On the vertical axis we have P which represents Price and on the horizontal axis we have Q which represents Quantity. D1 is the demand curve and S1 is the supply curve. The equilibrium condition is given at the point where the demand curve intersect with the supply curve or at the point where quantity demanded is equals to the quantity supplied. In this case it is given by point e. At point e, equilibrium price and equilibrium quantity is determined. For that case, the corresponding value for price which is the equilibrium price is 10 and the corresponding value for quantity which is the equilibrium quantity is 40. Therefore, at the point of intersection we get two corresponding values for price and quantity as 10 and 40 respectively. This represents the equilibrium price (10) and equilibrium quantity (40 units).
Initially the equilibrium condition is reached at point, e, where the equilibrium price is given by 10 and equilibrium quantity given by 40. As the income of the consumer increases, it will lead to a shift of the demand curve from D 1 to D 2. When the demand curve shift and the supply curve remain, the quantity demanded and the price of the commodity will be affected. The equilibrium position will shift from point, e, to point, E1. This means that new equilibrium quantity and price will be established. In that case, the new equilibrium quantity will be Q1 and the new equilibrium price will be P1.
Compare to the initial equilibrium price and quantity, an increase in income has resulting in a rise in both price and quantity. The initial equilibrium price (10) has moved to a new equilibrium price denoted by P1 indicating an increase of (P1 – 10) and the initial equilibrium quantity (40) has moved to a new equilibrium quantity denoted by (Q1) indicating an increase by (Q1 – 40) units.
The product demanded by the consumer is a normal good since, as the income of the consumer increase the quantity demanded for the by the consumer also increases. This indicates a direct proportionality between income and the product demand.
Business cycles also termed as economic cycles refers to the ups and downs as well as economy-wide fluctuations in an economy or production over many months or years. These ups and downs take place around a growth trend which is long-term. It involves change over time between boom/expansion (times when the economy is experiencing rapid growth), and recession/contraction (representing periods of relative decline or stagnation). Business cycle measurement is based on real GDP (Gross Domestic Product) growth rate. The business cycles do not follow a predictable or mechanic periodic pattern, despite being referred to as cycles. It is a market economy characteristic feature through alternating contractions and expansions characterizing a business cycle or through alternating slowdowns and speedups characterizing cycles in growth. An economy’s growth is not steady. It is characterized by patterns such as a peak, a trough/low-point, a contraction and an expansion. The patterns repeats itself though not predictable or regularly.
The business cycle
The business cycle/economic cycle are linked to an economy’s overall economic activity. The main indicator of business cycle is the GDP (Gross Domestic product). However, due to the variations in GDP, NBER (National Bureau of Economic Research) have indicated employment, industrial production as well as personal income as indicators of business cycles.
Phases of business cycle
The business cycle is categorized into four major phases, namely, expansion, peak, recession and trough. Expansion represents an economic period where the economic activity and consumer confidence is increased. The expansionary phase is made up of two parts recovery and boom. Recovery represents the initial part of the expansionary phase. During recovery consumer confidence starts to build up and some consumers begin to replace items, for example, small appliances and clothes. The business will start to increase or replace their inventory levels due to consumer demand.
Also business output will begin to increase and employment opportunities created. In this part unemployment rate will reduces but on the other hand there is occurrence of inflation. The second part is boom (McEachern 213). Consumer’s confidence continues to build up in a faster pace. This is witnessed by increased purchase of consumer goods. The business will employ more people resulting to an increase in the national income as well as a reduction in unemployment rates.
Consumers during this time start to purchase more goods including durables like houses and cars. Business also starts to invest in machines and equipments hence improved efficiency. The price of goods will increase and workers will also receive high wages. The rate of inflation will be high and unemployment rate will fall as the economy moves towards full employment.
Peak; this phase is reached at when the expansionary phase is at climax. The economy experiences a standstill and level off in output. In this phase consumer confidence starts to take a declining trend and they begin to slow their purchase of goods.
Contraction is the third phase and represents an economic period where both economic activity and consumer confidence are in a decline. Contraction phase comprise of two parts recession and depression. Recession represents a period where consumer confidence starts to decline. Durable and large goods such as cars, houses and major appliances are avoided by the consumers. Therefore, business activity starts to shrink through reduced output. Prices fall and a time workers receive wage cuts. It results in increased unemployment levels and eventually less buying and inflation starts to drop.
The second part is depression; in this face consumer totally lose confidence. This leads to slow pace of purchase. The businesses are forced to get rid of their stock levels and lower their production levels considerably to be in low levels. Business opts to lay off workers as a way to cut cost. As a result, unemployment rate rises and the national income reduced. The prices of goods fall considerably and as a result, companies close down or go bankrupt. Unemployment levels skyrocket and inflation is non-existent.
This is the last phase of business cycle. It represents the minimal or low-point of contraction. There is leveling off and standstill of output. Again, consumer confidence begins to level off to a point where consumers minimize their savings and do a little of commodity purchase.
The causes of recent recession
The recent recession witnessed is attributed to four reasons that include; credit crunch, falling houses prices, cost push inflation as well as collapse in financial sector confidence.
Credit crunch is a situation whereby there is shortage of cash and as a result there is less or no money to lend as loans. This can result due to a unexpected interest rate increase, capital markets lack of funds and government direct money control. The recent credit crunch is attributed to a sharp rise subprime mortgages default. The default occurred in US but its effects of shortage in cash cut across the whole world. The mortgage lenders in US sold mortgages to people with poor loan history and low income (Melvin & William, 89).
The incentive of paying brokers after selling a mortgage, leads to mortgage sell even when chances of default were high. When the US increased the interest rates due to inflation repayment of mortgage loans become expensive and many Americans could not afford as a result mortgage defaults increased. The US housing boom came to an end bringing down house prices hence could not guarantee a secured loan. As defaulters increase mortgage companies collapsed. As a result banks lost a lot of billions of pounds due to bad mortgage. The end result was difficulty to borrow and raise funds in the whole world. It also resulted in high interbank lending cost hence the money market dried up. The decline in borrowing has lead to a slowing economy bringing forth a real problem.
With the high interest rates, homeowners experienced cost push inflation due to rising food prices, rising petrol prices and health care costs. The high cost of health care, fuel and food has resulted in reduced consumer disposable income. As a result, the homeowners have a big problem in repaying their mortgages.
The other cause is credit default swaps. For instance, insurance company such as AIG that were supposed to insulate investment banks from defaulters of loan was also involved in the problem. Their operations in other countries were also troubled creating a worldwide problem.
The recent recession began in 2006 during the beginning of the summer when the prices of homes started to decline. The homeowners started to default on loan due to high interest rates as well as payment amounts. As a result they started to “walk away” from 2008 because of negative equity.
The great recession come to a technical end during mid-2009. The current recession is regarded as the worst recession not only resulted in job losses, high unemployment levels, high inflation rates and fuel and food prices, it lasting for a longer period of time nearly 18 months. Again, the recession is spread worldwide and the economic health of a country was uncertain. A lot of companies lay off their workers with minimal monthly sales being witnessed in most companies. The recent depression is categorized as the worst one in the post war era. It effects were felt in the whole world and recovery from it will take a long time.