Business Cycles

Meaning and Nature

Business cycle or trade is a part of the
capitalist system.
It refers to the Phenomenon of cyclical
booms and depression.
In a business cycle there are wave-like
fluctuations in aggregate employment,
income, output and price level.
Definitions
Prof. Haberler defines it as “ the business cycle in
the general sense may be defined as an alternation
of periods of prosperity and depression of good
and the bad trade”
Keynes defines it as “ A trade cycle is composed
of periods of good trade characterized by rising
prices and low unemployment percentages,
altering with periods of bad trade characterized by
falling prices and high unemployment
percentages.”
Prof. Mitchell defines it as “ Business cycles are a
type of fluctuations found in the aggregate
economic activity of nations that organise their
work mainly in business enterprises. A cycle
consists of expansions occurring at about the same
time in many economic activities followed by
similarly general recessions, contractions and
revivals which merge into the expansion phase of
the next cycle; this sequence of changes is
recurrent but not periodic…”
Thus…
The business cycle, in short is an alternate
expansion and contraction in overall
business activity, as evidenced by
fluctuations in measures of aggregate
economic activity, such as, the gross
product, the index of industrial production
and employment and income.
Types
Short Kitchin Cycle
The Long Jugler Cycle
The very long Kondratieff cycle
Building cycles
Kuznets cycle.
Phases
Depression
Recovery
Prosperity
Boom
Recession
Depression
This constitute the first stage of a business cycle.
It is a protracted period in which business activity in
the country is far below the normal.
It is characterized by a sharp reduction of
production, mass unemployment, low employment,
falling prices, falling profits, low wages, contraction
of credit, a high rate of business failures and an
atmosphere of all-round pessimism and despair
A decline in output or production is accompanied by
a reduction in the volume of employment.
All construction activities come to a more or less
complete standstill during a depression.
The consumer good industries such as food,
clothing etc are not soo much affected by
unemployment as the basic capital good
industries.
The prices of manufactured goods fall to low
levels.
Since the costs are “sticky” and do not fall as
rapidly as prices, the manufacturers suffer huge
financial losses.
Many of these firms have to close down on
account of accumulated losses
The fall in prices distorts the relative price
structure
The prices of agricultural commodities and raw
materials fall to a greater extent than the prices of
finished manufactured goods.
The agriculturists are hit more than the
manufacturing classes
The two longest depressions in the US history
were those of 1873-1879 (65 months), and 1929-
1933 (44 months).
Recovery
It implies increase in business activity after the
lowest point of the depression has been reached.
There is a slight improvement in economic activity.
The industrial production picks up slowly and
gradually.
The volume of employment also steadily increases.
There is a slow, but sure rise in prices accompanied
by a small rise in profits.
Attracted by rising profits, new investments
take place in capital goods industries.
The banks expand credit.
The business inventories also start rising
slowly.
The recovery continues until business
activity reaches approximately the same
level that it had achieved before the decline
set in.
The rate of recovery, it has been found, is
generally related directly to that of the preceding
depression.
The more severe the depression, the more rapid
will the recovery be.
Nothing can be said about the duration of the
recovery period. It depends upon the strength of
the forces which initiated the recovery period
The recovery could be initiated by new
innovations, government expenditure changes in
production techniques, investment in new regions,
exploitation of new sources of energy.
Prosperity
This stage is characterised by increased
production, high capital investment in basic
industries, expansion of bank credit, high prices,
high profits, a high rate of formation of new
business enterprises and full employment.
The longest sustained period of prosperity
occurred in the USA between 1923 and 1929 with
some minor interruptions in 1924.
Boom
It is a stage of rapid expansion in business activity
to new high marks, resulting in high stocks and
commodity prices, high profits and overall
employment.
The prosperity phase of the business cycle does
not end up with a stable state of full employment;
it leads to emergence of boom.
The continuance of investment even after full
employment results in a sharp inflationary rise of
prices.
Soon a situation develops in which the
number of jobs exceeds the number of
workers available in the market. Such a
situation is known as overfull employment.
Attracted by the rising profits, the
businessmen and industrialists further
increase their capital investments.
Runaway Inflation, prices rise sky-high.
Boom carries with it the seed of self-
destruction.
Bottle-necks begin to appear in the various
sectors of the economy.
Factors of production become scarce,
causing further spurt in their prices.
Some hastily set up firms collapse.
Recession
Failure of some businesses
The banks begin to withdraw loans from business
enterprises.
More business enterprises fail
Prices collapse and confidence is rudely shaken
Building constructions slow down and unemployment
appears in basic, capital goods industries.
This initial unemployment then spreads to other
industries.
Unemployment then leads to fall in income,
expenditure prices and profits.
The recession has cumulative effect.
Once a recession starts it goes on gathering
momentum and finally assumes the shape
of depression – first phase of the business
cycle is complete.
The 1957-58 recession in the USA was a
severe one.
Hawtrey’s Monetary theory of
the trade
“the trade cycle is a purely monetary phenomenon”
An elastic money supply, according to this theory, is
the basic cause of the operation of this business cycle.
Being elastic, the supply of money expands and
contracts alternatively.
Such expansion and contraction of money supply,
when it occurs leads to expansion and contraction of
business activity or to the operation of the business
cycle.
An increase in the supply of money (through
expansion of bank credit) accompanied by an
increase in its velocity of circulation initiates the
period of prosperity
An increased consumer’s outlays cause the
upswing of he business cycle
On the contrary, a decrease in the supply of money
accompanied by a decrease in its velocity of
circulation initiates the period of depression.
A decreased money supply results in decreased
consumer’s cycle.
Criticism
It does not take into account the non-monetary factors
which cause business fluctuations
It is not correct to say that business fluctuations are
caused by the actions of he bank
The theory exaggerates the importance of bank credit as
a means of financing the development and expansion of
business firms.
It is pointed out that a mere contraction of credit through
high interest-rates will not generate depression if the
businessman feel that the marginal efficiency of capital
is high
Schumpeter’s theory of
innovations
According to schumpeter innovations in the structure
of an economy are the source of economic
fluctuations.
By innovation he means the introduction of
something new that changes the existing method of
production.
The innovations may be of two types – (i) greater
waves of innovation (ii) smaller waves of
innovations. The former causes long business cycles,
while the latter leads to short business cycles.
Keynes’s theory of the trade
cycle
Keynes regards the trade cycle as mainly
due to “ a cyclical change in the marginal
efficiency of capital, through complicated
and often aggravated by associated changes
in the other significant short-period
variables of the economic system.”
A rise or an improvement in the MEC by leading
to an increased investment, creates more
employment and output and income in the
economy. It initiates the period of prosperity
which through the working of the multiplier leads
ultimately to the emergence of boom.
A decline or deterioration, on the other hand, in
the MEC, through decreased investment, leads to
unemployment and consequently to the
contraction of income and output. It initiates the
period of depression which through the reverse
working of the multiplier leads ultimately tot the
emergence of slump
Prof. Hicks’ theory of business
cycle
Prof. J,. R Hicks attributes the cyclical
fluctuations to the combined action of the
multiplier and the accelerator.
Control Of the business cycle
Monetary Policy
Fiscal policy
Automatic stabilizers.