|Article Title: Business cycle|
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Business cycle consists in the succession of stages characterized by fluctuations in the intensity of economic activity in a country or a group of countries linked economically.
Stages of business cycle
Business cycle consists of the following stages:
1.Expansion, that is divided into two other stages: recovery, where the private investment starts to rise; prosperity, where investments and consumptions rise quickly;
2.Contraction, that also consists of two stages: recession, where economic growth slows down, and depression, where economic growth undergoes a period of stagnation;
The main indicators which cause variations in business cycle are GDP and employment, which grow during expansion stage and decline during contraction stage.
Expansion stage peaks when the potential GDP, which measures the maximum production capacity of a country, is reached. When real GDP and potential GDP coincide, factors of production are fully employed.
Business cycle theory
Business cycle theories analyze the cycle in order to find strategies aimed at protracting as much as possible expansion stages and shorten contraction stages.
According to monetary theory, cyclical variations depend on the policies of banks regarding granting credit. When bank have excess of liquidity they grant loans at lower rates of interest, and wholesalers expand their stock purchase with bank loans. This encourages production and investment. But the expansion of credit reduce bank reserves and banks increase again their rates of interest, reducing not only purchase of stocks, but also output and investment. In this way credit reserves are reconstituted, causing inversion of the cycle and the beginning of an expansion stage.
According to Keynes the cycle is determined by the trend of investments which, in turns, depend on the expected profitability of the invested capital. The efficiency of the investment depends on five factors:
2.Level of organization
3.Price of capital goods
4.Cost of money to finance the investments
5.Trend of the market of the product
The main factor that influences decision of investment is the expectations about their profitability: if they are favourable the investment is made. Keynes notices how the expansion of the business feeds itself thanks to the multiplier mechanism. For example the creation of a new plant increases output and employment in all production sectors that supply materials and machinery necessary to build it and make it work.
The increase of the employment determines an increase in the demand towards the sectors that produce consumer goods. In this way it is created a cycle that feeds itself.