*Phases of a business cycle:

A typical business cycle is divided into:

i) Expansion/Prosperity/Peak/Upswing
ii) Recession/Upper turning point
iii) Contraction/Downswing/Depression
iv) Revival/Recovery/Lower turning point
According to Prof. Pigou, no phase has definite time interval. They may not be twins, but they belong
to the same family and so have similar characteristics.
1)Recovery: A recession/depression may have lasted for some time and the revival/low turning point
starts. The ‘originating’ or ‘starters’ may be some ‘endogenous’ or ‘exogeneous’ factors.

Suppose the durable/ semi-durable goods were out and need replacement. This leads to increased
demand for these goods. Thus, investments and employment increases. These industries start reviving
but they need inputs, factors, raw materials, accessories, components, spaces etc. from other
industries. These “other industries” face increase in demand, so they start hiring people & resources.

Plant & Machineries

3 Inventories

Fresh inventories (resources)

Cheap- Total cost (TC) not rise much.

Prices start rising, so Total Revenue (TR) start rising but Total Cost (TC) doesn’t rise much.

Therefore, Profit margin expands.

Demand increases

Plant size needs expansion

Therefore, resources, FOP, Plant & machinery will become faster.

Prices will start rising. Optimism sets in. An increase in investments will raise demand for bank loan.
This cumulative process of investments, employment, income, output, etc. will become self-
reinforcing. Here, revival enters recovery phase.

2)Prosperity: Demand, output, employment, incomes, etc. are at a high level. Prices increase but
income, wages, salaries, interest, etc. do not increase in the same proportion. This increase the profit
margin for producers, prospects of more profits raise the valuation of stock market optimism
everywhere.
Expectations of larger profits raises the demand for capital & bank lendings increase. This investment
is mainly in fixed capital, plant, equipment and machinery. Wholesalers & dealers also start piling
stocks. Again, expansionary process becomes cumulative & self- reinforcing, bill prices become very
high and hyper inflation sets in. Over-full employment is reached, the economy is said to be “over
heated” or “burning itself out”. This is a symptom of the beginning of the end of the prosperity phase
and beginning of recession.
The strains in the economy at this time are:
A) Scarcity of labor and raw materials leads to the cost increasing faster than prices.
B) Interest rates rise because of the scarcity of capital.
C) Very high prices lead to fall in demand.

Thus, profit margin for producers starts falling.

Therefore, Investment become more expensive and hence the volume of investment will fall.
This lowers business expectations. Inventories start piling because production is more relative
to the falling demand.
Thus, forces of contraction now become cumulative & self-reinforcing.
Investors, businessmen, entrepreneurs become over cautious. Optimum gives way to
pessimism. Stock market valuation fall. This is the beginning of upper turning point.

3)Recession: Forces of contraction win over forces of expansion. Banks, companies start
experiencing loses. We start seeing a liquidation of the loans, defaulters and the beginning of a fall in
prices. Profit margins shrink further. Some companies close down, others will reduce production.
Volume of employment shrinks. This again is cumulative.
Recession can be mild or severe feeling of panic starts. Collapse of confidence, demand for
liquidation increases. Firms & institutions announce their inability to meet debts. A recession, once
started, tends to build upon itself like a forest fire.

4)Depression: Fall in bank deposits, credit expansion stops, interest rates fall.
A depression is characterized by mass unemployment, mounting losses, interest rates nearing zero,
profits, wages, salaries, etc. all fall to lowest possible level.
Stick market collapses, businesses shut down, demand falls to basic minimum. All this is cumulative
& self-reinforcing. The economy reaches the ‘pits’ or “trough”. Thus, one business cycle is now
complete.

*Fiscal Policy-
. Fiscal Policy is the use of government revenue collection (taxation) and expenditure (spending) to
influence the economy.

Instruments of Fiscal Policy:

1)Budgetary policy
a) Balanced budget policy
b) Deficit budget policy
c) Surplus budget policy

2)Government expenditure
3)Taxation
4)Public Borrowings
a) Internal Borrowings
b) External Borrowings

Sources of Govt. Revenue:

1. Taxes Direct
Indirect
2. Fees, fines, tolls etc.
3. Profits from PSUs
4. Borrowings Internal
Externals
5. Dividends/Profits from RBI
6. Sale of PSUs/Disinvestments of Govt. (GE > GI)