Business Cycle

&
Unemployment
Business Cycle:
A business cycle is the characteristic up-down-up
fluctuations in real GDP.
Phases of Business Cycle

GDP
Growth
Trend
 4 Phases of Business Cycle
Phase-1: Expansion/Recovery/Growth
• During this phase economy recovers from the down.
• Economic growth becomes positive from negative.
• Real GDP of the country rises.
• Consumer and Business sentiment rises.
• Consumption and investment demand, general price & employment level also
increases.
Phase-2: Peak
• At this stage the real GDP and GDP growth becomes peak.
• From this point onwards GDP starts falling.
• There is an inflationary pressure in the economy due to higher consumption and
investment demand due to higher sentiment.
• Employment level also at peak.
Phase-3: Contraction/Recession
• During this phase economy downfall starts from the peak
• Real GDP starts decreasing and GDP growth rate becomes negative.
• Both Consumer and business sentiment is low
• Inflation rate is very low due to low demand.
• Unemployment rate rises.
• Many people lost their job
Phase-4: Trough
• At this stage economy reaches at the bottom level.
• There is a deflationary situation in the economy.
• Both consumer and business sentiment is very low.
• Unemployment level is at peak.
• From here economy starts recovering and again phase 1 starts from here.
Turning Points in Business Cycle:
When the economy hits the peak or trough in the business
cycle.
 Recession Vs Depression
Recession: A recession is economic contraction that lasts at least six
months.
 Negative GDP growth at least for 2 consecutive quarter.
Ex: 2008 US recession: Q1 GDP: -2.3%, Q2:2.1%, Q3: -2.1, Q4:-8.4%
Depression: A depression is longer and more severe.
 Negative GDP growth for many years.
EX:  The Great Depression, which lasted from 1929 to 1939
-Global GDP decline: -26% (1929-33)
-Global Unemployment: 24.9%(1933)
-Price Reduced by: 33% (Deflation)
 Business Cycle in India
Year GDP GDP GDP Peak & Trough
(Factor cost) (Manufacturing) (Agriculture)
Period-I (1957-58)
1956-57 5.69 7.51 5.44 Peak
1957-58 -1.21 3.85 -4.49 Trough
1958-59 7.59 4.95 10.08  
Period-II (1965-66)
1964-65 7.58 6.91 9.22 Peak
1965-66 -3.65 0.93 -11.04 Trough
1966-67 1.02 0.79 -1.42  
Period-III (1979-80)
1978-79 5.50 12.35 2.30 Peak
1979-80 -5.20 -3.22 -12.77 Trough
1980-81 7.17 0.19 12.89  
Period-IV (1991-92)
1990-91 5.57 6.05 4.11 Peak
1991-92 1.30 -3.65 -1.55 Trough
1992-93 5.12 4.14 6.79  

