Business Cycle 1

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Business cycle


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Introduction

A business cycle is basically defned interms o periods o expansion or recession.

During expansions the economy is growing

in real terms, indicating rise inemployment, industrial production, sales,personal income, etc.

During recession the economy iscontracting, which will be indicated bylarge scale unemployment, loss o output.

They are also known as trade cycles.


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these uctuations in economic acti!ity arerecurrent and ha!e been occurring periodicallyin a more or less regular ashion. Thereore,

these uctuations ha!e been called businesscycles. It may be noted that calling theseuctuations as "cycles# mean they are periodicand occur regularly, though perect regularity

has not been obser!ed. The duration o a business cycle has not been

o the same length$ it has !aried rom aminimum o two years to a maximum o ten to

twel!e years, though in the past it was otenassumed that uctuations o output and othereconomic indicators around the trend showedrepetiti!e and regular pattern o alternating

periods o expansion and contraction.


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u ucycles :

%. Business cycles occur periodically. Though they do

not show same regularity, they ha!e .some distinctphases such as expansion, peak, contraction ordepression and trough. &urther the duration o cycles!aries a good deal rom minimum o two years to amaximum o ten to twel!e years.

'. (econdly, business cycles are (ynchronic. That is,they do not cause changes in any single industry orsector but are o all embracing character. &or example,depression or contraction occurs simultaneously in allindustries or sectors o the economy. )ecession passesrom one industry to another and chain reactioncontinues till the whole economy is in the grip orecession. (imilar process is at work in the expansionphase, prosperity spreads through !arious linkages o

input*output relations or demand relations between!arious industries, and sectors.


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+. Thirdly, it has been obser!ed that uctuationsoccur not only in le!el o production but alsosimultaneously in other !ariables such asemployment, in!estment, consumption, rate ointerest and price le!el.

. Another important eature o business cycles isthat in!estment and consumption o durableconsumer goods such as cars, houses,

rerigerators are a-ected most by the cyclicaluctuations. As stressed by ./. 0eynes,in!estment is greatly !olatile and unstable as itdepends on proft expectations o pri!ate

entrepreneurs. These expectations oentrepreneurs change 1uite oten makingin!estment 1uite unstable. (ince consumption odurable consumer goods can be deerred, it alsouctuates greatly during the course o businesscycles.


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2. An important eature o business cycles isthat consumption o non*durable goods andser!ices does not !ary much during di-erent

phases o business cycles. 3ast data obusiness cycles re!eal that householdsmaintain a great stability in consumption onon*durable goods.

4. The immediate impact o depression andexpansion is on the in!entories o goods. 5hendepression sets in, the in!entories startaccumulating beyond the desired le!el. This

leads to cut in production o goods. 6n thecontrary, when reco!ery starts, the in!entoriesgo below the desired le!el. This encouragesbusinessmen to place more orders or goodswhose production picks up and stimulatesin!estment in capital goods.


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7. Another important eature o businesscycles is profts uctuate more than anyother type o income. The occurrence obusiness cycles causes a lot ouncertainty or businessmen and makes itdi8cult to orecast the economic

conditions. During the depression periodprofts may e!en become negati!e andmany businesses go bankrupt. In a ree

market economy profts are 9ustifed onthe ground that they are necessarypayments i the entrepreneurs are to beinduced to bear uncertainty.


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:. ;astly, business cycles areinternational in character. That is, oncestarted in one country they spread toother countries through trade relationsbetween them. &or example, i there is arecession in the


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3hases o Business

=ycle


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eren ases o us ness=ycle

Expansion >*increased consumerconfdence, which translates into higherle!els o business acti!ity. ;ike high

capital in!estment in basic industries asresult high stock, high prices, high proft.

It consists o three small stages >

%.)eco!ery

'.Boom

+.3eak


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%.)eco!ery

The turning point rom depression to

expansion is termed as )eco!ery or )e!i!al3hase.

=onsumer#s confdence starts to increase.

)ise in economic acti!ities.The reco!ery may take place because o

ollowing reason

?ew go!ernment expenditure

@xploitation o new sources o energy

Inno!ation

In!estment in new areas

=hange in the technology o production


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'.Boom

=onsumer#s confdence starts to increase at aaster pace.


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+.3eak

The economy has reached its peak.

6utput starts to standstill and le!el

o-. =onsumer#s confdence starts to

decline.

3eople start to stop their buying.

D3 begins to declinebustC.


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=ontraction

It is a period o decrease in consumerconfdence and economic acti!ity.

It consists o three smaller stages>

)ecession

Depression

Trough


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%.)ecession

it is a period o reduced economicacti!ity in which le!els o buying, selling,production, and employment typically

diminish. =onsumer#s confdence starts to

decrease a little.


