Group Report

Business Cycle

Submitted to:

Madam Shazia Nawaz

Submitted by:

Rida Akbar Roll no: 48

Zainab Khan Roll no: 50

Syeda Fiza Ali Roll no: 52

Aleena Arshad Roll no: 53

Fatima Zahra Roll no: 59

Iqra Ali Roll no: 62

Course Name: Business Economics

MBA (HRM) Weekend

Session 2022-202

Institute of Banking & Finance BZU, Multan

 Business Cycle

Business

A business is an organization or entity that sells goods or services for a profit. The important part
of this definition is that a business is something that operates in order to make a profit.

Cycle

A cycle is a series of events that happen repeatedly in the same order.

Do you enjoy roller coasters? Some coasters are mild, kiddy rides that never really go that high.
After a peak, they gently slope back down and then head back up. Other coasters are wild rides
with long steep slopes. It's a thrilling ride-well, for most of the riders.
 Introduction
Alternate Name: Trade cycle and Economic Cycle

Business cycles or Trade cycles refer to the continuous fluctuations in economic activity in the
economy as a whole. Fluctuations in economic activity are a feature of every economy and pose a
persistent problem in the short run normally. These short term fluctuations in economic activity,
which are reflected in output and employment levels, are called trade cycles.

So we can say, business cycle is an alternate expansion and contraction in overall business
activities. It is regular fluctuations in income, output and employment which tend to be self-
reinforcing or cumulative. It refers to wave like fluctuations and is invariably start in the industrial
sector and then spread itself over the other sectors of the economy quickly because in modern
economy, the different sectors are interrelated. In short business cycle or trade cycles are the ups
and downs in economic activities. So business cycles, boom in one period and slump in the
subsequent period, in economic activities are essentially continuous features of the economic
development of a country. Business cycles influence business decisions tremendously and set the
trends for future business. As we know there are five phases of business cycles namely,
Depression, Recovery, Prosperity, Expansion and Recession. As the name suggests, the period of
prosperity opens up new and lager opportunities for investment, employment, and production and
promotes business in the economy.

On the other hand, period of depression reduces business opportunities and investment as well as
employment in the economy.

Thus, in order to earn maximum profit, an entrepreneur must analyze the economic environment
of the period before taking his important business decisions.
Definition of Business Cycles

❖ According to Parkin and Bade’s,

“The business cycle is the periodic but irregular up-and-down movements in economic activity
measured by fluctuations in real GDP and other macroeconomic variables. A business cycle is not
a regular, predictable, or repeating phenomenon like the swing of the pendulum of a clock. Its
timing is random and, to a large degree, unpredictable.”

❖ 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.”

It is usually expressed as boom and bust. A boom cycle is characterized by high positive growth,
measured by indicators such as rising employment, high GDP growth, and high consumption
spending, all in real terms. The boom cycle is also characterized by a market, rising housing prices
and increasing wages. On the other hand, negative GDP growth, high unemployment rate, and low
savings and investments are features of a bust cycle.

Phases of Business Cycle

• Business Cycle has many distinct phases. The most widely classified phases are the
expansion (boom, upswing, prosperity, periods of ups), peak (turning point, upper turning
point), contraction (bust, downswing, recession, depression, periods of downs), and trough
(lower turning point, recovery).
1. Expansion

• This is the first phase of the business cycle, and it’s generally marked by an increase in
economic activity. GDP (Gross Domestic Product) rises, unemployment falls, and prices
increase. During this period, businesses are steadily growing their production and investing
in new opportunities.
• Expansion, in economics, an upward trend in the business cycle, characterized by an
increase in production and employment, which in turn causes an increase in the incomes
and spending of households and businesses.