Note: This is for your information & not required for exam
Features of Business Cycle:
(a) Aggregate Economic Activity
• Business cycles are a type of fluctuation found in the
aggregate economic activity of nations.
• Fluctuations in the aggregate employment, output, income
and price within an economy
(b) Expansions or contractions occurring at about the
same time in many economic activities
(c) Comovements
• Comovement means that many macro economic
variables move in same direction.
• But at different rates.
(d) Recurrent but not periodic
• Business Cycles are recurrent in the sense that they
happen many times.
• Cycles are not periodic in the sense that they
do not happen for specific times and for specific length
of time.
• It is irregular. Peaks and troughs do not occur at
regular interval.
(e) Persistence
• Initial declines in economic activity tend to be followed
by further declines for some time,
• Initial growth in economic activity tends to be followed
by further growth for some time.
• Reason: Due to interdependence in the economy, cyclical
movements faced by one sector spread to another sector
in the economy and from one economies to another
economies.
• Upswings and downswings are cumulative in their effects
due to spread starts from one industry to other industry.
Can we predict the business cycle?
Ans: Not predictable.
Because:
• Business cycles are Recurrent but not periodic.
• It happens many times in an economy
• It is irregular. The time interval varies from one cases
to another cases.
• Any thing irregular which can’t predictable.
Movement of Variable
1. Pro-Cyclical
2. Counter-Cyclical
3. Acyclical
Pro Cyclical & Counter Cyclical
Pro Cyclical: An economic variable moves along with business
cycle in the same direction.
 Positive co-relation with business cycle.
 Variable that tends to increase in expansion and tend to decrease in a
recession is classified as pro cyclical.
 Variable is at peak during business cycle is at peak
 Variable is at trough during business cycle is at trough
EX: Many stock prices are also pro cyclical because they tend to increase
when the economy is growing and falls when economy down.
EX: Investment, output and price rises when economy grows and falls
when economy contracts.
Counter Cyclical:
 An economic variable that is negatively correlated with the
overall state of the economy is said to be counter cyclical.
 The variable is falling during boom and rising during
recession or depression.
 It moves in opposite direction of Real GDP or business cycle.
Ex: Unemployment rate rises during recession and depression.
EX: Gold price rises during recession bcz investors prefer to
invest in gold when stock market falls.
 The variable is rising when the economy is falling and falling
when the economy is rising.
Acyclical: Moving independent of the overall
state of an economy.
•No relation with business cycle.
Ex: Imports
Leading Variable
Lagging Variable
Coincident Variable
Leading Variable/Indicator:
• A variable is leading when it tends to predict upcoming movements
in real GDP.
• any statistic that is used to predict and understand financial or
economic trends
Ex: Stock Market
When stock market performs well that means investors are expecting
that in future economy will perform well.
EX: New house Starts
If housing starts rise, it means builders are optimistic about the
demand in the near future
Here output or real GDP follows leading variable.
Lagging Variable:
A variable is lagging when it tends to follow recent movements in real GDP
EX: Inflation & unemployment rates are lagging variable
Coincident Variable:
A variable is a coincident variable when it is positively correlated with GDP, but
not leading or lagging
EX: Personal Income
When the economy grows personal economy grows
Pro cyclical, leading lagging example
 Causes of Business Cycle
External(Exogenous) vs Internal(Endogenous)
Internal Causes of Business Cycle:
Factors within the economic activity
1. Bank Credits/Money Supply
It is caused by expansion and contraction in bank credits. Economy
booms due to expansion in credit and downswing starts due to
contraction in bank credits.
2. Monetary & Fiscal policies
The economy booms when there is a tax cut, increase in govt.
spending's and lower interest rate.
On the other hand, if there is an increase in taxes or interest rates
and decrease in govt spending's, we will see a slowdown or
a recession in the economy.
3. Changes in Demand
• When the demand in an economy increases the economy
booms & when demand falls for a longer period economy
enters into recession.
4. Fluctuations in Investments
• The investments will fluctuate on the basis of a lot of factors
such as the rate of interest in the economy, entrepreneurial
interest, profit expectation, etc.
• An increase in investment will lead to an increase in economic
activities and cause expansion. A decrease in investment will
have the opposite effect and may cause a trough or even
depression.
5. Exchange Rate fluctuations
Economy booms during exchange rate depreciates &
economy falls due to exchange appreciates.
When exchange rate depreciates export increases and
import decreases. Due to higher export demand
employment, output and income increases. Economy
booms.
When exchange rate appreciates, export decreases &
import increases. Due to lower export demand
employment, output and income decreases. Economy
contracts
External Causes of Business Cycle:
Factors outside the economic activities
1.Natural calamities
2.War
During war economy focuses more on war and war equipment's. The focus shifts from consumer products and
capital goods. This will lead to a fall in income, employment, and economic activity. So the economy will face a
downturn during war times. And later post-war the focus will be on rebuilding. Infrastructure needs to be
reconstructed (houses, roads, bridges, etc). This will help the economy pick up again.
3. Revolutions
4. Political events
Politicians will pursue popular expansionary monetary and fiscal policies immediately before an election.
Economy booms. after the election is over, politicians will often reverse course, which may include cutting
spending, slowing the growth of money supply, and allowing interest rates to rise. Economy falls.
5. Migration
6. Changes in technology
Some exciting and new technology is always a boost to the economy.
Economic Stability:
 Economic stability means the economy shows no wide
fluctuations in key economic indicators, such as Real GDP,
unemployment or inflation.
 A stable economy demonstrates steady, manageable growth in
GDP and employment.
 Manageable growth means the economy grows at a sustained
rate that does not spark inflationary pressures, result in higher
prices and negatively affect corporate profits.
Policies for Economic Stability:
When sharp swings in GDP, unemployment, inflation
and other measures point to unstable conditions,
governments often respond with fiscal and monetary
policy measures
Fiscal Policy for Economic Stability
 Fiscal policy usually involves changes in taxation and spending policies.
During Recession/Contraction
 When GDP and employment declines, governments may Lower taxes and increase their
spending's.
 Lower taxes mean more disposable income for consumers and more cash for businesses
to invest. AD rises and economy recovers.
 Stimulus-spending programs, which are short-term in nature and often involve
infrastructure projects, can also help drive business demand by creating short-term jobs.
During expansion & Boom Period
 During expansion and boom time, the economy is unstable due to higher demand and
inflation.
 To control inflation, Govt. may increase taxes and reduce their spending.
 Increasing income taxes usually mean less disposable income for consumers and less
demand in the economy as a result price also decreases.
Monetary Policy for Economic Stability:
Monetary policy usually involves in adjustment of interest rates and liquidity in
the banking system.
During Recession/Contraction
 When economy declines, central banks lower the interest rates for ease
access to credit for businesses and individuals.
During Expansion/Boom
 There is inflationary pressure in the economy when the economy booms.
 To check the inflationary pressure in the economy, central banks may
increase the interest rates as a result money supply, demand and price
decreases in the economy.
Unemployment
Unemployment Rate (4.2% Nov 21)
Unemployment rate is the number of people who are
unemployed as a percentage of total labour force or total
work force.

