Trade Cycle

Definition
• “Business Cycles are a type of fluctuation found in the aggregate
economic activity of nations that organises their work mainly in
business enterprises. A cycle consists of expansion occurring at about
the same time in many economic activities followed by similar general
recession, contractions and revival which merge with expansion phase
of the next cycle, this sequence of changes is recurrent but not
periodic”
• The rhythmic fluctuations taking place in an economy, at intervals in
the form of boom and depressions are called trade or business cycles
Business Cycle
 Shows the periodic up and down movements in
economic activities.
 Economic activities measured in terms of production,
employment and income move in a cyclical manner
over a period of time.
 Cyclical movement is characterized by alternative
waves of expansion and contraction.
 Associated with alternate periods of prosperity and
depression.
Characteristics of Business Cycles
 Periodicity
 Wavelike movements in income and employment occur at intervals of
6 to 12 years.
 Gap between two cycles is not regular or predictable with certainty.
 Synchronism
 Impact is all embracing, i.e. large sections of the economy experience
the same phase.
 Happens because of interdependence of various sectors of the
economy.
 Self Reinforcing
 Due to interdependence in the economy, cyclical movements faced by
one sector spread to other sectors in the economy; and from one
economy to other economies.
 Thus the upward swing of the cycle is reinforced for further upward
movement and vice versa.
Types of Trade Cycles
• Minor Cycles: 2-5 years
• Major Cycles: 8 -12 years
• Very Long cycles: 50 to 60 years
Phases of Business Cycles
• Expansion
• Recession
• Depression or Trough or Contraction
• Recovery
 Phases of Business Cycle
Peak Four phases:
GNP G
Expansion
C D G’ Expansion, B to C and
(%)
From F
Expansion
Peak, (Boom) C to D
Contraction
E F Contraction D to E
G Slump
(recession),
Contraction A B
Trough Trough (Slump/
Time Unit depression) A to B and E
(years) to F

• Time gap between two bouts of trough (from B to E) or peaks (from

D to G) can vary between 6 to 12 years.
• For 3 to 5 years, the economy experiences growth, then for another
3 to 5 years, it faces contraction or recession.
• GG’ is the steady growth line, to show that the general trend is that
of growth.
Phases of Business Cycle
Contd.

 Expansion: when all macro economic variables like output,

employment, income and consumption increase.
 Prices move up, money supply increases, self reinforcing feature of
business cycle pushes the economy upward.
 Peak: the highest point of growth; referred to as boom.
 Stage beyond which no further expansion is possible,
 Sees the downward turning point.
 Contraction: means the slowing down process of all economic
activities.
 Trough: the lowest ebb of economic cycle.
 Followed by the next turning point in the cycle, when new growth
process starts afresh.
 Features Expansion or BOOM Recession Depression Recovery
Employment Increases Suddenly falls Very Low Slowly Rises
Output Increases Falls Falls very low Slowly Rises
Prices Rise Fall sharply Falls very low Begin to rise
Bank Credit Expands Suddenly falls Falls low Begins to expand
Wages Rise Falls Falls very low Begin to rise
Stocks Rise Fall Falls very low Begin to rise
Feelings Optimism Doubt and Fear Pessimism Optimism
Causes of Business Cycles
Explanations given to explain economic cycles:
 Climatic changes such as sunspots that may cause different
moods.
 Psychological aspects of entrepreneurs and consumers, such as
moods of optimism and pessimism.
 Monetary phenomenon like changes in money supply, rate of
interest, etc.
 Economic factors, such as over investment, under consumption
and over savings.
 Shocks in the conditions under which producers supply goods
such as technological breakthroughs.
Effects of Business Cycles
During Expansion
 High growth: large investments, increase in employment, income and
expenditure
 Inflation: Increase in investment forces more money supply in the system,
demand for factor inputs increases, hence their prices increase which
increases cost of production. So wages and prices of goods also increase.
 Severe Competition: Firms resort to large amount of non productive
expenditure on advertisements and publicity.
During Recession
 Unemployment, excessive inventory, below capacity operations and
liquidation of firms.
 Excess inventory: Those firms which had produced in abundance during
expansion phase face the problem of maintaining unsold items.
 Retrenchment: in order to reduce investment, recession phase is marked by
large scale retrenchment.
Controlling Business Cycles
At Firm Level
 Precautionary Measures: to be taken at the time of
expansion
 Investments: deter from investing huge amount of funds in fixed
assets.
 Inventory: should not create large inventory of raw material or
finished goods.
 Products: diversify in different markets and different products, so
that risk is diversified.
 Curative Measures: to be taken at the time of recession
 Pricing: Flexibility should be the right strategy, so that during
recession prices may be adjusted to increase demand without eating
away the margins.
Controlling Business Cycles
At Government Level
 Monetary Measures: Central bank uses methods of credit control.
 Rediscount rate:
 Expansion: increase the rediscount rate to curb money supply
 Recession: reduce the rate to increase money supply.
 Reserve ratios:
 Expansion: the ratios are increased so that banks are left with less cash to
be extended as credit
 Recession: the ratios are decreased so that banks can extend easy credit.
 Two major reserve ratios are SLR and CRR
 Open market operations:
 Expansion: sells securities and takes away disposable income from people.
 Recession: buys securities to give more in the hands of people
 Selective credit control:
 Banks are advised to extend credit to certain areas, while restrict to certain
other areas.
Controlling Business Cycles
Contd.
 Fiscal Measures
 Public expenditure
 Expansion: Government reduces expenditure to curtail demand
 Recession: Government increases expenditure on various activities
like health, transport, communication, etc., thus income of
individuals increases; this in turn increases aggregate demand.
 Public revenue
 Expansion: An increase in taxes takes away portion of people’s
money income and thus brings down aggregate demand.
 Recession: It is desirable that governments reduce taxes.
 An appropriate combination of these measures is adopted after
thorough examination of the causes of business cycles.
Questions
• It is a well-known fact that modern economies are characterized by
business cycles. Does this mean that its very easy for firms to decide
whether to expand or not, since entrepreneurs can easily forecast
future growth?
• Why might the unemployment rate continue to rise during the early
stages of expansion?