CHANAKYA NATIONAL LAW UNIVERSITY

2011-2016
A PROJECT ON

TRADE CYCLE

SUBMITTED TO: DR. P.C.VERMA FACULTY: ECONOMICS SUBMITTED BY: ASHAR AKHTAR ROLL NO.:535 SEMESTER: III

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ACKNOWLEDGEMENT

I feel myself highly delighted, as it gives me incredible pleasure to present a research paper on TRADE CYCLE.

I would like to enlighten my readers regarding this topic and I hope I have tried my best to pave the way for bringing more luminosity to this topic.

I am grateful to my faculty DR. P.C.Verma who has given me an idea and encourage me to venture this project. I would like to thank librarian of CNLU for their interest in providing me a good back up material

At

finally

yet

importantly

would

like

to

thank

my

parents

for

INCOMMENSURABLE support.

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RESEARCH METHODOLOGY

AIMS AND OBJECTIVES:

The aim of the project is to present a detailed study of TRADE CYCLE in relation to ECONOMY.

SCOPE AND LIMITATIONS:

Though this is an immense project and pages can be written over the topic but because of certain restrictions and limitations I was not able to deal with the topic in great detail.

SOURCES OF DATA:
The following secondary sources of data have been used in the project1. Papers 2. Books 3. Websites

METHOD OF WRITING:
The method of writing followed in the course of this research paper is primarily analytical.

METHOD OF RESARCH:
The research work of this project is based on doctrinal method.

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TABLE OF CONTENTS

ACKNOWLEDGEMENT

RESEARCH METHODOLOGY

CHAPTERS:

1. 2. 3. 4. 5. 6.

Introduction Theory Occurrence Phases of trade cycle Conclusion BIBLIOGRAPHY

5 8 9 10 15

APPENDICES: BIBLIOGRAPHY

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Introduction

The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (an expansion or boom), and periods of relative stagnation or decline (a contraction or recession). Business cycles are usually measured by considering the growth rate of real gross domestic product. Despite being termed cycles, these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.

The term business cycle refers to a wave like fluctuation in the overall level of economic activity particularly in national output, income, employment and prices that occur in a more or less regular time sequence. It is nothing but rhythmic fluctuations in the aggregate level of economic activity of a nation. Different writers have defined business cycles in different ways. According to Prof. Haberler : The business cycle in the general sense may be defined as an alternation of periods of prosperity and depression of good and bad trade.

In the words of Prof. Gordon: Business cycles consists of recurring alternations of expansion and contraction in aggregate economic activity, the alternating movements in each direction being self- reinforcing and pervading virtually all parts of the economy.

According to Keynes: A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, alternating with periods of bad trade characterized by falling prices and high unemployment percentages. Thus, one can notice a common feature in all these definitions, i.e., variations in the aggregate level of economic activities in different magnitudes.

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There are different versions given by various groups of economists about the meaning of trade cycles. However, Clement Juglar was the first economist who was statistically established the presence of business cycles in the latter half of the 19th century. Since then extensive research has been conducted on the subject and there has been much difference of opinion among economists in respect of its definition. According to W C Mitchell and A F Burns Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities followed by similarly general recessions, contractions and revivals which merge into the expansion phase of next cycle: this sequence of change is recurrent but not periodic: in duration business cycles vary from more than once year to ten or twelve years: they are divisible into shorter cycles with amplitudes approximating their own.

In Keynes words, A Business cycles is composed of periods of good trade characterized by rising prices and low unemployment percentages alternating with periods of bad trade characterized by falling prices and high unemployment percentages. Thus, a marked feature of a business cycle is the boom being followed by a depression, a recovery and again boom conditions in a free enterprise economy which is highly industrialized.

According to R A Gordon, Business cycles consist of recurring alternations of expansion and contraction in aggregate economic activity, the alternative movements in each direction being self-reinforcing and pervading virtually all parts of the economy. In other words, business cycles are regular fluctuations in income, output and employment, which trend to be selfreinforcing or cumulative. Once a change starts, it tends to gather speed fast.

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In A H Hansens view, business cycle is a manifestation of the industrial segment of the economy from which prosperity or depression is redistributed to other groups in the highly interrelated modern society. We can thus say that a trade cycle invariably starts in the industrial sector and then spreads itself over the other sectors quickly because in modern economy, the different sectors are interrelated. John Tin Bergen considered the cyclical fluctuations as the interplay between erratic shocks and an economic systems ability to perform cyclical adjustment movement to such shocks Ragnar Frisch has echoed the same expression in the following words. Impulses from outside operate upon the economy causing it to move in a wave-like manner, just as an external shock will set a pendulum swinging.