Unemployment Rate x 100

 Unemployment rate was very high during lockdown (26.1 %

in April, 2020)
 Types of Unemployment
• Frictional unemployment
• Structural unemployment
• Cyclical unemployment
• Seasonal unemployment
• Disguised Unemployment
• Voluntary Unemployment
• Natural Unemployment
Frictional Unemployment:
When a person does not have a job due the process of moving one
job to another. Further more it could also be the time period which a
person is searching for a job.
• Also called Search unemployment
Ex: A person left the present job to find a better opportunity.
Ex: A person fired and looking for another
Ex: University graduates who are searching for the job after completion of the
degree.
Structural Unemployment:
• Structural unemployment is a form of involuntary
unemployment caused by a mismatch between the skills
that workers in the economy can offer, and the skills
demanded of workers by employers.
• Structural unemployment is often brought about by
technological changes that make the job skills of many
workers obsolete.
• Structural unemployment is due to lack of skills.
EX: Some workers are fired because they do not know how to use some new technology
adopted by company.
Cyclical Unemployment:
 Unemployment problem due to business cycle.
 Due to up and down in the economy.
EX: During recession period many people lost there job.
Ex: Due to COVID-19 world wide many lost the job.
India’s unemployment rate rose to 26.1% during lockdown.
Seasonal Unemployment:
 Unemployed during a particular period of time in a year.
 Particular season in the year they are employed and remaining period
unemployed.
EX: In agriculture farmers are unemployed after crop.
Ex: Ice cream sellers are unemployed during winter.
Disguised Unemployment:
 Disguised unemployment exists where part of the labour force is either left
without work or is working in a redundant manner where the productivity
is zero.
 That does not affect the aggregate out put.
 Marginal productivity of the labour is zero.
EX: In rural areas, where agriculture is the main source of income, this kind
of unemployment can be seen often. If a piece of land requires only three people to
work on it and instead five members from the family are working on it, then the two
extra people are said to be in a situation of disguised unemployment.
Voluntary Unemployment:
• It is a situation when a person is unemployed because of not being
able to find employment of his/her own choice.
• It is a situation the person is not unemployed due to unavailability
of job in the economy but not finding a job in his/her choice.
Ex: who rejects a position for looking for better payment.
Natural Rate of unemployment
• It is the minimum level of unemployment when the
economy is functioning well and healthy.
• It is also considered as full-employment level or potential
level of employment.
• Natural unemployment refers to the unemployment that
exists when the labor market is in perfect equilibrium.
 Causes of Unemployment
 Slow growth of industrialization
 Low foreign investment
 Agriculture is a Seasonal Occupation
 Slow economic growth
 Fall of cottage and small industries
 Lack of infrastructure
 Immobility of labour
 Lack of irrigation facilities
Impacts of Unemployment
 GDP decreasing
 Rise in Govt. burden for unemployment allowances & eradication programme
 Rising poverty
 Rising govt. borrowings and deficits.
 Standard of living decreasing
 Rising Crime rates
 Political tension
Okun's Law:
Okun’s Law states the relationship between a country’s
unemployment rate and Loss of GDP growth.
 Inverse relationship between GDP growth &
unemployment rate.
 Every 1% rise in unemployment rate leads to 2% lower
of GDP growth.
 To reduce 1% unemployment rate, Country’s GDP growth
needs to increase by 2% more than its potential growth.
 This law is based on empirical results of 13 countries data.
 Okun’s Law
2% rise in GDP growth leads 1% fall in unemployment
Real Business Cycle Theory:
 Up and down in the economy due to Real shocks in
economy
 Which are un predictable & un expected
 EX: Natural calamities, War, Technological changes,
Production innovations etc.