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'.Depression

Depression is the most fearful stage of atrade cycle.

The phase of depression (also called

slump) is characterized by low economicactiities.

!apid decline in general output

and employment."t is characterized by shortfall inproduction#mass unemployement#fall inprices# low wages# contraction of credit#

high rate of business failure


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+.Trough

=ontraction reaches a minimum, or @conomy hits bottom.

6utput starts to standstill and le!el o-.

=onsumer#s confdence starts to le!elo-.

@nd o recession, growth resumes.


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$auses of %usiness $ycle

&) "nterest rates : =hanges in the interestrate a-ect consumer spending andeconomic growth. &or example, i theinterest rate is cut, this reduces borrowing

costs and thereore increases disposableincome or consumers. This leads to higherspending and economic growth. Eowe!er, i

the =entral Bank increase interest rates toreduce ination, this will tend to reduceconsumer spending and in!estment. Theselead to an economic downturn and

recession.

') $h i h i A i i


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') $hanges in house prices : A rise inhouse prices creates a wealth e-ect andleads to higher consumer spending. A all in

house prices causes lower consumerspending and bank losses.

) $onsumer and %usiness $ondence : 3eopleare easily inuenced by external e!ents. I there is a

spread o bad economic news, this tends todiscourage people rom spending and in!estingmaking a small downturn into a bigger recession.But,

when the economy reco!ers this can cause apositi!e bandwagon e-ect. @conomic growth,encourages consumers to borrow and banks to lend.

This causes higher economic growth. =onfdence is

an important actor in causing the business cycle.

*) + lti li E, t Th lti li - t


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*) +ultiplier E,ect : The multiplier e-ectstates that a all in in!estment may cause abigger fnal all in real D3. &or example, i the

go!ernment cut public in!estment, therewould be all in aggregate demand and a risein unemployment. Eowe!er, those who losttheir 9obs would also spend less, leading to

e!en lower demand in the economy.Alternati!ely, an in!estment could ha!e apositi!e multiplier e-ect.

-) ccelerator E,ect : This states that in!estmentdepends on the rate o change o economic growth. Ithe growth rate alls, frms reduce in!estmentbecause they don#t expect output to rise 1uickly.(mall changes in the rate o growth ha!e a big e-ecton in!estment le!els.

/) " t $ l ( th t


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/) "nentory $ycle : (ome argue thatthere is a natural in!entory cycle. &orexample, there are some "luxury# goods

we buy e!ery f!e years or so. 5hen theeconomy is doing well, people buy theseluxury items causing aster economic

growth. But, in a downturn, people delaybuying luxury goods and so we get abigger economic downturn.

+easures to $ontrol %usiness


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+easures to $ontrol %usiness$ycle

Two type o measure are adopted tocontrol the business cycle

3re!enti!e measure

=orrecti!e measure 0reentie measure :

%. To )educe The Dependence 6 Agriculture 6n?ature

' /aintain @1uilibrium Between Demand And(upply (care oods By Import And @xport

+ =heck 6n (peculati!e Acti!ities

?ationaliFation 6 Basic Industries

$ ti


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$orrectie measure : &) Fiscal +easures : During the period o boom, there

should be decrease in public expenditures, increase intaxes and increase in public debt. 6n the other hand,during the period o depression, the policy o increase inpublic expenditures, decrease in taxes and decrease in

public debt is adopted by the go!ernment.

') +onetary +easures : /onetary measures meanscontrol o money and credit supply in the country. 5hen weare acing boom or ination, the central bank reduces thetotal 1uantity o money in circulation. The bank can adopt

di-erent measures like bank rate policy, open marketoperations and rationing o credit etc.6n the other hand,incase o depression, the central bank can increase the1uantity o money by lowering the bank rate or purchasing

the securities and discounted the bills o exchange.

) "nternational +eas res Toda e er


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) "nternational +easures : Today e!erycountry has trade relation with other countries.I there is ination or deation in one country,

it can be easily be carried to other countries,the example o great depression can be gi!en.Business cycle is an international phenomenaand it should be tackled on international le!el.

Di-erent measures ha!e been suggested bythe economists to control the businessuctuations e-ecti!ely.

(uch as > aC =ontrol o international production.

bC International bill stock control andinternational in!estment control.

*) 1t t $ t l f 0 i t


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*) 1tate $ontrol of 0riate"nestment : I the go!ernment controlsthe pri!ate in!estment, cyclical

uctuations can be controlled withinlimits. 5hile the other economists whoagree with the abo!e !iew, they say that

pri!ate in!estment will be discouraged. -. Direct control: it include licensing,

price wages control, export duties,

exchange control 1uotas, monopolycontrol

/.utomatic stabilizers: by means o

progressi!e income tax

Business Cycle 1

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