In brief the above definitions of trade cycles, reveals some important characteristics of trade cycles, they are: (A) A business cycle is an economy-wide phenomenon. When depression sets in the industrial sector, it cannot be restricted there. Soon it spreads to agriculture, trade and transport sectors; so is the case during boom. (B) A business cycle shows a wave-like variation in economic activity. The expansion or prosperity is followed by a depression and so on the economy moves from one extreme to another almost like a pendulum. (C) Business fluctuations tend to recur; they come again and again after the lapse of some time. The time or periodicity is not always the same. Nor are the causes always the same. Some trade cycles may last only two or three years while others may be of six to eight years in duration. (D) Trade cycles are selfreinforcing or cumulative. Once, the cyclical movement starts in one direction, it tends to feed on itself. The force of the economic crisis tends to increase. Once the prosperity phase starts, it tends to run out of control of the policy markers.

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Theory The first systematic exposition of periodic economic crises, in opposition to the existing theory of economic equilibrium, was the 1819 Nouveaux Principes d'conomie politique by Jean Charles Lonard de Sismondi. Prior to that point classical economics had either denied the existence of business cycles, blamed them on external factors, notably war, or only studied the long term. Sismondi found vindication in the Panic of 1825, which was the first unarguably international economic crisis, occurring in peacetime. Sismondi and his contemporary Robert Owen, who expressed similar but less systematic thoughts in 1817 Report to the Committee of the Association for the Relief of the Manufacturing Poor, both identified the cause of economic cycles as over production and under consumption, caused in particular by wealth inequality. They advocated government intervention and socialism, respectively, as the solution. This work did not generate interest among classical economists, though under consumption theory developed as a heterodox branch in economics until being systematized in Keynesian economics in the 1930s. Sismondi's theory of periodic crises was developed into a theory of alternating cycles by Charles Dunoyer, and similar theories, showing signs of influence by Sismondi, were developed byJohann Karl Rodbertus. Periodic crises in capitalism formed the basis of the theory of Karl Marx, who further claimed that these crises were increasing in severity and, on the basis of which, he predicted a communist revolution. He devoted hundreds of pages of Das Kapital to crises.

Classification by periods

In 1860, French economist Clement Juglar identified the presence of economic cycles 8 to 11 years long, although he was cautious not to claim any rigid regularity. Later, Austrian economist Joseph Schumpeter argued that a Juglar cycle has four stages: (i) expansion (increase in production and prices, low interests rates); (ii) crisis (stock exchanges crash and multiple bankruptcies of firms occur); (iii) recession (drops in prices and in output, high interests rates); (iv) recovery (stocks recover because of the fall in prices and incomes). In this model,
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recovery

and

prosperity

are

associated

with

increases

in

productivity,

consumer

confidence, aggregate demand, and prices. In the mid-20th century, Schumpeter and others proposed a typology of business cycles according to their periodicity, so that a number of particular cycles were named after their discoverers or proposers:

the Kitchin inventory cycle of 35 years (after Joseph Kitchin); the Juglar fixed investment cycle of 711 years (often identified as 'the' business cycle); the Kuznets infrastructural investment cycle of 1525 years (after Simon Kuznets also called building cycle]); the Kondratiev wave or long technological cycle of 4560 years (after Nikolai Kondratiev).

Interest in these different typologies of cycles has waned since the development of modern macroeconomics, which gives little support to the idea of regular periodic cycles

Occurrence

There were frequent crises in Europe and America in the 19th and first half of the 20th century, specifically the period 18151939. This period started from the end of the Napoleonic wars in 1815, which was immediately followed by the Post-Napoleonic depression in the United Kingdom (181530), and culminated in the Great Depression of 192939, which led into World War II. See Financial crisis: 19th century for listing and details. The first of these crises not associated with a war was the Panic of 1825. Business cycles in OECD countries after World War II were generally more restrained than the earlier business cycles. This was particularly true during the Golden Age of Capitalism (1945/501970s), and the period 19452008 did not experience a global downturn until the Late-2000s recession. Economic stabilization policy using fiscal policy and monetary policy appeared to have dampened the worst excesses of business cycles, and automatic stabilization due to the aspects of the government's budget also helped mitigate the cycle even without conscious action by policy-makers.
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In this period the economic cycle at least the problem of depressions was twice declared dead. The first declaration was in the late 1960s, when the Phillips curve was seen as being able to steer the economy. However, this was followed by stagflation in the 1970s, which discredited the theory. The second declaration was in the early 2000s, following the stability and growth in the 1980s and 1990s in what came to be known as The Great Moderation. Notably, in 2003, Robert Lucas, in his presidential address to the American Economic Association, declared that the "central problem of depression-prevention has been solved, for all practical purposes." Unfortunately, this was followed by the 20082012 global recession. Various regions have experienced prolonged depressions, most dramatically the economic crisis in former Eastern Bloc countries following the end of the Soviet Union in 1991. For several of these countries the period 19892010 has been an ongoing depression, with real income still lower than in 1989. This has been attributed not to a cyclical pattern, but to a mismanaged transition from command economies to market economies.

