Construction Industry- Recession and Economic Cycles - Assignment Example

 Construction Industry- Recession and Economic Cycles Contents Index Pages 1. Introduction 2 2. Task-1: Construction industry tends to enter recession first And is often the last to recover. 2 3. Fundamental concepts of economics 3 4. The construction industry and recession 6 5. Recovery 7 6. Task-2: Economic Cycles 8 7. Business cycle analysis 9 8. Why business activity fluctuates 9 9. Government Intervention 12 10. Construction Industry and Economic cycles 12 Introduction Economic cycles form part of the characteristic features of a market driven economy. The period of expansion is a time when the industry is booming and growth rate is achieving its maximum potential. The country’s GDP or gross domestic product defines the total market value of all goods and services that are produced within a country for a given financial period. (Best Aaron, 2007) Task-1 Construction industry tends to enter recession first and is often the last to recover. Recession is mechanism that occurs at certain periods in a business cycle. Recession causes a decline in economic activity and therefore has a cascading effect on other area of socio-economics. A decline in sales leads to a drop of production which affects the employment scenario. Income falls which leads to further fall in sales. This cascading effect results in a vicious cycle leading to an overall decrease in economic activity. ( Verick Sher and Islam Iyanatul, 2010) Fundamental concepts of economics 1. Scarcity and choice- this concept defines the basis of economics. This is a condition that originates from a society having unlimited desires while having to settle with limited resources. Human resources include health, education and skill set of people. Land, wood, fish and oil are called natural resources. Buildings, equipment, roads, dams form part of the capital goods needed to improve production services.( Saunders Phillip and Gilliard June, n.d) 2. Opportunity Cost is a benefit that is traded off in selecting the next best alternative. This occurs when resources are scarce and the opportunity is given up for use in other purposes. Tradeoffs on the other hand involve accepting less of one particular entity to have more of another service. Society engaging in a tussle between having more of energy while at the same hampering the environment is an example of a trade-off. 3. Supply and Demand- Demand refers to the quantity of product or service that is desired by customers at a given point in time. Supply indicates the how much can the market offer to meet that demand. In market economics the relationship between demand and supply form the basis for allocation of resources. a. The Law of Demand states that when all factors are constant the higher the price of the commodity lesser is the demand. This increased cost increases the opportunity cost of buying that particular product. b. Law of Supply states that higher is the price at which a product is sold higher will be the quantity supplied. This is profitable for the producer because selling at a higher price would mean more revenue generation. ( Saunders Phillip and Gilliard June, n.d) c. When the function of supply and demand is equal the economy is said to have attained equilibrium. This is located at a point on the graph at which supply and demand meet. This is a hypothetical situation and is difficult to achieve since price of goods and services are constantly changing with fluctuations in demand and supply. d. Shifts in a demand curve occur when there is an increase in demand of a commodity without any change of price. An example could be increase in beer consumption without any decrease in price. The reason might be increase in environment temperatures causing more people to taking beers or another reason could be beer becoming the only available drink in that particular area. Shift in the Supply curve would occur when a decrease in available raw material or other factors would cause a decrease in production but would still force the vendor to retain the same selling price to maintain status quo. ( Saunders Phillip and Gilliard June, n.d) e. Allocation of resources –There are three major economic decisions regarding resource allocation. Resources can be allocated based on tradition by following the footsteps of our previous generation or could be decided by a larger central authority. These are therefore called traditional resource allocation and command resource allocation. The third allocation is driven by market prices by which signals provided by a mix of consumers, workers, investors and business firms reflect in the supply and demand of a particular good or services. ( Saunders Phillip and Gilliard June, n.d) The Construction Industry and Recession The recession to particular country (say UK) can occur for a variety of reasons 1. An economic slowdown in country like the US with which there is an major trade partnership could start a recession 2. The banking system of the US and UK follows a practice which provides customer easy access to loans while at the same time not having a guarantee process by which the bank can raise the money from the customer in case of default. Customers failing to repay these loans could cause a severe pressure on the financial status of the bank itself. To raise the money for its security houses were disposed off at very low rates. This in turn caused a sharp fall in property prices resulting in a negative impact on the construction industry. A credit deficit in the banks stalls the lending capability of the bank thus creating further obstacles for the construction industry since all major construction projects require a large capital investment which needs to be provided by the bank. ( Verick Sher and Islam Iyanatul, 2010) 3. High prices of crude oil have a cascading effect on the price of all essential commodities. This drives up inflation. In such a scenario customer would limit the resources (money) they have in buying materials like food and clothing which are the bare essentials. Construction works are therefore put on hold and the industry suffers. 4. In order to counter a budget deficit, the government may decide to increase the taxes. The spending power of individual’s decreases thus impacting the construction sector. 5. When recession hits a particular region it is the construction industry that is first affected and the last to recover. This is because the growth of a country is dependent on the amount of money the government is ready to use for infrastructure development. Once recession hits, all these projects are put on hold till a solution is found out. This is an ideal case of ‘Opportunity lost’. Recovery of the economy would slowly bring back customer confidence, however the banks would tend to be more cautious next time lending. It would be a period of time after which banks start lending again for the execution of these construction projects. This causes the construction industry to recover last. ( Saunders Phillip and Gilliard June, n.d) Recovery Stock markets indicate that the global financial crisis is on the decline and industrial growth is back on track. The figures however indicate that the growth is not as robust due to a net slow down in the European Union. Growth rate in the Czech Republic and Italy was on the negative side while growth rates for Greece, Hungary and Spain also continued to diminish. Economies of US and Japan have begun to pick up mainly due to the “inventory Effect” due to the usage and completion of stocked products leading to necessary replenishment of inventory.