Business cycle

Introduction
A business cycle is basically defined in
terms of periods of expansion or recession.
During expansions the economy is growing
in
real
terms,
indicating
rise
in
employment, industrial production, sales,
personal income, etc.
During
recession
the
economy
is
contracting, which will be indicated by
large scale unemployment, loss of output.
They are also known as trade cycles.

 these fluctuations in economic activity are

recurrent and have been occurring periodically
in a more or less regular fashion. Therefore,
these fluctuations have been called business
cycles. It may be noted that calling these
fluctuations as cycles mean they are periodic
and occur regularly, though perfect regularity
has not been observed.
The duration of a business cycle has not been
of the same length; it has varied from a
minimum of two years to a maximum of ten to
twelve years, though in the past it was often
assumed that fluctuations of output and other
economic indicators around the trend showed
repetitive and regular pattern of alternating
periods of expansion and contraction.

Features of business
cycles :

1. Business cycles occur periodically. Though they do

not show same regularity, they have .some distinct
phases such as expansion, peak, contraction or
depression and trough. Further the duration of cycles
varies a good deal from minimum of two years to a
maximum of ten to twelve years.
2. Secondly, business cycles are Synchronic. That is,
they do not cause changes in any single industry or
sector but are of all embracing character. For example,
depression or contraction occurs simultaneously in all
industries or sectors of the economy. Recession passes
from one industry to another and chain reaction
continues till the whole economy is in the grip of
recession. Similar process is at work in the expansion
phase, prosperity spreads through various linkages of
input-output relations or demand relations between
various industries, and sectors.

 3. Thirdly, it has been observed that fluctuations

occur not only in level of production but also
simultaneously in other variables such as
employment, investment, consumption, rate of
interest and price level.
4. Another important feature of business cycles is
that investment and consumption of durable
consumer
goods
such
as
cars,
houses,
refrigerators are affected most by the cyclical
fluctuations. As stressed by J.M. Keynes,
investment is greatly volatile and unstable as it
depends on profit expectations of private
entrepreneurs.
These
expectations
of
entrepreneurs change quite often making
investment quite unstable. Since consumption of
durable consumer goods can be deferred, it also
fluctuates greatly during the course of business
cycles.

 5. An important feature of business cycles is

that consumption of non-durable goods and
services does not vary much during different
phases of business cycles. Past data of
business cycles reveal that households
maintain a great stability in consumption of
non-durable goods.
6. The immediate impact of depression and
expansion is on the inventories of goods. When
depression sets in, the inventories start
accumulating beyond the desired level. This
leads to cut in production of goods. On the
contrary, when recovery starts, the inventories
go below the desired level. This encourages
businessmen to place more orders for goods
whose production picks up and stimulates
investment in capital goods.

 7. Another important feature of business

cycles is profits fluctuate more than any
other type of income. The occurrence of
business cycles causes a lot of
uncertainty for businessmen and makes it
difficult to forecast the economic
conditions. During the depression period
profits may even become negative and
many businesses go bankrupt. In a free
market economy profits are justified on
the ground that they are necessary
payments if the entrepreneurs are to be
induced to bear uncertainty.

 8.
Lastly,
business
cycles
are
international in character. That is, once
started in one country they spread to
other countries through trade relations
between them. For example, if there is a
recession in the USA, which is a large
importer of goods from other countries,
will cause a fall in demand for imports
from other countries whose exports would
be adversely affected causing recession
in them too.

Phases of Business
Cycle

Different Phases of Business

Cycle
Expansion
:-increased
consumer
confidence, which translates into higher
levels of business activity. Like high
capital investment in basic industries as
result high stock, high prices, high profit.
It consists of three small stages :
1.Recovery
2.Boom
3.Peak

1.Recovery
The turning point from depression to
expansion is termed as Recovery or Revival
Phase.
Consumers confidence starts to increase.
Rise in economic activities.
The recovery may take place because of
following reason
New government expenditure
Exploitation of new sources of energy
Innovation
Investment in new areas
Change in the technology of production

2.Boom
Consumers confidence starts to increase at a
faster pace.
Unemployment levels fall.
Business starts increase their construction levels.
Rise in National Income.
Rapid increase in economy.
Inflation increase at very high rates.
More profit
Demand for consumer goods and production rises

3.Peak
The economy has reached its peak.
Output starts to standstill and level
off.
Consumers confidence starts to
decline.
People start to stop their buying.
GDP begins to decline(bust).

