to save their money rather than spend it. This marks the contraction period.
Lastly, when the supply far exceeds the demand it marks the trough in the economic cycle.
It is noteworthy that natural phasing does not mean economic cycles cannot be influenced. Look around, and you’ll find your government trying to either slow down or pace up the market.
Using monetary and fiscal policies, for example, countries try to either expand or contract their economy.
However, the interesting fact here is that no country ever wants to be at the peak or trough. The other two phases promise more growth but neither of the peak and trough.
Although it might seem that business cycles may only affect the economy, the truth is they have several real-world implications.
For example, if a community faces economic contraction, individuals may find it difficult to land a good job. Similarly, during an economic expansion, individuals may be able to earn more than they actually deserve.
There are many other implications that can be deduced from trade cycles.
Nonetheless, studying the cycle can also implicate hope for rebound and recovery after economic depressions.