BUSINESS CONTEXT

Business Context

Business Context

Part 1

i)

Business cycles, in economics, are periods which alternate between prosperity and depression. They have occurred with varying amplitudes and periods of duration since the advent of the Industrial Revolution. Fluctuations in output are accompanied by fluctuations in employment and income. Cycles are not precisely repeated because their causes are complex and variable. Some students of the business cycle measure cycles from trough to trough or peak to peak. Joseph Schumpeter (1883 - 1950) argued that this was improper and inconsistent with the historical driving forces. He identified four stages of the cycle: prosperity (expansion from an equilibrium to the peak); recession (decline from the peak to the next point on the trend line); depression (further fall to the trough); and revival (expansion from the trough to the next equilibrium on the trend line). He measured the business cycle from equilibrium through the four phases to the next equilibrium. The National Bureau of Economic Research, on the other hand, identified two phases, expansion and recession, and measures business cycles from peak to peak or trough to trough. (Drazen, 2011: 145)

Fluctuations in the level of business activity in an economy brought about by changes in demand conditions, particularly increases and decreases in investment spending. The business cycle is characterized by four phases, with the economy moving upwards from 'depression' through 'recovery' to 'boom' and back through 'recession' to depression once again. The depression stage of the cycle is characterized by a very low level of demand relative to supply capacity, accompanied by low levels of output, unsold stock and high unemployment. As demand picks up in the recovery stage, stock levels fall and output and employment increases. Boom conditions are characterized by full-capacity levels of output and employment, but with a tendency for the economy to 'overheat', producing inflationary pressures. The ending of a boom is followed by a period of recession, with falling demand leading to modest falls in output and employment at first but then accelerating into depression as demand continues to fall. In practice, however, governments attempt to use anticyclical fiscal policy and monetary policy to stabilize the economy, aiming in general to keep total demand in balance with the supply capabilities of the economy thus avoiding undesirable output- and employment-losses as well as containing inflation. (Frey, 2010: 177)

ii)

From the perspective of the political business cycle approach (PBC), macroeconomic fluctuations are generated or reinforced by the political system. Governments intervene in the economy to improve their chances of re-election and/or to pursue ideological goals. Governments thereby create business cycles, instead of pursuing a socially optimal stabilization policy. Political actors are not seen as benevolent, but rather as self-interested individuals, as is generally assumed in economics for other individuals acting in the economy. (Alesina, 2008: 651-78)

The PBC approach builds on systematic interactions between the economy and the polity. A wealth of empirical evidence shows that macroeconomic conditions have important influences on voter attitudes and on election outcomes (Nannestad and Paldam, ...