2. Peak

• This phase is also called boom or prosperity phase

• A peak is the highest point between the end of an economic expansion and the start of a
contraction in a business cycle.
• The peak is the point at which an expansion turns into contraction.Expansion has reached
its maximum growth, and now businesses are maxed out. They no longer have room to
 grow or invest, so they stop doing both—which affects supply
(production), demand (usage of goods and services), employment, investment, prices, etc
• Business gathers momentum.
• Rise in real output and income of the people.
• According to Haberler “ Prosperity is the state of affairs in which the real income
consumed, real income produced and the level of employment is high or rising or there are
no idle resources or unemployed workers.

3. Recession

• The recession is a period of economic decline that lasts from six months to a year;
sometimes it can last up to 18 months or more (referred to as “Depression”). During this
period most types of economic activity come to a halt. The unemployment rate rises as
businesses lay off workers, and prices for goods and services drop.
• A recession is actually a specific sort of vicious cycle, with cascading declines in output,
employment, income, and sales that feed back into a further drop in output, spreading
rapidly from industry to industry and region to region.

4. Depression

• This phase is also known as trough or slump phase.

• This is the lowest point of the business cycle, which may also be referred to as the
recession’s trough. At this point, GDP (Gross Domestic Product), employment, production,
consumption, investment, personal income, and business profits are all low.
• Heavy unemployment exists
• Prices start to fall
• Overcapacity in production
• Business profits are low
5. Recovery

• This phase is also known as Revival phase

• The recovery phase starts when economic activity begins to rise again. It’s marked by an
increase in economic activity, as businesses start hiring again and production begins to pick
up.
• Unemployment declines and prices begin to increase modestly. This period can last for
months or years depending on how long it takes an economy to recover from a
depression—which happens in a small number of depressions that have been studied by
economists.
• Profit rise
• Employment rises
• Businesses confidence grows

Comparison of business cycle

Expansion Peak Recession Depression Recovery

Increase in Highest point Business activity Lowest point of Economic

economic between the end slows down. business cycle. activity begins
activity. of expansion and to rise again.
start of
contraction.

GDP rise Expansion has Employment and GDP, Business starts

reached its output decline. employment, hiring again and
maximum production are production begin
growth low. to pick up.

Unemployment Rise in real Income and Business profits Profits and

falls. output and price falls. are low. Employment
income of rise.
people.
Business activity The economy is Purchasing Price is low but
Price Increase gathers moving toward power of man is costs are also
momentum. depression. low. low.
Features of Business Cycle

Business cycles may exhibit peculiar features depending on the fundamentals of the economy.
Nevertheless, they possess some basic common features such as:

• Fluctuations in aggregate economic activities that affect all economic indicators such as
GDP, interest rate, and unemployment rate concurrently.
• Changes in economic activities in all sectors of the economy including the real government,
financial and external sector simultaneously.
• Distinct phases that differ in length and severity.
• Persistent nature given that they tend to last for long periods of time
• Contagion effect due to globalization. Once it starts in one country it easily spreads to other
countries.
• Cyclical fluctuations are recurring in nature.
• A trade cycle contains self-generating forces which tend to terminate one phase and bring
the other phase of the cycle.
• A trade cycle is cumulative self-reinforcing.
• Trade cycles are prevailing in their impacts. They affect virtually every part of the
economy.
• Keynes pointed out that a trade cycle is characterized by the presence of crisis.
• Business cycles by and large follow a pattern of development.
• Business cycles occur periodically. It is synchronic in nature which means that changes not
occur only in single industry, but in the whole industry.
• Business cycles are international in character
• Investment and consumption of durable goods are most affected by business cycles
• One of the important features of business cycles is that consumption of non durable goods
and services does not change much during the phases of different trade cycles.
• The cycle will not have identical spacing, and thereby, asymmetric nature of the cycle
exhibits a different time period of occurrence.
• Most of the macroeconomic variables are affected by the cyclical movement. In the
upswing phase, output, prices, employment, income shows a upward trend, while an
 opposite trend is observed in downswing phase. Even though the trend is similar, but the
magnitude of impact may be different.