 Contraction
It is a period of decrease in consumer
confidence and economic activity.
It consists of three smaller stages:
Recession
Depression
Trough

1.Recession

it is a period of reduced economic

activity in which levels of buying, selling,
production, and employment typically
diminish.
Consumers
confidence
starts
to
decrease a little.
Unemployment is increasing while
inflation is dropping.
Fall in income , expenditure, demand ,
price, and profit

2.Depression
Depression is the most fearful stage of a
trade cycle.
The phase of depression (also called
slump) is characterized by low economic
activities.
Rapid decline in general output
and employment.
It is characterized by shortfall in
production,mass unemployement,fall in
prices, low wages, contraction of credit,
high rate of business failure

3.Trough

Contraction reaches a minimum, or

Economy hits bottom.
Output starts to standstill and level off.
Consumers confidence starts to level
off.
End of recession, growth resumes.

Causes of Business Cycle

1) Interest rates : Changes in the interest
rate affect consumer spending and
economic growth. For example, if the
interest rate is cut, this reduces borrowing
costs and therefore increases disposable
income for consumers. This leads to higher
spending and economic growth. However, if
the Central Bank increase interest rates to
reduce inflation, this will tend to reduce
consumer spending and investment. These
lead to an economic downturn and
recession.

 2) Changes in house prices : A rise in

house prices creates a wealth effect and
leads to higher consumer spending. A fall in
house
prices
causes
lower
consumer
spending and bank losses.
3) Consumer and Business Confidence : People
are easily influenced by external events. If there is a
spread of bad economic news, this tends to
discourage people from spending and investing
making a small downturn into a bigger recession.
But,
when the economy recovers this can cause a
positive bandwagon effect. Economic growth,
encourages consumers to borrow and banks to lend.
This causes higher economic growth. Confidence is
an important factor in causing the business cycle.

 4) Multiplier Effect : The multiplier effect

states that a fall in investment may cause a
bigger final fall in real GDP. For example, if the
government cut public investment, there
would be fall in aggregate demand and a rise
in unemployment. However, those who lost
their jobs would also spend less, leading to
even lower demand in the economy.
Alternatively, an investment could have a
positive multiplier effect.
5) Accelerator Effect : This states that investment
depends on the rate of change of economic growth. If
the growth rate falls, firms reduce investment
because they dont expect output to rise quickly.
Small changes in the rate of growth have a big effect
on investment levels.

 6) Inventory Cycle : Some argue that

there is a natural inventory cycle. For
example, there are some luxury goods
we buy every five years or so. When the
economy is doing well, people buy these
luxury items causing faster economic
growth. But, in a downturn, people delay
buying luxury goods and so we get a
bigger economic downturn.

Measures to Control Business

Cycle
Two type of measure are adopted to
control the business cycle
Preventive measure
Corrective measure
Preventive measure :
1. To Reduce The Dependence Of Agriculture On
Nature
2 Maintain Equilibrium Between Demand And
Supply Scare Goods By Import And Export
3 Check On Speculative Activities
4 Nationalization Of Basic Industries

 Corrective measure :
1) Fiscal Measures : During the period of boom, there
should be decrease in public expenditures, increase in
taxes and increase in public debt. On the other hand,
during the period of depression, the policy of increase in
public expenditures, decrease in taxes and decrease in
public debt is adopted by the government .
2) Monetary Measures : Monetary measures means
control of money and credit supply in the country. When we
are facing boom or inflation, the central bank reduces the
total quantity of money in circulation. The bank can adopt
different measures like bank rate policy, open market
operations and rationing of credit etc.On the other hand,
incase of depression, the central bank can increase the
quantity of money by lowering the bank rate or purchasing
the securities and discounted the bills of exchange .

3) International Measures : Today every

country has trade relation with other countries.
If there is inflation or deflation in one country,
it can be easily be carried to other countries,
the example of great depression can be given.
Business cycle is an international phenomena
and it should be tackled on international level.
Different measures have been suggested by
the economists to control the business
fluctuations effectively.
Such as :
(a) Control of international production.
(b) International bill stock control and
international investment control.

 4)
State
Control
of
Private
Investment : If the government controls
the
private
investment,
cyclical
fluctuations can be controlled within
limits. While the other economists who
agree with the above view, they say that
private investment will be discouraged.
5. Direct control: it include licensing,
price wages control, export duties,
exchange control quotas, monopoly
control
6.Automatic stabilizers: by means of
progressive income tax