As we know, the performance of a firm is never the same over an extended period of time. There are always ups and downs in the economic activity and output of a firm. These cyclic phases are known as business cycles or trade cycles. Let us learn a little more about the importance of business cycles.
Importance of Business Cycles
Every company must go through their share of ups and downs. And each trading cycle is characterized by its own unique features. There are four basic phases – expansion, peak, trough/depression, and recovery. A firm must always identify which phase it is currently in. It must also always be prepared for a sudden change in the cycles since these cycles are impossible to predict. Let us see the importance of business cycles and their relevance for firms.
(Source: Economic Discussion)
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1] Help Frame Appropriate Policies
A business cycle will affect all the sectors of an economy. Similarly, it will also affect all sectors of a firm as well. Right from demand to supply to the cost of production every aspect will depend on the phase of the business cycle. So the firm must be able to correctly identify its current phase. This will help them frame appropriate business and trade policies. For example, if the firm is going through expansion it will be the correct time for aggressive investment policies or an expansion in the workforce.
2] Strategic Business Decisions
The business cycle of a firm will also have a huge impact on their business decisions. Managers and entrepreneurs take strategic business decisions based on the phases of the trade cycle. A business cannot be stagnant it must constantly keep updating to stay with the times. So different phases of the cycle demand different actions from the firm.
So if the economy is going through an expansion the management can make the strategic decision to expand the business or increase their output levels. But if the firm is in a trough then spending must be reined in and policies should be formed accordingly. Management may even decide to shut down some product lines temporarily or even permanently. Such important business decisions will depend on the trade cycle.
3] Greatly Affect Cyclic Businesses
Changes in the economy affect all firms but not uniformly. There are certain businesses that are more vulnerable to a change in the phase of a trade cycle. Such firms have to keep a very close look at the changes in the economy at all times. Some examples are the fashion industry, electronics industry, food and beverage industry, real estate industry etc.
For such firms when the economy is in a boom, they must capitalize. Because a depression in the economy will affect them the most. So this is one of the main importance of business cycles.
4] Entry and Exit from Market
For the success of a product launch, the phase of the trade cycle for its introduction is a very important factor. It is much harder for a new product to survive a sluggish economy that is moving towards a depression. Even the prices, sales policy, promotions of the new product will depend on the phases of the business cycle.
And on the other hand, if a product has to exit the market, again the conditions must be studied. If the economy is coming out of a depression and seeing a revival then perhaps the exit can be delayed. This is another importance of business cycles.
Solved Question on Importance of Business Cycles
Q: A firm should look to expand its workforce during a contraction phase. True or False?
Ans: The given statement is False. During contraction, the supply of goods is more than the demand. Increasing the workforce will only add to the already high production cost. The workforce may be added during the Expansion phase to keep up with demand and increase profitability.