BUSINESS CYCLE

CONTENTS

Meaning & Feature of Trade Cycle

Types of Cycles
Phases of Business Cycle
Causes & Effects of Business Cycle
Theories of Business Cycle

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 The term business cycle refer to the wave-like
fluctuations in the aggregate economy
activity,particularly in employment,output and
income.

 Business cycle is also known as “trade cycle”,it

refers to the cyclical movement of ups and
downs in business and economic activity.

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 Mitchell defined a trade cycle as “a fluctuation
in aggregate economic activity”

 According to Haberler, ‘The business cycle in

the general sense may be defined as an
alternation of periods of prosperity and
depression,of goods and bad trade’

 The business cycle refers to the cyclical

variation in economic activity.

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 FEATURES OF
BUSINESS CYCLE

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 A trade cycle is a wave-like movement.
 Cyclical fluctuations are recurrent in nature.
 Expansion and contraction in a trade cycle are
cumulative in effect.
Though cycles differ in timing and
amplitude,they have a common pattern of
phases which are sequential in nature.

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PHASES OF A BUSINESS CYCLE
 Prosperity Phase - expansion or the upswing

 Recessionary Phase - a turn from prosperity to

depression

 Depressionary phase - contraction or downswing

 Revival or recovery phase- the turn from depression to

prosperity

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 PROSPERITY PHASE

 Haberler defines prosperity as ,” A state of affairs in which the real

income consumed, real income produced and the level of employment
are high or rising and there are no idle resources or unemployed
workers or very few either”

 In the expansionary phase of business cycle, following events occur :

 income level tends to rise

 unemployment rate tends to decline
 industrial growth rate tends to accelerates
 actual output level exceeds the potential output level
 investment increases
 investors become optimistic and more enthusiastic
 consumption tends to rise
 consumer demand for goods and services tends to increase
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 The prosperity phase comes to an end when the forces
following expansion becomes progressively weak

 In view of high profits and business optimism, entrepreneurs

invest more and invest further

 But scarcity of resources particularly the shortage of raw

materials and labour, cause bottleneck and business
calculations go wrong

 This results in the fall of prosperity phase

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 RECESSIONARY PHASE

 When prosperity ends recession begins, it is a deep downward

movement of the business and economic activity.

 Liquidation of the stock market, repayment of bank loans and the

decline of the prices are the outward symptoms

 During recession, the businessmen loose confidence, everyone feels

pessimistic about the future probability of investment

 Hence, the investment will drastically curtailed and production of

capital goods industries will fall

 Reduced income causes a decrease in aggregate expenditure and thus,

the general demand falls, in turn the profits and business decline

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 DEPRESSIONARY PHASE
 During depression the most pathetic conditions prevails in the economy

 Real income produced, consumed and the rate of employment fall due to
idle resources and capacity

 The characteristics of depression are reverse of prosperity, they are :

 rise in the level of unemployment
 shrinkage in the volume of output and trade
 price deflation
 fall in the interest rates
 contraction of bank credit

 So, during depression :

businessmen postpone replacement of their plant and machinery
consumers postpone to buy during durable goods

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 RECOVERY PHASE

 The revival or recovery phase refers to the change of economy from the
depression and prosperity

 Once the expansionary movement starts , the economy will move

towards revival phase

 During this period the level of employment, output, income increases

slowly and situation improves

 When this happens, revival slowly emerges into prosperity and the
cycle repeats itself

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 CAUSES OF BUSINESS CYCLE
 Banking Operations : By expanding and
contracting credit creation, changing
discount rates, and the ratio between,
deposits and cash reserves , banks change
the volume of money supply in the economy
& contribute to the business cycle.
 Capital Goods & Consumer Goods:
Changes in the proportion between capital
goods and consumer goods production in the
economy can also leads to shortages or
surpluses in commodity supply in short run .
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 Cyclical Changes in Weather: The
change in weather also affects the trade
cycle lie production of agriculture and
other things .It affects the wage rate, raw
material cost etc.

 Purchasing Power : If the purchasing

power does not correspond to the
expansion or contraction of production ,
market suffers from problems and effects
business cycle.
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 EFFECTS OF BUSINESS CYCLE
DURING EXPENSION
 It encourages production and investment
and their by increases employment ,
income and finally demand
 Rich become still richer, poor become still
poorer
 During inflation, debtors gain while
creditors
 During inflation businessmen gain
because cost do not rise as rapidly as price
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 EFFECTS OF BUSINESS
CYCLE DURING RECESSION
 Demand for inputs has decreased , input prices
etc

 The level of national income and expenditure

declines rapidly

 The level of national income and expenditure

declines rapidly

 Workers lose their jobs

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 THEORIES OF
BUSINESS CYCLE

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 INNOVATION THEORY
It is given by J.A. Schumpeter. He states that
innovation is the originating cause of trade cycle.
He classifies into five categories:
1. Introduction of new type of goods.
2. Introduction of new methods of production.
3. Opening of new markets.
4. Discovering of new sources of raw material.
5. Change in the organization of an industry,
like the creation of a monopoly , trust, or cartel.

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 MONETARY OVERINVESTMENT
THEORY
This theory is given by Austrain economist ,F.A Hayek.
it’s main focus is on the analysis of equilibrium between
production of capital goods and consumption goods. when
the production is in equilibrium then production of capital
goods and consumption goods is in same proportion as the
distribution of monetary demand by consumers between
consumption and saving.
UNDER CONSUMPTION(OR OVER
SAVING) THEORY

 Hobson’s analysis of trade cycle note worthy. The

central idea of Hobson’s theory is that during the
course of economic prosperity, profiters share a larger
part of increased income than the wage earners.

 Thus, relatively, inequality of income in the

community increases. The large income recipients ,
however, will consume only a portion of their income
and save the rest.

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 CLIMATIC THEORY
 Given by William Herschel & Stanley
 Acc. To this theory , they linked business
cycle with sunspot. Due to this spot,
climatic changes occurs and it affect rainfall
and crop production.
 Depression & Prosperity Phase take place
due to climatic conditions .
 This theory is very old .Now business
cycle is not dependent on climate.

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 ‘KEYNES’ MEC THEORY
 Keynes MEC Theory
 It refers to the marginal efficiency of the
capital
 It defines the expected rate of profit on
new investment
 Business cycle appears as a result of the
fluctuations in the rate of investment due
to marginal efficiency of capital

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Measure to control Business
Cycle
 .
Two type of measures are adopted to control business cycle :-

Preventive Measures : Aim to avoid of the occurrence of B.C.

To reduce the dependence of Agriculture on nature.
Equilibrium between demand and supply.
Check on speculative activities.
Nationalization of basic industries.

Corrective Measures :
Monetary Policy : Introduced by central bank of the country
which control the money supply and cost of credit in the
economy. It uses two types of measures.

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 Quantitative Measures :
 Open Market Operation : Sell the security from
 market in boom and purchase security from the market
in depression.
 Bank Rate : High B.R in boom and vice versa. SLR &
CRR = High rates in Boom and vice versa.
 Qualitative Measures : Credit rationing, direct action,
etc.

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Fiscal Policy :
Introduced by Govt. which shows management of public
revenue, expenditure and public debt to achieve certain
objective. Govt. can control on investment by taxation policy.

Direct Controls :
For the speedy and effective control of business cycle, govt.
should resort to direct physical control. Direct control include
licensing, rationing of scare and essential goods, price and wage
control, export-import control, exchange control, control over
hoarding and black marketing, control of monopolies &
restrictive trade practices etc.

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