Business Cycles

These are oscillations in national income or the level of aggregate

output which have often been observed to follow a wave like
pattern with certain measure of regularity or periodicity in terms of
time, duration and sequence.
Task at hand of the Experts
 What factors trigger business cycles ?
 How are booms and recessions caused?
 How does aggregate business activity expand and reach a
peak?
 How does a market crash?
 What generates recession and what factors determine its
duration?
 How does an economy recover from a trough or depression and
takes an upturn?
Nature of Business Cycles

 These are the swings in national income, output and employment causing
expansion and contraction in most of the sectors of the economy.
 Cyclical patterns are neither smooth nor regular.

 These cyclical patterns are observed over a long time period, most generally

from 20 to 30 yrs.
Samuelson Nordhaus Comments [1998]
…….No exact formula, such as might apply to the revolutions of the
planets or of a pendulum, can be used to predict the duration and
timing of business cycles. Rather, in their irregularities, business
cycles more closely resemble the fluctuations of the weather……
The cycles are like mountain ranges, with different levels of hills
and valleys. Some valleys are very deep and broad………..
Amplitude and Frequency
Amplitude is the maximum distance by which national income
deviates from the trend line.This amplitude varies as the cycle
proceeds with irregular pattern.
Frequency refers to the number of times the cycle repeats itself
over a period of time.
One cycle is completed between two consecutive peaks.
Damped & Explosive Cycles
On a damped cycle, the amplitude declines and the
national income eventually converges with the trend
line.
In explosive cycle, the amplitude increases as the cycle
proceeds and the oscillations above and below the trend
line become wider and wider so that the economy
reaches a crisis point requiring urgent public policy
intervention.
PEAK
High degree of capacity utilisation [matching demand]

Further increase in demand---Increased in price & not output

As capacity utilisation levels are already high
How output can be raised?
Through new Investment---High cost of input [Due to
scarcity]
But what about prices?
Prices are also high
PROFITABILITY
CRASH
 Momentum of the pick period is broken

But how it is possible?

External Shock
 Massive withdrawal of foreign investment
 Sudden increase in the price of some raw materials [crude
petroleum]
 A political change in the country
 A natural calamity

LEADING TO…..
Uncertain economic conditions
Rife speculation
What a business men will do?
WAIT & WATCH POLICY
Postponement of all important decisions
No expansion of emerging projects
 Variable Consequences

Agg. Demand Falling

Pdn. & Falling
employment
Recession
A nightmare of a Business Credit Demand Falling
Manager
Possible consequences Competition Rising ?
Imports Falling
Exports Falling
National Income Falling

Interest rate Falling

Exchange rate Uncertain
TROUGH & DEPRESSION
 It is a lower level of economic activity

 Consumer demand is abysmally low

 Unemployment is high

 Huge industrial excess capacity

 Postponement of new business decisions

What’s about its duration?

It takes a long time for the economy to settle, a decade or even
more [Great Depression of 1930’s]
How it will be set right?
Through strong macroeconomic Policy decisions and a structural
shake-up
More emphasis on generation of more income avenues
Switch over from heavy industry to small scale and cottage
industries.
RECOVERY
It is a transitional stage between Trough and Expansion
If sustained , leads to ………Expansion
 Future expectation are positive and optimistic
 Business confidence picks up momentum
 Replacement of worn-out machinery
 New flow of investment

Is there any chance of the economy to revert back to slump?

YES, THEN HOW?
Misfiring of macroeconomic policy
A natural calamity
EXPANSION

 Phase of Prosperity
 Business optimism all around
 Rising capacity utilisation levels
 Falling inventory levels
 Growth picks up momentum
Economy approaches to full employment level
 1.
Increse in 2.
supply of Pumping of
Money/ Fall in Money
thecash balance
of the household

EXPANSION 3.Increased income

&
expenditure

5.Increased Price &

Profit
Margin
4.Increased
Demand
 1.Scarce & more
5.Restriction of Bank
Expensive
Credit/ Multiplier Resource
Effect

2.Strained Infrastructure/
Pdn.
Bottlenecks

4.Increased Factor
Price/High Demand
for Credit- 3.Increased
High Credit- Deposit Ratio Demand for
Factors
 1.Contractionary
induces
sluggish investment of
5.Issuance of fresh business sector
Credit by Banks

2.Transaction Demand fo
money goes down
4.Comfortable
credit-deposit
ratio
3.Credit payments
are made
Multiplier-Accelerator Mechanism
Accelerator: Rate of investment in an economy depends basically on
the rate of change in output.
High rate of growth High rate of Investment
K=a.Y………..1
a [accelerator co-efficient]=capital-output ratio-depends on level of
technology
∆K=a. ∆Y, where ∆ denotes change and
or, I= a. ∆Y………2, where I denotes investment.
If ∆Y=100 and a=4 then an investment of 400 will be caused.
Accelerator-Rises and falls in aggregate demand or output produce
corresponding changes in investment.
Multiplier-And changes in investment, as per multiplier mechanism,
produce multiplier mechanism, produce multiple changes in the level
of output.
Interpretation:
The combined impact of multiplier and accelerator is capable of
producing significant fluctuation in an economy.
Multiplier-accelerator interaction has the power to explain a complete
business cycle including the cumulative nature of expansion and
contraction processes, floors and ceilings and the upper and lower
turning points.
Floors and Ceilings [Role of Accelerator]
Expansion Phase
Expansion Phase---constrained factors-supply bottlenecks---escalating
costs----squeezing Profit margins---slows down rate of growth of
output----ACCELERATOR in action---fall in Investment in new plant
& machinery---Fall in income & consumer demand----EXCESS
CAPACITY---further fall in inv.-----Growth momentum broken-----------------
CEILING is hit
Floors
Rapid contraction process----Deep Recession
Should the economy collapse? If not why?
Presence of
Minimum Aggregate demand
[past savings or debt]
Social security measures Household Sector
Expansionary fiscal policy
Business Sector
Investment is needed for
Replace worn out capital
New innovations
New business opportunities
This sets in the floor & the economy settles in the low-level equilibrium.
 UPPER AND LOWER TURNING POINTS

GDP3
Turning Points:
Expansion---Contraction

GDP ,
Inv.
GDP1
Contraction---Expansion
GDP2

I 3

I1

I2

Time
Upper Turning Point:
Falling rate of growth of –Income [Ceiling]—Fall in Investment
[ACCELERATOR]----MULTIPLIER----Upper Turning Point
-----Expansion to Contraction
Trough-----replacement of Inv. demend’/Govt. expenditure [Exp.
Fiscal Policy]---Multiplier----rise in Investment & Income-----
ACCELERATOR-----Lower turning Point
-----Contraction to Expansion
Policy-Induced Cycles
Recession----Govt. Expenditure, if overdose
What would be the consequence?
Multiplier-Accelerator Interaction
High AD & Supply Constraints
INFLATION
Fiscal Policy
Cuts in Govt.Exp
If , Govt. intervention is large
RECESSION
Ill-timed stabilisation Policy
Time gestationRole of Endogenous forces
Political Business Cycles
Welfare Projects
Infrastructure Projects Expansion
New Public works
Direct employment generation Programmes
Imported Cyclical Fluctuations
Exogenous factors and Global LINKAGES
Exports Perspective
FDI Perspective