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Business Cycle

1. The rhythmic fluctuations in aggregate economic activity that an

economy experiences over a period of time are called business cycles
or trade cycles.
2. A trade cycle is composed of periods of good trade characterised by
Meaning of rising prices and low unemployment percentage, altering with periods
Business Cycle of bad trade characterised by falling prices and high unemployment
(aka Trade Cycle) percentages.
3. Business cycle refers to alternate expansion and contraction of
overall business activity as manifested in fluctuations in measures of
aggregate economic activity, such as, gross national product,
employment and income.

Characteristics of 1. Recurrent, but not periodic.

Business Cycle 2. Length of the business cycle & its different phases is unpredictable.

EXPANSION
1. The following economic variables increases:
National Output, Employment, Aggregate Demand, Capital, Consumer
Expenditure, Sales, Profits, Stock Prices, Bank Credit (Loans),
Phases of Business Selling Prices, Cost of Production, Net Investments, Standard of
Cycle Living, Consumer Spending, Business Confidence, Production, and
Factor Incomes.
2. This state continues till there is full employment of resources and
production is at its maximum possible level using the available
productive resources i.e. peak is arrived.

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PEAK
1. The term peak refers to the top or the highest point of the business
cycle.
2. Input Prices ↑ Output Prices ↑ Cost of living ↑
Demand for Durable Goods ↓ Gradually, Aggregate Demand ↓

CONTRACTION
Supply > Demand , Demand for Equipment ↓ , Labour Demand ↓
Input prices ↓ , Wages ↓ , Aggregate Demand ↓ , Selling Prices ↓
Investments ↓ , Employment ↓ , Bank Credits ↓ , Investor’s confidence ↓
Unemployment ↑

DEPRESSION
Phases of Business
1. Depression is the severe form of recession and is characterized by
Cycle
extremely sluggish economic activities.
2. Growth rate becomes negative and the level of national income and
expenditure declines rapidly.
3. Demand ↓ , Prices ↓ , Interest Rates ↓ , Business Confidence ↓
Bank Credits ↓ , Bankruptcy & Liquidation↑

TROUGH & RECOVERY

1. Trough marks the end of pessimism and the beginning of optimism.
2. The process of reversal is initially felt in the labour market.
3. Because of very cheap labour & input prices, producers start to
produce again. Therefore, Business Confidence↑
4. Investments↑, Bank Credits↑, Employment ↑, Agg. Demand↑,
Unemployment ↓

1. These indicators changes before the real output changes.

2. Examples: Stock Prices, Profit Margins, Housing Index, Value of New
Leading Indicators
Orders for Consumer Goods, New Orders for P&M, Index of
Consumer Confidence & Money Growth Rate.

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1. These indicators change after the real output changes.

Lagging Indicators 2. Examples: Unemployment, Corporate Profits, Labour Cost pu, Interest
Rates, Consumer Price Index & Commercial Lending Activity.

1. These indicators change as the real output changes i.e. they describe
Coincident the current state of the business cycle.
Indicators 2. Examples: GDP, Industrial Production, Inflation, Personal Income,
Retail Sales and Financial Market Trends.

EXAMPLES OF BUSINESS CYCLE

1. It started in the US and became worldwide.

2. The global GDP fell by around 15% between 1929 and 1932.
3. John Maynard Keynes regarded lower aggregate expenditures in the
economy to be the cause of massive decline in income and
employment.
4. Monetarists opined that the Great Depression was caused by the
Great Depression
banking crisis and low money supply.
of 1930
5. Other economists blamed deflation, over-indebtedness, lower profits
and pessimism to be the main causes of Great Depression.
6. Increased money supply, huge international inflow of gold, increased
governments’ spending due to World War II etc., were some of the
factors which helped economies slowly come out of recession and
enter the phase of expansion and upturn.

1. Due to over-optimism in the market, there was a great rise in stock

prices of dot-com companies
Information 2. However, the collapse of the bubble took place during 1999-2000 and
Technology Bubble many dot-com companies ran out of capital and were acquired or
Burst of 2000 liquidated
3. Stock markets crashed and slowly the economies began feeling the
downturn in their economic activities.

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REASONS
1. Large liquidity or money supply with the banks
Global Economic 2. Low Interest rates
crisis (2008-09) 3. The rising price of housing
4. Housing bubble burst
5. Default of sub-prime mortgages

1. The duration of these cycles vary. The intensity of fluctuations also

varies.
2. The length of each phase is also not definite.
3. Business cycles generally originate in free market economies and
easily transmitted to all other sectors.
Features of 4. Some sectors such as capital goods industries, durable consumer
Business Cycles goods industry etc, are disproportionately affected. Moreover,
compared to agricultural sector, the industrials sector is more prone
to the adverse effects of trade cycles.
5. It is difficult to make an accurate prediction of trade cycles before
their occurrence.
6. Business cycles are contagious and are international in character.

FLUCTUATIONS IN EFFECTIVE DEMAND

1. According to Keynes, fluctuations in economic activities are due to
fluctuations in aggregate effective demand.
2. During contraction, Investors sell stocks and buy safe-haven
investments. Moreover, consumers lose their jobs and stop buying
anything but necessities.
Internal Causes of
3. The bust cycle eventually stops on its own when prices are so low
Business Cycles
that those investors that still have cash start buying again.
However, this can take a long time, and even lead to a depression.
4. Variations in exports and imports can also lead to business
fluctuations as well.

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FLUCTUATIONS IN INVESTMENT
Increase in Investments leads to Expansion while Decrease in Investments
leads to Contraction.

VARIATIONS IN GOVERNMENT SPENDING

Increase in Government spending leads to Expansion while Decrease in
Government spending leads to Contraction.

MACROECONOMIC POLICIES
1. Monetary Policy: Decrease in Interest and Increase in Money Supply
leads to Expansion while Increase in Interest and Decrease in Money
supply leads to Contraction
2. Fiscal Policy: Increase in Tax and Decrease in Government spending
leads to Contraction while Decrease in Tax and Increase in
Government spending leads to Expansion

MONEY SUPPLY
1. According to Hawtrey, trade cycle is a purely monetary phenomenon.
2. Excessive increase of credit and money also set off inflation in the
economy.
3. Decrease in the supply of money may reverse the process and
initiate recession in the economy.

PSYCHOLOGICAL FACTORS
1. According to Pigou, business fluctuations are the outcome of these
psychological states of mind of businessmen.
2. If entrepreneurs are optimistic about future, the expansionary phase
may begin
3. If the entrepreneurs are pessimistic, the economy faces contraction
in economic activities

SCHUMPETER’S INNOVATION THEORY

Other Theories According to Schumpeter’s Innovation Theory, trade cycles occur as a result
of innovations which take place in the system from time to time

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COBWEB THEORY
The cobweb theory propounded by Nicholas Kaldor holds that business cycle
result from the fact that present prices substantially influence the
production at some future date. The present fluctuations in prices may
become responsible for fluctuations in output and employment at some
subsequent period.

1. Wars
2. Post War Reconstruction.
3. Technology Shocks
External Causes
4. Natural Factors (Mostly affects economies which are mainly
agrarian)
5. Population Growth v/s Economic Growth

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