The trade cycle is a term that is commonly used, and one that many people assume that you know the definition of. However, the trade cycle has many different features and types to it, which are not very easy to understand. So what is the trade cycle? The trade cycle, also known as the business cycle or economic cycle, are regular fluctuations in the level of economic activity around the productive potential of the economy.
Trade cycles tend to have four main phases:
o Peak or boom:
When the economy is at a peak or is in a boom, national income and output is said to be high. It is likely that the economy will be working beyond full employment. Overheating is therefore present. As a result of this, consumption and investment will be high as households and firms will be willing to consume and invest. Tax revenues will be high. Wages will be rising and profits will be increasing. Imports will also be increasing as people will have more disposable incomes and so are likely to demand more from foreign countries. There will also be inflationary pressures in the economy.
When the economy moves into a downturn, output and income will fall. This then leads to a fall in consumption and investment, as consumers have less disposable income and they will be less willing to spend. Tax revenues begin to fall and government expenditure on benefits begin to rise. This is because unemployment rises and more people are on low-incomes. Imports decline and inflationary pressures ease.
At the bottom of the cycle, the economy is said to be in recession (or depression or trough or slump). Economic activity is at a low in comparison with previous years. High unemployment exists, so consumption, investments and imports will be low. Prices of goods and services will be falling, so there will be deflation. People generally have less money and
As the economy moves into a recovery (or expansion) phase, national income and output begin to increase. Unemployment begins to fall and consumption, investments and imports begin to rise. Workers feel more confident about demanding wage increases and so government expenditure on transfer payments begin to fall. Inflationary pressures begin to rise.
A very well-known example of the recession phase is the Great Recession, which occurred between 2008 and 2013. The recession began after the global credit crunch and led to a long period of low economic growth and rising unemployment, which lead to a number of other problems.
The causes of the trade cycle can be categorised into two main types: demand-side shocks and supply-side shocks.
o Demand-side shocks are those that affect aggregate demand, and include:
• House prices rise too high and there may be a sudden collapse in the demand for housing which leads to a fall in house prices. This decreases consumer confidence, which results in less consumer spending and a decrease in the amount of house built, decreasing output and increasing unemployment.
• The central bank may increase interest rates as a result of rising inflation. If the interest rate is too high, it reduces consumer spending which leads to a recession.
o Supply-side shocks are shocks which affect aggregate supply, and include:
• Natural disasters are supply-side shocks as they disrupt the production process. For example, Hurricane Katrina’s terrible effect upon the oil and gasoline industry.
• Technological advances that improve the productivity of labour. These improvements cause the quantity supplied to increase and the price to fall.