What is Business Cycle

A trade cycle is composed of periods of

good trade characterized by rising prices
and low unemployment %ages, alternating
the periods of bad trade characterized by
falling prices and high unemployment
%ages.
KEYNES
Characteristics of Business Cycles
• These are wave like fluctuations in economic
activity.
• Cyclical in nature
• Sequences of changes in business cycle recurr
frequently and in similar pattern.
• The rhythm or the periodicity b/w the cyles need
not be similar.
• They are a type of fluctuations found in the
aggregate economic activity and not in any
single firm or industry.
 Phases of Business Cycles
• Expansion or prosperity or the upswing
• Recession or upper turning point
• Contraction or depression or downswing
• Revival or recovery or lower turning point
 EXPANSION
• Demand, output, employment and income are at
high level.
• They tend to raise prices but wages , salaries ,
interest rates, rentals and taxes do not rise in
proportion to the rise in prices.
• The gap b/w prices and costs increases the
margin of profit.
• Rapid rise in the stock market value.
• Economy is engulfed in the waves of optimism.
• There is increase in investment leading to the
expansion of economic activity.
 RECESSION
• Profit margins decline as costs strart
overtaking prices.
• Some firms close down and others reduce
production and try to sell out accumulated
stocks.
• Investment, employment, income and
demand decline.
 DEPRESSION
• General decline in economic activity
• Considerable reduction in the production of
goods and services, employment, income,
demand and prices.
• Fall in bank deposits
• Credit expansion stops because the business
community is not willing to borrow.
• Bank rates fall considerably
• Mass unemployment in the economy.
 Theories of Business Cycles
• Hawtrey’s monetary theory
• Schumpeter’s theory of innovation
• Keynes's theory
 HAWTREY,S MONETARY
THEORY
Acc. To Mr. R.G Hawtrey, The trade cycle is
purely monetary phenomenon.
• It is the changes in the monetary demand that
cause prosperity and depression.
• Non- monetary factors such as strikes, floods,
earthquakes, wars, etc. may at their best cause
partial depression but not general depression.
• Cyclical fluctuations are caused by expansion
and contraction of bank credit.
The expansion phase of trade cycles starts
where bank increase credit facilities.
These encourage borrowings on part of
merchants and producers.
This is because it is very sensitive to
changes in rate of interest.
Large orders are placed and more factors
of prod. are employed.
This leads to increase in the productive
activity, depletion in the stock, in income, in
outlay, demand and at the same time
causes of goods.
 DEPRESSION
• Prosperity comes to an end when banks stop credit
expansion.
• Banks refuse to lend credit because funds are depleted
and money in circulation is absorbed in form of cash
holdings by the consumers.
• Banks ask businessmen to repay loan.
• For this the businessmen start selling their stock at
reduced rates.
• There is a fall in the demand of the factors of prod.
• As a result there is a fall in the income. Unemployment
comes into picture.
• Unable to pay loan some firms go in to liquidation and
further contraction of credit by the banks.
 CRITICISM
• Over emphasis of monetary factors and total neglect of
non monetary factors.
• Just expansion and contraction of credit cannot originate
either boom or depression in the economy.
• Traders do not depend exclusively on bank credit.
• Decisions regarding the accumulation and depletion of
stocks are not solely governed by the changes in the
interest rates.
• Over emphasis on stock factor
• The theory fails to explain the periodicity of cycles.
 SCHUMPETER'S THEORY OF
INNOVATIONS
• Trade cycles are the outcome of the
economic development in the capital
economy.
• This approach involves the development
of his model into two phases
• The first stage deals with the initial impact
of innovation
• Second stage follows through reactions to
original impact.
 CIRCULAR FLOW
• The first approximation starts with the eco.
System in equilibrium with every factor
fully employed.
• Product prices are equal to both average
and marginal costs.
• Profits and interest rates are zero.
• There are no savings and investments.
• The same products are produced year
after year in the same manner.
 INNOVATION
The model starts with the break of the circular
flow by the introduction of Innovation
Innovation takes place in the following ways;
• Introduction of new product
• Introduction of new production method.
• Opening up of new market
• The conquest of the new source of raw material
• The carrying out of new organizations or
industry.
The innovating entrepreneur is financed by
the expansion of bank credit. He starts
bidding resources from other industries.
Money income increase. Price begin to rise.
The new innovation starts producing goods
and there is increased flow of goods in the
economy. Consequently the supply exceeds
demand . Prices and the cost of prod. of
goods decline until recession sets in..
The Schumpeter's first approximation
consists of the two phase cycle. The
economy starts at the equilibrium state,
rises to peak and then starts downward into
recession and continues till new equilibrium
is reached. This new equilibrium will be at
higher level of income than the initial one
because of the innovation which started the
cycle.
The second approximation follows through the
reactions of the impact of original innovation. Once
the original innovation becomes successful , the
other entrepreneurs follow it in ‘ swarm like
clusters.' Consequently the money income
increases and help to create cumulative
expansion throughout the economy. With
increase in purchasing power the prices further
rise it induces secondary wave of credit. After a
period of gestation, the new products start
appearing in the market displacing the old
products and enforcing a process of liquidation,
readjustment and absorption.
 CRITICISM
• Meaning of Innovation not clear.
• Only innovations are not the cause of cycles.
Trade cycles may be due to psychological,
natural and financial causes.
• Too much importance on bank credit.
• If innovations are financed through voluntary
savings or internal funds there may not be any
inflationary gaps.
• Unrealistic assumption of full employment of
resources.
 KEYNES THEORY OF TRADE
CYCLES
• Keynes regards the trade cycle as mainly due to
a “ a cyclical change in the marginal efficiency
of capital, though complicated and often
aggravated by associated changes in the other
significant short period variables of the economic
system.”
• Acc. To Keynes the principle cause of
depression and unemployment in the economy
is the lack of aggregate demand.
• Similarly the main cause of downturn is the
reduction in investment.
 EXPANSION PHASE
• During the expansion phase the MEC is
high and businessmen are optimistic
• Rapid increase in the rate of investment.
• Output, employment and income also
increase due to the effect of the multiplier.
 DEPRESSION
• As boom progresses, there is tendency for MEC
to fall because of to reasons:
• As more and more of goods are produced
stealthily, the current yield on them declines .
• At the same time the current costs of new capital
goods rise due to shortages of of material and
labour.
The fall in MEC increases the rate of interest . As a
result the investments fall s leading to
cumulative decline in the employmet.
 CRITICISM

• Overemphasis on expectations.
• Much focus on MEC and its effect on the
rate of interest.
• Some of the variables like the MEC,
expectations cannot explain different
phases of the business cycles.
• Missed out the acceleration principle.
 General measures to control
Business Cycles
• Preventive measures
• Curative measures
 PREVENTIVE MEASURES
• Availability of Complete Information right time
• Taking due care that
• Inventories do not increase or decrease
excessively.
• Financial commitments do not exceed financial
resources.
• Overhead cost per unit of output should not be
allowed to go up
• Acceptance and placement of orders should be
done after due consideration
 Measures to control Business
Cycle
• Monetary Policy
• Fiscal Policy
• Direct control
 CURATIVE MEASURES
• Proper monitoring of costs during the
recession period.
• Changes in quality and nature of product
to fill up sagging demand.
• Changes in sale methods and strategies to
adjust to new situation.
• Utilization of retained profits.