Peter Decaprio: Explaining why certain industries in an economy can be more negatively affected by a business cycle.

There are a few industries in an economy that can be more negatively affected by a business cycle explains Peter Decaprio. These industries would include the construction industry, the retail industry, and generally any industry that is heavily reliant on discretionary spending.

The “business cycle” refers to periods of economic growth (recovery) and decline (recession). The length of the business cycle will vary from country to country but each one consists of periods where consumer confidence levels are high or low based on their perceptions towards current and future financial conditions.

Industries such as construction and retail depend on people having disposable income and access to credit. During boom times when consumers perceive their current financial position to be good they will spend money; if only for necessities then also on discretionary items. When the economy goes into decline consumers will reduce their spending levels which means there is less demand for products and services in these types of industries. This effect trickles down to other industries as suppliers may be force to lay off employees or even shut down operations completely further exacerbating the economic condition.

This makes it difficult for economies that are heavily reliant on these types of industries (e.g., Australia) because they are still susceptible to business cycles despite having relatively good economic conditions overall (such as Australia’s terms of trade, budget surplus, etc.).

There are many different definitions of the term ‘business cycle’. The common thread between them all though is that it refers to a periodic fluctuation in aggregate economic activity surrounding its long-run trend. The ‘cycle’ can be define as a combination of fluctuating GDP or employment levels. And trending growth rates, output gaps, and potential growth rates over time.

Business cycles can be divided generally into three phases:

1. Expansion:

This is the phase where economic activity is increasing and inflation pressures are rising and demand for labour exceeds supply driving unemployment levels to fall says Peter Decaprio. Inflationary pressures during this phase tend to come from strong domestic demand, commodity prices and wages. Since capacity utilization has not yet been reach meaning there is still slack in the economy. Overall business confidence tends to be high as firms begin spending again on equipment, plant, machinery etc., which they had deferred when demand was low during economic decline (also known as the ‘recession’ phase).

2. Peak:

This is the phase where economic activity reaches its zenith and inflation pressures are at their highest levels for that particular cycle. Wages catch up to commodity prices and capacity utilization has reached around 85%. During this phase, unemployment may be high, depending on how quickly the economy expands. And capacity utilization rises to normal levels, but it should generally remain below average. Business confidence tends to decline as demand slows. While consumers experience shortages in supply or delays in delivery of goods and services. Due to bottlenecks in production (and possibly labor). The risk of a recession becomes more prominent at this stage unless policymakers can stabilize growth through adjustments. Such as interest rates says Peter Decaprio.

3. Recession:

This is the phase where economic activity declines and inflation pressures ease down. Unemployment levels rise as demand slows and firms may cut jobs to compensate for reduced output. Capacity utilization tends to drop below its average level, creating spare capacity which dampens economic conditions further. During this phase, consumers experience an increase in the supply of goods. Due to factories reducing production rates (and possibly closures) but also see prices decline as commodity prices fall. Business confidence remains low or falls even further at this stage. Making it difficult for policymakers to stabilize the economy.

Economists tend not to agree on what causes business cycles although the main theories have been outlined by leading academics:

Classical/Neo-Classical Thought:

The classical school is the oldest school of economic thought. And is based on one fundamental law: supply creates its own demand. When economic activity increases, firms tend to produce more. With their available resources, demand for their products, therefore, tends to rise and in turn, they employ more people. As this becomes a chain reaction, employment rises and unemployment falls which then drives up demand further?

The link between production and spending (and therefore output and income) was explain. Jean-Baptiste Say said “supply creates demand”. Therefore any shortfalls during downturns would be overcome through the natural inclination towards self-centeredness. According to classical thinkers such as William Jevons who believed that there is always enough for everyone’s needs (provided markets function completely).

Conclusion:

As the classical school argues that supply and demand naturally balances. And that an economy can only produce what it is capable of producing. They would hold that any temporary mismatch or shortfall in demand during a downturn will be overcome. Through higher production explains Peter Decaprio. Therefore the solution to short-term employment problems resulting from a recession is not to intervene with monetary or fiscal policy. But instead, allow for self-organizing market forces to operate. Which would result in increased production and therefore job creation. The risk of a recession at this stage is minimal.

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