Business Cycle

DEFINITION
• The business cycle or economic cycle refers to the
fluctuations of economic activity about its long term
growth trend.

• The cycle involves shifts over time between periods of

relatively rapid growth of output (recovery and
prosperity), and periods of relative stagnation or decline
(contraction or recession).

• These fluctuations are often measured using the real gross

domestic product

• Perodic up’s and down’s movement in economic activity

BUSINESS CYCLE CURVE
STAGES OF BUSINESS CYCLE
• Boom :

- Results from too much spending.

- Economy experiences rapid inflation
- Factors of production become expensive

• Recession :

- Results from too little spending.

- GDP is falling
- Demand in the economy will fall leading to
closure of firms and unemployment
Slump :

- High level of unemployment.

- Business will rapidly close down creating serious
consequences for the economy

• Growth/Recovery :

- GDP is rising

- Unemployment is falling
- Business are experiencing rising profits
- ‘Feel good’ factor among the people as
their incomes are rising
 FEATURES OF BUSINESS CYCLE

• PERIODICITY:
 Occurs in 6 to 12 years
 The gap between two cycles is not certain
• SYNCHRONIZATION:
Interdependence of sectors leads to slowdown in
one sector affects the other sector
• SELF ENFORCING:
Most critical features of business cycle
Cyclical movements in one sector spreads to other
sector
TYPES OF BUSINESS CYCLE
• The Short Kitchin Cycle :

It is also known as the minor cycle, which is of approximately 40

months duration

on the basis of on the basis of his research that a major cycle is
composed of two or three minor cycles of 40 months research that a
major cycle is composed of two or three minor cycles in 1923

• The Long Jugler Cycle :

This cycle is also known as the major cycle. It is defined “as the
fluctuation of business activity between successive crises.”

This cycle is also known as the major cycle. It is defined “as the
fluctuation of business activity between successive crises.”
• The Very Long Kondratieff Cycle :

In 1925, N.D. Kondratieff, the Russian economist,

came to the conclusion that there are longer waves of
cycles of more than 50 years duration, made of six Jugler
cycles

A very long cycle has come to be known as the

Kondratieff wave

Kuznets Cycle :

This cycle occurs in the intervel of 7 to 11 years

Post-World War II Recessions
Another Look at Expansions and
Recessions
Changing nature of the Indian
business cycle from 1950 - 2010
• Our focus is to compare India's business cycle in the pre
1991 economy, with the post 1991 Indian economy, after
the large scale liberalization reforms of 1991
COMPARISON OF INDIAN BUSINESS
CYCLE BETWEEN POST REFORM AND
PRE-REFORM
Introduction of trade cycle
• It is a cyclic process
• It refers to ups and downs in the level of
economic activity
• It is a period during which trade expands
then slow down and then expands again
• Time gap between two trough ( or peaks)
will vary between 6 to 12 years
TERMS TO REMEMBER
•
TERMS TO REMEMBER
•
TERMS TO REMEMBER
• Accelerator :

 Changes in demand for consumer goods bring about

wider changes in the production of appropriate capital
goods
Theories of trade cycle/business
cycle
 Climatic or Sunspot theory

 Keynes’ theory

 Hick’s Theory

 Hawtrey’s monetary theory

 Innovation theory

 Over-investment theory

 Over-production theory
Sunspot theory
 Trade cycles are caused by sun spots.

 Sunspots appear on the face of the sun.

 Almost at regular intervals of 10.4 years

SPOT APPEARS

SUN EMITS LESS HEAT

CROP YIELD WILL BE LOW

INCOME OF FARMER FALLS

LESS PURCHASING POWER

Drawback
• Based on only agro based theory
• Good or bad crop can only be one factor of
depression or expansion but they cannot
account for all the features
• The trade cycle occur at regular intervals
of 10.4 years, while length of the trade
cycle is 7 to 8 years
Keynes’ theory
• Deals with fluctuations in income, employment
and money
• concept of Marginal Efficiency of Capital(MEC)

