Business Cycle

The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occurs around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth. The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occurs around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth. Introduction

Definition According to Keynes, "Trade Cycle is composed of periods of good trade characterized by rising price and low unemployment percentage altering with periods of bad trade characterized by falling price and high unemployment percentage"

Features: A Business Cycle Exhibits a Wave like Movements Cyclical fluctuations are recurrent in nature Expansion and contraction in Business cycle are cumulative in effect Downward movement is quicker and upward movement is slower In Business cycle profits fluctuate more than other incomes

Phases of Trade Cycle A trade cycle is commonly divided into four well-defined and inter-related recurring phases: Prosperity -Expansion of the upswing. Recession -A turn from prosperity to depression. Depression -Contraction or downswing. Recovery -The turn from Depression to Prosperity.

Prosperity Phase -Expansion or the Upswing When there is an expansion of output, income, employment, prices and profits, there is also a rise in the standard of living. This period is termed as Prosperity phase. Due to full employment of resources, the level of production is Maximum and there is a rise in GNP (Gross National Product). Due to a high level of economic activity, it causes a rise in prices and profits. There is an upswing in the economic activity and economy reaches its Peak. This is also called as a Boom Period.

Features of prosperity  High level of output and trade.  High level of effective demand.  High level of income and employment.  Rising interest rates.  Inflation.  Large expansion of bank credit.  Overall business optimism.  A high level of MEC (Marginal efficiency of capital) and investment.

Recessionary Phase -Turn from Prosperity to Depression A business-cycle recession is a general slowdown in economic activity. Recession—a period of decline in total output, income, employment, and trade Rather, they ask the business community to repay their loans. This starts the recessionary phase. In order to repay bank loans, businessmen start selling their stocks. This sets the process of falling prices. They also cancel orders with producers.

Features of Recession  According to Hawtrey, prosperity cannot continue limitlessly. It comes to and end when banks stop credit expansion.  Banks refuse to lend further because their cash funds are depleted and the money in circulation is absorbed in the form of cash holdings by consumers.  Another factor is the export of gold to other countries when imports exceed exports as a result of high prices of domestic goods.  These factors force the banks to raise the interest rates and refuse to lend.

Depressionary Phase – Contraction or Downswing During a depression, the most deplorable conditions prevail in the economy. Real income earned, real income produced and the rate of employment fall or reach subnormal levels due to idle forces and capacity.

Features of Depression:  Shrinkage in the volume of output, trade and transactions  Rise in the level of unemployment  Fall in the aggregate income of the community  Fall in the structure of interest rates  Curtailment in consumption expenditure and reduction in level of effective demand  Contraction of bank credit

Revival or Recovery phase – the turn from depression to prosperity

Important Business Cycle Theories 1.Purely Monetary Theory 2.Monetary Over-investment Theory 3.Non-monetary Over-investment Theory 4.Under Consumption Theory 5.Psychological Theory

Hawtrey’s Purely Monetary Theory  This trade cycle is a purely monetary phenomenon  It is changes in the flow of monetary demand on the part of the businessmen that lead to prosperity and depression in the economy  He opines that the non-monetary factors like strikes, floods, earthquakes, droughts, wars, etc may at best cause partial depression, but not a general depression.

 Growth Phase  The expanded phase of the trade cycle starts when banks increase credit  The expanded phase of the trade cycle starts when banks increase credit facilities   They are provided by reducing the lending rate of interest and by purchasing securities.   These encourage borrowings on the part of the merchants and producers. This is because they are very sensitive to changes in the rate of interest. So when credit becomes cheap, they borrow from banks in order to increase their stock or inventories.   For this they place large orders with producers who, in turn, employs more factors of production to meet the increasing demand. Consequently, money incomes of the owners of factors of production increase thereby increasing expenditure on goods. The merchants find their stock being exhausted.

 Boom Phase  They place more orders with producers. This leads further increase in productive activity, in income, demand and a further depletion of stocks of merchants.  According to Hawtrey “ Increased activity means increased demand and increased demand means increased activity. A vicious circle is set up, a cumulative expansion of productive activity”.  As the cumulative process of expansion continues, producers quote higher and higher prices. Higher prices induce traders to borrow more in order to hold still larger stocks so as to earn more profits.  Thus optimism encourages borrowings, borrowings increase sales, and sales increases optimism.

 Recession Phase  According to Hawtrey, prosperity cannot continue limitlessly. It comes to and end when banks stop credit expansion.  Banks refuse to lend further because their cash funds are depleted and the money in circulation is absorbed in the form of cash holdings by consumers.  Another factor is the export of gold to other countries when imports exceed exports as a result of high prices of domestic goods.  These factors force the banks to raise the interest rates and refuse to lend.  Rather, they ask the business community to repay their loans. This starts the recessionary phase. In order to repay bank loans, businessmen start selling their stocks. This sets the process of falling prices. They also cancel orders with producers.

 Slump phase  This in turn, leads to reduction in the demand for factors of production. There is unemployment, income falls.  Falling demand, prices and incomes are the signals for depression. Unable to repay bank loans, some firms go into liquidation thus forcing banks to contract credit further. Thus the entire process becomes cumulative and the entire economy is forced into depression.  According to Hawtrey, the process of recovery is very slow and halting. As depression continues, traders repay bank loans by selling their stocks at whatever prices they can.  As a result, money flows into the reserves of the banks and funds increase with the banks.

 Trade cycle is not a purely monetary phenomenon.  It is a World wide phenomenon. Disadvantages

The Great Depression ( ) was the deepest and longest-lasting economic downturn in the history of the Western industrialized world. In the United States, the Great Depression began soon after the stock market crash of October 1929, which sent Wall Street into a panic and wiped out millions of investors. Over the next several years, consumer spending and investment dropped, causing steep declines in industrial output and rising levels of unemployment as failing companies laid off workers.

Fundamental Causes Businesses produced too much Wages and farm prices remained low Bankers made unwise loans to businesses and individuals Many Americans were trying to get rich quick Trade between the U.S. and the other nations declined