Types of Business Cycle

Following the writings of Prof. James Arthur and Schumpeter, we can classify business cycle into
three types based on the underlying time period of existence of the cycle as follows:

➢ Short Kitchin Cycle (very short or minor period of the cycle, approximately 40 months’
duration)
➢ Longer Juglar cycle (major cycles, composed of three minor cycles and of the duration
of 10 years or so)
➢ Very long Kondratieff Wave (very long waves of cycle, made up of six major cycles and
takes more than 60 years to run its course of duration)

Business Cycle Indicators

Business cycle indicators are economic that provide valuable information about the cycle. These
indicators help economic agents to track business cycle activities and make realistic forecasts for
business decisions and policies. The indicator could be classified into three groups leading,
coincident and lagging.
 • Leading Economic Indicators

Leading indicators predict business cycle peaks and troughs three to twelve months before they
occur. These indicators are manufacturers' new orders for consumer goods and materials and non-
defense capital goods; index of vendor performance; index of stock prices; and new building
permits for private housing. Others include interest rate spread; money supply; average workweek
in manufacturing; index of consumer expectations; and average weekly initial claims for
unemployment insurance.

• Coincident Economic Indicators

The coincident indicators measure current economic conditions to determine the actual phase of a
business cycle in an economy. They are a primary source of information for documenting the
official business cycle turning points. These includes: the number of employees on non-
agricultural payrolls; industrial production; real personal income (after subtracting transfer
payments); and real manufacturing and trade sales.

• Lagging Economic Indicators

This category indicates business cycle peaks and troughs three to twelve months after they actually
occur. The lagging indicators include labor cost per unit of output in manufacturing; average prime
interest rate; amount of outstanding commercial and industrial debt; consumer price index for
services; consumer’s credit as a fraction of personal income; average duration of unemployment;
and the ratio of unsold goods to sales for manufacturing and trade.

Measures to Control Business Fluctuations

Following are the main measure which can be suggested for the effective control of business
cycle fluctuation.

1. Monetary Policy

2. Fiscal Policy

3. State Control of Private Investment

 4. International Measures to Control of Business Cycle Fluctuation

5. Reorganization of Economic System

1. Monetary Policy

• Monetary policy as measure to control business cycle fluctuation refers to all those
measures which are taken with a view to control money and credit supply in the country.
When we are in the state of full employment and we are facing inflation, a deflationary
policy may be adopted. The central bank can reduced the quantity of money in circulation.
The bank can adopt different measures for this purpose, like increase in the bank rate,
selling of securities in the market, increasing the reserve ratio of the member banks etc.
• On the other hand, in case of deflation the central bank can adopt inflationary monetary
policy by lowering the bank rates or purchase of securities. Monetary policy has achieved
a very limited success in the past, because central bank has not full power over the supply
of money and credit in the country. Moreover, the quantity of money has failed during the
world depression of 1930s.

2. Fiscal Policy

• Fiscal policy as measure to control business cycle fluctuation nowadays is considered to

be a powerful anti-cycle weapon in the hands of the government. Fiscal policy involves the
process of shaping the public finance (income and expenditure) with a view of reduce
fluctuations in the business cycle and attainment of full employment without inflation.
• In case of inflation the governments reduces the public work programs, imposing heavy
taxes on business profits to discourage private investment, reduces purchasers power,
taking loans from the people, prepares surplus budget to reduce public debt. All these fiscal
measures greatly help in reducing the inflationary trend in the economy.
• If the economy facing depression, the government increases it expenditure on public works
programs like construction of new canals, new roads, buildings etc. Increase in government
expenditure, income, employment, profit and consumption of the people. In order to
 encourage private investment the government reduces taxes on profit. The government also
prepares deficit budget and the deficit is met by loans. All these fiscal measures to control
business cycle sets in upswing in the economy.