Phases of a Trade Cycle:

A business cycle is a short term picture of the behavior of real output in a private enterprise economy. Industrialized economies having free market mechanism have economic growth over the long period. But the process of economic growth is often shaken by business cycles, which show up-turn and downturn of income, output and employment. A business cycle can be shown to be a wave-like path of the economys real output. Economists often describe a business cycle with the help of distinct phases or stages. The four phases of a business cycle are: a) Slump b) Recovery c) Boom d) Deflation These have demarcated in the diagram, now we can describe the four phases of a typical trade cycle as follows:

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Slump or Depression:

This is the most critical and fearful stage of a trade cycle. Haberler has described depression as a state of affairs in which real income consumed or volume of production per head and the rate of employment are falling and are sub-normal in the sense that there are idle resources and unused capacity, especially unused labor. A Slump or depression shows itself first in a substantial decline in general output and employment. The decline in economic activity is not, of course, uniform. Contraction in output might be much more in manufacturing such as machinery and equipment, mining, construction and transport than in retail trade or agriculture.

While output and employment tend to fall fast during the slump, prices and wages continue to decline. This is really agonizing experience for both the producers and workers.

Prices decline because of the expectations of producers in general that these would continue to fall in spite of all governmental efforts. While the producers try to dispose of their stocks at the current market prices, the consumers tend to post pone their purchases in the hope that the prices would fall further and they would be able to benefit from it. Scared by the general slump in the economy, the financial institutions press the producing firms to return their advances according to the contract. This forces the producers to meet their contractual obligations through unintended sales of their inventories in a market where prices are already declining. This deepens the depression further. Most firms reduce their output and as such are forced to lay-off workers. As unemployment increases, the wages tend to fall under its pressure. However, the fall in wages is less than the fall in prices. This is because workers unions strongly oppose wage reductions. The rate of fall in prices of agricultural raw materials is generally more than that of manufactured products. This is because the producers are not prepared to lift off the supplies of the raw materials, which causes a sharper fall in their prices than the prices of manufactures. The

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wholesale prices fall faster than the retails prices. These sudden changes in the relative price structure of the economy cause dislocations in production and exchange. Depression or slump leads to redistribution of the national income. Profits and wages fall faster relatively to rent and other fixed incomes. Incomes of shareholders go down fast. This reduces the deposits with banks and other financial institutions. They, in turn, follow the policy of credit contraction. While producers are reluctant to borrow because of dull trade conditions, the financial institutions are hesitant in lending for fresh investments. This causes the depression to persist for a longer period than it would have losted on its own.

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Recovery: Recovery shows the upturn of the output and employment of the economy from the state of depression. Recovery is most probably the result of the fresh demand for plant and equipment arising from the consumer goods industries, which has been postponing this investment during depression. The replacement demand starts the recovery process. Wages and other incomes show a noticeable rise. Profits also start rising, which spurs the producers to float fresh investment proposals in the stock market. It must be pointed out here that a non-intervention policy from the government fails to start the recovery phase. Recovery is a slow and halting process. The government has to pursue stabilization policies and show special initiatives in dispelling the pessimistic mood of the investors. The economic system, left to itself, is likely to stagnate in the state of depression for an intolerably long period for the working class.

Boom or Prosperity:

During the recovery phase, rise in output and incomes of the people induce substantial increase in aggregate spending. This has a multiplier effect. This cumulative process of rising investment and employment forges ahead. As investors become more confident, expanding productive activity takes the economy to a boom or prosperity phase. It means that there is a state of enthusiasm in the business community. Industrial and commercial activity, both speculative and non-speculative, shows remarkable expansion. Construction activity gets a bog boost. Share markets reflect the general state of exuberation of the investors. Financial institutions tend to expand credit as the interest rates and discount rates go up. Thus, everyone seems to be happy during the state of prosperity, which ultimately, of course, proves to be short-lived.

