Economic Activities in Phases of Business Cycle

We will now learn about resource use fluctuation, housing sector activity and external trade in the context of the phases of the business cycle.

Resource Use Fluctuation

During the build-up to peak phase, production is high. Firms will keep inventory that is enough to meet the demand. They will not keep more as it will lock their capital. At the peak though, sales will slow down and a slow build-up of inventory will take place.

Once the recession phase starts, sales slow down drastically. Companies stop holding inventory, which further leads to a slowdown in the economy. In the recession stage companies keep low inventory. Once the cycle reaches trough stage, the next stage is an upward trend in the economy. Sales begin to improve and there is increased demand. This means the sales-inventory ratio will be low. Firms will start increasing inventory to meet growing demand and the sales-inventory levels will move back to normal.

Labour and capital in the context of business cycles can be adjusted theoretically. In real terms though it is impractical to reduce and increase workers and machinery during the varying stages of the business cycle. Instead companies will modulate the time both these factors are used. In the high demand phase workers and machines will work overtime and vice-versa in periods of low demand. In the case of machines, lesser maintenance and replacement will be done to reduce costs in times of low demand. Only in the case of a protracted downturn will workers be laid off.

Housing Activity

The housing sector is a big source of demand and behaves differently during the various stages of the business cycle. The housing market does well during the early phase of the business cycle. A growth in housing harbingers a further growth in the economy. Low interest rates stimulate growth in the housing market, while high interest rates reduce demand in the housing market.

In the recovery stage or growth stage of the economy when incomes are increasing, there is growth in the demand for housing as well. In the recession or trough stages there is a fall in the demand for housing and therefore a fall in construction related activity as well.

While housing boosts economic growth, by itself it does not result in the growth of the economy. In the upward movement to the peak, the demand for housing is high. With increase in prices, investors may seek to park their funds in housing, leading to a further increase in growth of the housing sector. As in the case of Ireland people borrowed from banks to invest in housing. Construction increases manifold – a pile up of inventory occurs. As the economy becomes sluggish there is a fall in prices and speculation in the housing sector ends. The housing bubble burst in Ireland resulted in banks sitting on a pile of bad debt. In Ireland’s case the housing activity was not real demand, but fuelled by speculative gains.

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