Activity Variation With Business Cycle

Business Activity

Business cycle indicators such as inventories are crucial. Companies need to maintain an adequate supply of inventory to meet demand, but they do not want to tie up too much capital in inventory. In many industries, the inventory ratio to sales has thus trended toward a normal level in periods of sustained economic growth.

The sales growth slows, and unsold inventories accumulate as an expansion reaches its peak. Inventory levels increase above their normal levels, as shown by the inventory-sales ratio.

One of the causes of the subsequent economic recession is that firms reduce production in response to an unplanned increase in inventory. Whether inventory increases are planned or unplanned, they contribute to GDP statistics. If an analyst only considers GDP growth and not inventory sales ratio, he could see economic strength instead of economic weakness.

When contractions are at their trough, the opposite happens. In response to lower sales demand, firms reduce production levels to adjust for lower demand in sales; however, once sales growth accelerates, inventories deplete more quickly. Thus, the inventory sale ratio is decreased below its normal value as a result. As firms increase output to meet the increased demand, the inventory sales ratio will increase to normal levels.

Resource Use During an Expansion

The low prices that characterise the recession and trough phases of the business cycle prompt consumers to buy more goods and services. This leads to an increase in aggregate demand. The business cycle then moves into the expansion stage. Here, the economy may experience shortages because demand is higher than supply. During this period, the riskiest assets, such as growth stocks, will experience high increments in prices.

The expansion phase is then followed by the peak of the business cycle and subsequently, the contraction phase.

Housing Sector

There is a strong correlation between the housing sector and interest rates. This is because the construction and subsequent purchasing of homes depends on the mortgage rates at which the homebuyers can finance their mortgages. Therefore, when interest rate is low, consumers are encouraged to purchase more real estate.

Apart from interest rates, the housing sector also closely follows the business cycle trends. This was evident in the financial crisis of 2008. When home prices are low compared to average income, the cost of owning a house reduces, and the demand rises.

The External Trade Sector

Imports increase as demand for foreign goods and services increases. Hence, imports are highly dependent on domestic cycles.

However, exports also depend on external business cycles. When a country’s economy is booming, its currency strengthens in comparison to foreign currencies. This currency value appreciation makes exports expensive in comparison. This leads to reduced exports and thus reduced production output. This effect then subsequently depreciates the currency’s power, thereby favouring exports.

Question

In general, imports respond to:

1. Level of exports.
2. Domestic GDP growth rate.
3. The domestic industrial policy.

Solution

The correct answer is B.

Imports show the domestic needs for imported goods and change with domestic growth.

On the other hand, exports most likely depend on external business cycles.