3. State Control of Private Investment

Some economists have suggested that if a government takes control of private investment is a
tool to control of business cycle fluctuations can be controlled within the limits. The other
economists, who disagree with the above view state that if a government takes control of private
investment, private investment will be discouraged. Low investment will reduce employment
and income. J.M Keynes is of the view that if we adopt the middle way we can get control of
business cycle fluctuation.

4. International Measures Control of Business Cycle

Today, every country has trade relations with the rest of the world. If there is inflation or deflation
in one country, it can be easily carried to other countries. The example of great depression can be
given. Business cycle is an international phenomenon and it should be tackled on international
level. Different measures to control business cycle fluctuations have been suggested by some well-
known economists these are:

▪ Control of International Production

▪ International Bill Stock Control
▪ International Investment Control

5. Reorganization of Economic System

Some economists suggest that there should be complete reorganization of the whole economic
system to control of business cycle fluctuation. The capitalistic system of production should be
replaced by the socialistic system of production. In socialistic economy, there are few chances of
cyclic fluctuations. In 1930, when all capitalist countries of the world were suffering from
depression, it was only socialist countries which were free from such crisis.

➢ Theories of Business Cycle

A business cycle is a complex phenomenon which is common to every economic system. Several
theories of business cycles have been propounded from time to time to explain the causes of trade
cycle. In order to analyses the problem of trade cycle, it is essential to review the important theories
of trade cycle.

➢ Hawtray’s Monetary Theory of Business cycles

• Hawtray was of opinion that in depression monetary factors play a critical role. The main
factor affecting the flow of money and money supply is the credit position by the bank. He
made the classical quantity theory of money as the basis of his trade cycle theory.
According to him, both monetary and non-monetary factors also affect trade. His theory is
basically the product of supply of money and expansion of credit. This expansion of credit
and other money supply instrument create a cumulative process of expansion which in
return increase aggregate demand. This theory is based upon the following beliefs:
• Consumer’s total expenditure comprises expenditure on consumption and investment.
• Consumer’s total outlay is the total money income of community.
• Stock market is very sensitive.
• Bank credit plays an important role in money supply.
When the process of expansion starts with the credit creation process and money supply, then
economy easily attains a boom phase. During boom, bank realizes that they have reduced their
results due to over credit creation which is dangerous. Expansion of credit is stopped which set the
downward tendencies in motion. It is a common phenomenon that when there is no credit
expansion in the economy then there is no prosperity. Heavy shortage of bank reserve occurs due
to drainage of cash from the banking system. Then this phase converted into depression due to
shortageof money supply in the economy. In simple words we can say that with the decline in
effective demand, depression phase starts.According to this theory the only cause of fluctuations
in business is due to instability of bank credit. So it can be concluded that Haw tray’s theory of
business cycle is basically depend upon the money supply, bank credits and rate of interests.

Criticism of the theory

• Hawtray neglected the role of non-monetary factors like prosperous agriculture, inventions,
rate of profit and stock of capital.
• It only concentrates on supply of money.
• Increase in interest rates is not only due to economic prosperity but also due to other
• factors.
• Over-emphasis on the role of wholesalers.
• Too much confidence in monetary policy.
• Neglect the role of expectations.
• Incomplete theory of trade cycles.

➢ Innovation Theory

The innovation theory of business cycle is invented by an American Economist Joseph

Schumpeter. According to this theory, the main causes of business cycles are over- innovations.
He takes the meaning of innovation as the introduction and application of such techniques which
can help in increasing production by exploiting the existing resources not by discoveries or
inventions. Innovations are always inspired y profits. Whenever innovations are introduced it
results into profitability then shared by other producers and result into decline in profitability. Then
it further leads to a new innovation and generate profits. Schumpeter has classified innovation in
following categories:

• Introduction of new type of product.

