Business Cycle/Trade Cycle

1. What is a business cycle?

• Business cycles are fluctuations in the aggregate economic
activity, generally concerned with the economy as a whole.
These fluctuations that recur with regularity.
• Shumpter, defines business or trade cycles as, ‘ the wave
like deviations in the level of business activities from the
equilibrium or trend line
• ‘Trade cycles are regular upturn and downturn in all
economic activities like aggregate employment, income,
output and price level; known as boom or slump in the
economy
 2. Features of Business cycles
• Periodic or regular – may occur periodically at regular
interval of 10 to 12 years and all phases come regularly
• It covers all the sectors of the economy – may start from
one sector and spread over all other sectors
• It is international or universal; may start from US and
spread all over the world
• Process of expansion and contraction are self reinforcing
• Affects different people of the society differently
 3. Phases of Trade cycle
• Recession Phase
• When there is downturn from the peak or boom ( last for short
period)
• Its outer signs are strain on banking system and increase in
bad debts of banks, and beginning of declining of prices
• Decline in profit margin
• Costs start overtaking prices
• Investment, income and demand declines
• Contraction Phase – recession and depression phases;
unemployment rises, general price levels fall; type of capital
goods falls
• Expansion phase- comprises recovery and prosperity
 Cont..3. Phases of Trade cycle
• Depression – considerable reduction in
production of goods/s, employment, income,
demand and prices
• Fall in bank deposit,
• Mass unemployment, fall in general price level,
wages, profits, wages and interests
• Trough – lowest point of depression or lower
point of aggregate economic activity
• May be short lived
• Its end pave the way to revival
 Cont…
• Recovery Phase- is also called revival
• Increase in business activity after lowest point of
depression
• Once started the levels of employment, income and
output rise steadily
• Prosperity Phase - In this phase, demand, output,
employment and income are at the high level
• They tend to raise prices; but wages, salaries,
interest rates, rentals and taxes do not rise in
proportion to general price
 Cont..
• The peak or boom – upper turning of trade cycle
• National income is at the highest
• It is likely that economy would working beyond the full
employment level
• Continue investment even after the stage of full
employment would result:
• Scarcity of labor, raw materials, leading to rise in costs
• Rise in interest rates
• Failure of consumption to rise
• Additional pressure on factors of production
• No. of jobs exceeding no. of workers
 Business Cycle
Real GDP

Peak
per year

Peak

y
rit
Re

pe
ce

os
ss

Pr
io
n

y
er
De

v
pr

co
es

Re
si
on
Trough

Time Period
One cycle
 How to control
• A) Fiscal policy – through taxation and budget measures
• - During expansionary phase the government can make a
balanced budget and increase taxation to stabilize
• - During contractionary phase or depression the government
can increase spending and relax taxation
• - during contrationary phase deficit budget is advisable
• B) Monetary policy
• - the extreme effects of business cyclical fluctuations can be
checked by monetary instruments like open market operation –
sell and purchase of government bonds & papers;
• - the bank rate or repo – central bank can alter banks
borrowing rates to influence money supply. During
expansionary phase the Nepal Rastra Bank can increase the
repo rate to control banks credit flow and vice versa during
 Cont…
• - cash reserve ratio (CRR) : during
expansionary phase the CRR is raised
and money supply is checked and vise
versa done during contractionary phase to
encourage the economy’s investment
• Other selective measures and moral
suasion