What Causes Business Expansion & Contraction in the Business Cycle?
Your business has to be prepared for expansion or contraction in response to the business cycle. Customer demand grows during booms and shrinks during recessions, causing business expansion and contraction. While economists propose different theories for why demand changes, they agree that business cycles are a pervasive feature of the economy and that businesses have to develop strategies to exploit expansions and survive contractions.
You see growth leading to an expansion of your business when customers start placing more orders. This part of the business cycle is characterized by factors such as increasing consumer confidence, dropping unemployment rates, increasing disposable income and low inflation. The growing customer demand resulting from a favorable economic environment leads you to respond to increasing orders by hiring additional staff and ordering more supplies and materials. The expansion of your business reinforces economic growth. A good strategy for your business during this part of the cycle is to build on business strengths and reduce weaknesses.
During the final stages of a period of growth you see increased inflationary pressures as demand outstrips the supply capacity of businesses. Interest rates tend to rise. Higher prices from inflation reduce demand and the growth of economic activity slows. Businesses respond by postponing expansion plans and reducing investment due to high interest rates. These measures further reduce growth. Your business can react by consolidating expansion and gains made during the growth period to prepare for a possible recession. Sometimes growth resumes after a pause, but at other times the economy starts shrinking.
When demand starts decreasing, you see fewer orders from customers and you buy fewer supplies for your production. As demand shrinks below a certain minimum for your company, you start cutting staff and your business contracts. The combined effect of business contraction makes the unemployment rate increase and reduces consumer confidence. Business investment drops and overall economic activity decreases. Your business strategy must be to cut costs and avoid spending as profits drop due to decreasing business volume.
After a period of recession, businesses have cut costs and are able to lower prices. Lack of demand reduces inflation and interest rates tend to decrease. The lower prices stimulate new demand and you start seeing increased orders from customers. With interest rates low, you may decide to invest in additional capacity or upgrade your equipment to raise productivity. Businesses start to expand and hire new employees. The unemployment rate drops and consumer confidence rises. Another period of growth with corresponding business expansion follows and completes the business cycle.