• The introduction of new technique of production.
• Discovery of new markets.
• Finding new sources of raw material.
• Changing or improving the old source of raw material for better productivity

Once innovation is introduced, producer has to manage the market for the product. According to
Schumpeter, innovations lead to short waves. The money market and banks also play significant
role in innovation theory. He also explains the up-swing and the down-swing of the business cycle
with the help of innovations. The upswing wave starts with the profitable innovations when a new
raw material, new technology takes place, it will result higher profit to the producer. They progress
and reach to peak position with the help of credit facilities given by banks or other financial
institutions. Once boom position is reached, market flooded with multiple products and as a result
there is decline in profitability. Again after some time, new inventions are take place and wave of
recovery starts. He assumes the stoppage of innovations and lack of innovation by the entrepreneur
as the main reason of recession in the economy.

This theory has also suffered some criticism:

• Innovation fails to explain the period of boom and depression.

• Innovation may be major factor of investment and economic activities but not the complete
• Process of trade cycle.
• This theory is based on the assumption that every new innovation is financed by the banks
andother credit institutions but this cannot be taken as granted because banks finance only
short term loans and investments.
 ➢ Keynesian theory of Business Cycle

Aggregate effective demand of an economy occupies a centre stage in Keynesian economics as it

determines the level of income, output and employment in the short run. Aggregate demand is
composed of total expenditure of the consumers on consumption goods and producers on
investment goods. However, fluctuations in aggregate demand can be explained by the fluctuations
in investment demand, as consumption demand is more or less stable in the short run. Investment
demand is conditioned upon the expected rate of profit (or Marginal Efficiency of Capital, by
following Keynesian terminology) and rate of interest. Again rate of interest is found more or less
sticky in the downward direction in the short run, and thereby, expected rate of profit plays an
instrumental role in explaining variations in investment demand.

Overall, the theory suggests that fluctuations in business cycle can be explained by the perceptions
on expected rate of profit of the investors. In other words, the downswing in business cycle is
caused by the collapse in the marginal efficiency of capital, while revival of the economy is
attributed to the optimistic perceptions on the expected rate of profit. Moreover, Keynesian
multiplier theory establishes linkages between change in investment and change in income and
employment. However, the theory fails to explain the cumulativecharacter both in the upswing and
downswing phases of business cycle and cyclical fluctuations in economic activity with the
passage of time.

➢ Hicks’s Theory of Business Cycle

Hicks extended the earlier multiplier-accelerator interaction theory by considering real world
situation. In reality, income and output do not tend to explode; rather they are located at a range
specified by the upper ceiling and lower floor determined by the autonomous investment. In the
theory, it is assumed that autonomous investment tends to grow at a constant percentage rate over
the long run, the acceleration co-efficient and multiplier co- efficient remain constant throughout
the different phases of the trade cycle, saving and investment co-efficient are such that upward
movements take away from equilibrium. The actual output fails to adjust with the equilibrium
growth path overtime. In fact, it has a tendency to run above it and then below it, and thereby,
constitute cyclical fluctuations overtime.
Although Hicksian theory has various merits but, it suffers from some weaknesses also. Some of
these are:

• Wrong assumption of constant multiplier and acceleration co-efficient.

• Highly mechanical and mathematical device.
• Wrong assumption of no-excess capacity.
• Full-employment ceiling is not independent

➢ Samuelson theory of Business Cycle

Prof. Samuelson is an eminent economist to build a trade cycle model by integrating the theory of
multiplier and acceleration principle. Samuelson model shows how multiplier and acceleration
interact with each other in order to generate income as well as to increase consumption and
investment demand more than expectations which cause cyclic economic fluctuations. This effect
is also called as leverage effect or super multiplier. For the proper understanding of this model first
we know the concept of autonomous investment and derived investment. Autonomous investment
is incurred by the government with the objective of social welfare. It is also called public
investment. The autonomous investment is the investment which is done for the sake of new
inventions in techniques of production. Derived investment is the investment undertaken in capital
equipments which is induced by increase in consumption. This theory is based on some
assumptions such as there is no excess production capacity in an industry, current year
consumption is based in previous year’s income, government is not involved in any activity and
there is no foreign trade, etc.

