Trade cycle or business cycle refers to cyclical fluctuations in economic activities like employment, income, prices etc. It is a characteristic feature of capitalist system. In a trade cycle, there are alternating waves of expansion and contraction. These waves recur frequently and in similar patterns. It comprises of a period of good trade wherein the prices are high and unemployment is low and a period of bad trade wherein the prices are low and unemployment is high.
A business cycle usually consists of four phases. These phases do not have a definite time intervals or periodicity. The four phases are: recovery, prosperity, recession and depression.
Recovery is the first phase in the trade cycle. It is the revival period. Here entrepreneurs increase the level of investment. This in turn leads to increased employment and income. A increased income level means more purchasing power in the hands of people which leads to more demand for consumer goods. This leads to increase in prices for commodities and eventually leads to profit generation Business expectations improve and optimism prevails.
Prosperity is the second phase in the trade cycle. In this stage, demand, output, employment and income are at the peak levels. Increased profits lead to increased stock market values. There is expansion in economic activities. Demand and prices go up. The production level is very high and known as boom. The economy surpasses the level of full employment to reach the level of over full employment. This leads to inflation and is a sign of end of prosperity.
Recession is the third phase of the trade cycle. It starts when there is a downward descend from the peak. The level of investment declines and consequently the demand for raw materials decline as well. Liquidity preference rises in the economy. The margin of profit declines and a wave of pessimism spreads in the business. Recession can be mild or severe.
Depression is the fourth phase of the trade cycle. It’s characteristic feature is the general fall in all economic activities. Production, employment, income decline. This general decline in economic activities lead to fall in bank deposits. Credit creation declines and bank rate falls. Distribution of national income change and margin of profit declines.
There are several factors responsible for the existence of fluctuations and trade cycles. External factors like political events, growth rate of population, migrations, discoveries, innovations etc are responsible for the cyclical fluctuations in the economy. As far as internal factors are concerned, mechanisms within the economy give rise to repetitive fluctuations. Over investment is one such factor. It is the credit availability by the banks which leads to over investment in capital goods rather than consumer goods. This eventually brings depression in the economy. Competition may be another reason for fluctuations. The profit motive causes firms to anticipate demand and subsequently do excess production. For this, firms hire more workforce and cost of production increases. This raises the prices of the commodities and decline in the demand for them. This ultimately leads to depression.