MEC:-
where price of capital=yield from capital

Example: buying of a machinery- how much return

will we get in the coming years
FACTORS
• Rate of investment depends upon

 Rate of interest

 Marginal efficiency of capital

• Entrepreneurial expectations
Pessimistic
Optimistic
 Rate of
investment

Marginal Rate of
efficiency of interest
capital

Supply price
Prospective
of capital
yield
goods

Entrepreneurial
expectations
Keynes’ theory
• Govt expenditure helps the economy to recover
• Growth path cannot continue indefinitely. Excess inventory of
capital goods brings pessimistic feelings in entrepreneurs
who fear recession, which discourages further investment
• Example :
 $100 million dam Project;
 10,000 people employed (increases demand for consumer
goods)
 30,000 people in different sectors gets benefit whose
combined income is say 250 million
 Vice versa also happens
Hick’s Theory
• Occurs due to interaction of multiplier and accelerator

• Super multiplier

• Upswing is the outcome of multiplier and accelerator

• downswing is the outcome of multiplier alone, since

accelerator remains inactive

• Upper turning point is affected by elements like

population, technology, capital stock

• At lower turning point there is increase in net investment,

turning cycle upwards
Hick’s Theory
• Warranted rate of growth : is the one that will sustain itself
in congruity with equilibrium of saving and investment
• Autonomous investment :
Direct response to invention
Long range investment
• Induced investment : Level of income
• Multiplier and Accelerator : Time Lag
Consumption of current year is a function of income of
last year ( ex: buying a car) . With a lag of 1 year
Investment is function of output of same year
HAWTREY’S MONETARY THEORY
• This trade cycle is a purely monetary phenomenon

• It is changes in the flow of monetary demand on the part of

businessmen that lead to prosperity and depression in the
economy

• He opines that non-monetary factors like strikes, floods,

earthquakes, droughts, wars, etc. may at best cause a
partial depression, but not a general depression.
HAWTREY’S MONETARY THEORY
 GROWTH PHASE

• The expanded phase of the trade cycle starts when banks increase
credit facilities.

• They are provided by the reducing the lending rate of interest and by
purchasing securities

• These encourage borrowings on the part of 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 stocks or inventories.

• For this, they place larger orders with producer 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 stocks being exhausted.
HAWTREY’S MONETARY THEORY
• BOOM PHASE

• They place more orders with producers. This leads further increase
in productive activity, in income, outlay, 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 goods so as to earn more
profits.

• Thus optimism encourages borrowing, borrowing increases sales,

and sales raise optimism.
HAWTREY’S MONETARY THEORY
 RECESSION PHASE

• According to Hawtrey, prosperity cannot continue limitlessly. It

comes to an 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 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.
HAWTREY’S MONETARY THEORY
 SLUMP PHASE
• This, in turn, leads to reduction in the demand for factors of
production. There is unemployment. Incomes fall.
• 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 economy is
forced in to 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 banks and funds
increase with banks
Disadvantage
• Trade cycle is not purely monetary phenomenon

• It is world wide phenomenon

Real business cycle
• Business cycle are driven entirely by technology shocks
rather than by monetary or changes in expectations

• If there is an invention, productivity will increase and

business people invest more on that. It leads to boom

• If there is lack of invention, the productivity will decrease

Innovation theory
• Innovation can be of various types

1-new product

2-new market

3-niche market

4-new technology

5-new source of raw material

Innovation theory
• Innovation leads to more production

• Ultimately increase in aggregate demand

• Further increase in income of business

Drawback of innovation theory
The full employment assumption is unrealistic.

Bank is not the only source of finance for every innovation

in business.

Many times the profits are ploughed back to finance

innovations.

Innovation cannot be the sole cause of business cycle.

Over prod. theory
• If economic system is capitalism,all the entrepreneurs
wants to produce goods which are profit making

• Leads to high competition because of entry of new firms

• Profit making possibility : high

• Due to over production activity, initially everything

increases
Cont’d
Thereafter as a result firms starts withdrawing resulting in

 Less demand

 Less income

 Less production

 Less labour
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