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Recession: The end to prosperity phase comes because of certain tendencies in the private-enterprise economy prevalent during the boom conditions. They are: a) as prices rise, wages tend to lag behind. As a result, purchasing power of workers, who form a majority of the people, tends to lag behind the supply of consumer goods. b) Expansion of production is hampered by shortages of some inputs and bottlenecks in production. c) Excessive demand for labor and materials pushes up both the factor and the product prices but in a disproportionate fashion. d) The nonavailability of credit beyond a particular rate of expansion might also act as a serious break on prosperity. Financial institutions including banks cannot expand credit beyond a limit put by their reserve requirements. As this limit is reached, they start recovering their loans. Shortages of finance crop up. Firms are forced to liquidate their stocks when most firm try to sell there output at the same time, the price level starts falling. When some firms get involved in losses in this way, a wave of pessimism runs through the share markets. Production schedules by firms are curtailed; workers are laid off and outstanding orders for raw materials are cancelled. In this way the wave of pessimism gets transmitted to other sectors of the economy. The whole economic system thereby runs into a crisis. Thus the next stage of the trade cycle, called recession of deflation starts.

When sure signs of recession appear on the stock and financial markets, over-pessimism, nervousness and fear born out of uncertainty overtake the businessmen. In this atmosphere, new projects are shelved. Even the projects in hand may be abandoned. Some firms go sick. Others simply go bankrupt. All this hastens the process of economic contraction. The fall in the purchasing power of the general public reduces demand for consumer goods, which aggravates the slackening demand for machines and equipment. The business would goes panicky. What was recession or deflation fore some time now converts itself into depression.

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Conclusion In this topic we explore the concept of the business cycle. A business cycle occurs due to the fluctuations that an economy experiences over time resulting from changes in economic growth. Understanding business cycles is the essence of a course in macroeconomics. Economists try to discern where the economy is located and more importantly where it is heading in order to deal with possibly adverse future economic events. When the economy is at or is heading in an undesirable direction, economists may apply fiscal or monetary policy tools to change the course of the economy. In general, a business cycle describes changes in the demand-side of the economy as measured by GDP, where: GDP = C + I + G + NX Over time, GDP does not remain constant and will change for many reasons, economic and noneconomic. Economic reasons include changes in government policies such as taxes and interest rates. The non-economic reasons are too many to even consider listing, but include factors such as war, drought, natural and man-made disasters.

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The horizontal axis measures time, while the vertical axis yields the real GDP growth rate. As the graph shows, we begin with an increasing growth rate of real GDP during an economic expansion. Eventually, growth approaches and then reaches a peak. Why are peaks reached, or why doesn't economic growth continue to increase indefinitely? The answer is prolonged periods of economic growth (or short periods of very intensive economic growth) are eventually accompanied by rising inflation rates (or the threat of higher inflation). The higher prices (inflation) bring forth counter cyclical policies used to dampen inflationary pressures The defining part of the business cycle is a recession. Without a recession, the economy doesn't really experience a business cycle, just a period of a prolonged economic expansion. Between 1992 and 2000, the U.S. economy did not see a recession and set the record for the longest period of economic expansion without a recession. There were changes in real GDP growth during this time period, GDP even decreased in the first quarter of 2003, but no recession. The table above shows how the business cycle evolved in the 20th century. Prior to 1945, periods of recession were almost as common as days when the economy was growing. As we will discuss in Unit 9, until the Great Depression of the 1930s, economic policy makers generally did little to counteract the forces that drove the business cycle, choosing instead to allow the economy to take its own course. The result was long (typically almost 2 years) and frequent recessions that we usually much more severe than modern-day recessions. Modern economic thought is characterized by the use of both fiscal and monetary policies to counteract and smooth out the business cycle. As the table shows, economists have had success in using these policies to make the dealings of U.S. firms, as well as the life of Americans who work and save in financial markets less turbulent. To better understand the use of fiscal and monetary policies, take another look at the GDP equation: GDP = C + I + G + NX GDP is the sum of consumption + investment + government spending + net exports (exports imports). This equation can be written in further detail as:
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GDP = C(Y - T) + I(r) + G + NX Y is equal to income and T represents taxes. (Y - T) gives us disposable income and thus consumption depends on the level of disposable income C(Y - T). r represents the interest rate and investment responds to changes in the interest rate.

As r increases, I will decrease. As r decreases, I will increase.

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BIBLIOGRAPHY Business Cycles, Part 2 -----------------------------------------------------------------------------------------------------------------------------------------F. A. Hayek

A Study in Trade-Cycle History: Economic Fluctuations in Great Britain 1833-1842-----------------------------------------------------------------R.C.O.Matthews

The trade cycle ---------------------------------------------------------------------------------------------------------------------------------------------------Lavington F.

Readings in Business Cycle Theory-----------------------------------------------------------------------------------------------------------------------------American Economic Association Business-cycle theory: its development and present status---------------------------------------------------------------------------------------------------Alvin Harvey Hansen

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