( Verick Sher and Islam Iyanatul, 2010) Task-2 Economic Cycles Economic cycles are defined as a period or phase during which economic growth faces slowdown and the industry goes into recession. An economic cycle is not a periodic occurrence but recurs between phases and may last between two to eight years. Economic cycles of recession are characterised by decrease in production activity, income, employment and trade. There have been different approaches that have been proposed by economists over the last fifty years. Frisch (1933-1965) proposed that impulse in a economic cycle takes the form of a shock and it propagates via damped fluctuations in response to the impulse. Slutzky (1937) observed the cyclic nature of this economic cycle. Long and Plosser (1983) also proposes that economic cycles would not be affecting all industries in the same degree. However economic variables are affected and economic activity slows down cutting across industry lines even if the sectors are unrelated. ( Albanesi Stefania, 2010) Business cycle analysis Business cycles exist in today economic charter though the timing of this is not very predictable. It is a market phenomenon that there cannot be a continuous period of growth for an indefinite period of time. This would lead to a situation which only exists in the hypothetical world. The business cycles follow a sine curve during which there is a crest and a trough.( Buerkin Claudia and Wallbaum Holger, 2003) The crest symbolises the spurt in business activity while the trough symbolizes the drop in production.( Blake et al, 2004) Why business activity fluctuates 1. Inventory Recession- When there is excessive optimism regarding the future growth and potential of the market it causes an increase of production. However, if the markets are not expanding with the same potential it leads to accumulation of stock leading to recession. 2. Rolling Recession- Due to an economic slowdown several areas of an economy are hit one way or the other. The degree to which this growth is stunted in each sector varies. Since any industrial process is a synergy between different sectors recovery in one sector might not lead to a recovery in another sector at the same rate. 3. Political events can also cause a rapid fluctuation in economic activity. Elections, wars, political coups and natural disasters also affect the business activity of an entire region. 4. Wrong Government Policies- Misuse of the monetary and the fiscal policy by the government leading to an incorrect borrowing and lending of money. This leads to extremely large fiscal deficit which makes a economy difficult to recover.( Verick Sher and Islam Iyanatul, 2010) 5. Banks lending without assessing the paying capacity of customers tends to create a huge deficit of money within the bank if loans are not fully recovered. Instability in banks leads to capital shortage for industrial and construction development. 6. Fluctuations in the price of petroleum products due to variations in markets of the OPEC counties leads to a halt in construction related activities. 7. Seasonal variations in business activity can be called Non-Cyclical Fluctuations during which a spurt in spending by the customers during the festival season is followed by a few months of very dull business activity. This can cause seasonal variations in economic cycles. The business cycle of trough and a crest is a phenomenon that is bound to happen after a period of time. A period of increased economic activity will inevitably be followed by a dip in growth. However, how much of this dip would affect the general economy of a country depends on the policies followed by the government and the robustness of the industrial sector at that given point of time.( Blake et al, 2004) A dip in business activity for brief period is good because this leads to consolidation of the industry. A market essentially follows a system of demand and supply and goods are produced on the concept of a forecasted demand over the future years. Any reason which would hinder this forecast from becoming a possibility tends to put the market into recession. Hence this is the period during which the company can dispose of its stock and put things into perspective. Ways and methods would be discussed in increasing the efficiency of production during this period because it is during these trying times that one can assess the capability of one’s resources. Areas of improvements are observed and put into company policy. One this is put into the system, the work process improves for the better and the economic growth achieved after recession is higher than the original growth envisaged. (Verick Sher and Islam Iyanatul, 2010) Government Intervention There is a limit to which a company can hold on without government intervention, especially if the company is one which employs lot of people and affects the economic index of a country as a whole. The two sectors that are highly critical include the auto industry and the construction industry. Recession in a business growth is a vicious cycle during which loss of economic activity leads to lower production, leading to unemployment. ( Saunders Phillip and Gilliard June, n.d) The spending power of people reduces and this further dampens economic activity. During the recent recession phase from which US is slowly recovering, had Mr. Obama as the President pumping in more money back into the economy to reverse this vicious cycle. The construction Industry and economic cycles The construction sector is one area which is highly affected by recession. As stated earlier when there is a recession and banks are not lending money all construction works are put on hold since investment in this area require a lot of capital. Since the amount of money in circulation is less, people tend to postpone the purchase of durable goods like houses to a more stable period. Demand for new works are also low since buildings and other infrastructure that are built by the construction sector have a long life span. However this would soon show signs of change as the economy recovers. Reference Lists 1. Albanesi Stefania, “Business Cycles”, Columbia University, January 2010, p.1 2. Best Aaron et al, “Measurement Beyond GDP”, International Conference, Brussels, November 2007, p.1 3. Blake et al, “Competitiveness of the UK Construction Industry”, Construction Economics and Statistics, November 2004, p.25 4. Buerkin Claudia and Wallbaum Holger, “Concepts and instruments for a sustainable construction sector”, UNEP Industry and Environment, April 2003, p.55 5. Saunders Phillip and Gilliard June, “ A Framework for Teaching basic Economic Cocepts”, Economic America, n.d, p.p 9-27 6. Verick Sher and Islam Iyanatul, “The Great Recession of 2008-2009: Cuases, Consequences and Policy Responses”, Institute for the Study of labour, May 2010, p.10-15 Read More