According to this theory process of multiplier starts working when autonomous investment takes
place in the economy. With the autonomous investment income of the people rises and there is
increase in the demand of consumer goods. It directly affected the marginal propensity to consume.
If there is no excess production capacity in the existing industry, then existing stock of capital
would not be adequate to produce consumer goods to meet the rising demand. Now in order to
meet the consumer’s requirements, producers will make new investment which is derived
investment and the process of acceleration principle comes into operation. Then there is rise in
income again which in the same manner continue the process of income propagation. So in this
way multiplier and acceleration interact and make the income grow at faster rate than expected.
After reaching its peak, income comes down tobottom and again start rising.

This theory has also some weaknesses such as:

• This model only concentrates on the impact of the multiplier and acceleration and it
ignored therole of producer’s expectations, changing business requirements and
consumer’s preferences etc.
• It is not practically possible to compute the fact of multiplier and acceleration principle.
• It has wrong assumption of constant capital output ratio.

Causes of Business Cycle

There are several factors that affect business cycles in any country. These include:

1. Natural factors
2. Wars
3. Political instability
4. Supply of money
5. Future expectation
6. Population explosion
7. Globalization.
1. Natural Factors

The change in the pattern of economic activities may occur due to nature factors such as weather,
flood and earthquake for instance, unfavorable rainfall can result in low or poor agricultural yield.
Consequently, this would imply shortage of primary agricultural raw material for industrial
production. If this persists, economic activity reduces, thereby pushing the economy towards a
bust. A boom, however, is likely to occur when there is favorable weather condition. For example,
when there is sufficient rainfall across the country, agricultural activities could receive major boost
in terms of yields. This could promote growth in the entire economy.
 2. Wars

War situations affect economic activities in two ways: misallocation of resources and inability to
harness human and material capital. In the former, government embarks on unproductive spending
that may not enhance growth, while the latter comes from displacement of labor, leading to
unemployment and loss of output. During peace time, it is expected that economic activity would
blossom which helps to expand economic activities and a period of recovery sets in.

3. Political Stability and Economic Policy

Change of government and inconsistent government policies could influence the business cycle,
Political stability and consistent government policy helps to build confidence and encourage
investment in the economy. On the other hand, instability and inconsistent policies create
uncertainty in the economy and cause business activities to slow down. In taking economic
decisions, economic agents consider the effect of government’s economic policies on their
business interests and may decide to divert their capital to other countries or make investment in
non-productive businesses.

4. Monetary Conditions

The monetary policy of the government influences business cycle or instance, an expansionary
monetary policy increases the supply of money which results in higher credit at lower interest rate,
leading to a boost in the aggregate demand. However, excessive expansion has the potential of
raising inflation rate in the economy. On the other hand, a contractionary monetary policy would
slow down economic activities.

5. Expectations

Expectations play a major role in business activities thereby affecting business cycles. When
economic agents (Individuals, household, firms and government) are confident about the future,
they trend to spend more, and this leads to expansion in economic activities. Uncertainty about the
future tends to reduce or postpone spending which consequently results in the contraction of
business activities and may lead to recession in the economy.
 6. Population Explosion

Population explosion (excessive increase in population) without a commensurate increase in

output could pose serious economic challenges including high unemployment, poverty, and
widening inequality thereby leading to low aggregate demand and economic slowdown. However,
the reverse is the case when population explosion is matched with increased output.

7. Globalization

Global interaction and integration makes it possible for shocks arising from any country to spread
to other countries. A shock in stronger economies like USA and UK could severely affect
economies of the rest of the world. A recession in USA or China, for instance, could reduce
demand for Nigeria’s crude oil. On the other hand, a boom in US could increase demand for
Nigeria’s crude oil.