Chapter no: 04

TRADE CYCLES By Mrs Paras Channar

LECTURE OBJECTIVES
 Phases of the Business Cycle
 Modern Theories of Business cycle
 Causes of Trade Cycle
 Control of Trade Cycle
TRADE CYCLE
The alternating periods of expansion and contraction in the economic activity has
been called business cycles or trade cycles.
In the words of J.M. Keynes
“A trade cycle is composed of periods of good trade characterized by rising prices
and low unemployment percentages, alternating with periods of bad trade
characterized by falling prices and high unemployment percentage.”
PHASES OF TRADE CYCLE
PHASES OF TRADE CYCLE
Business Cycle (or Trade Cycle) is divided into the following four phases :-
Prosperity Phase : Expansion or Boom or Upswing of economy.
Recession Phase : from prosperity to recession (upper turning point).
Depression Phase : Contraction or Downswing of economy.
Recovery Phase : from depression to prosperity (lower turning Point).
PROSPERITY PHASE
When there is an expansion of output, income, employment, prices and profits, there is also
a rise in the standard of living. This period is termed as Prosperity phase.
The features of prosperity are :-
High level of output and trade.
High level of effective demand.
High level of income and employment.
Rising interest rates.
Inflation.
Large expansion of bank credit.
Overall business optimism.
A high level of MEC (Marginal efficiency of capital) and investment.
PROSPERITY PHASE
Due to full employment of resources, the level of production is Maximum and there
is a rise in GNP (Gross National Product). Due to a high level ofeconomic activity, it
causes a rise in prices and profits. There is an upswing in the economic activity and
economy reaches its Peak. This is also called as aBoom Period.
RECESSION PHASE
The turning point from prosperity to depression is termed as Recession Phase.
During a recession period, the economic activities slow down. When demand starts
falling, the overproduction and future investment plans are also given up. There is a
steady decline in the output, income, employment, prices and profits. The
businessmen lose confidence and become pessimistic (Negative). It reduces
investment. The banks and the people try to get greater liquidity, so credit also
contracts. Expansion of business stops, stock market falls. Orders are cancelled and
people start losing their jobs. The increase in unemployment causes a sharp decline
in income and aggregate demand. Generally, recession lasts for a short period.
DEPRESSION PHASE
When there is a continuous decrease of output, income, employment, prices and profits, there is a fall
in the standard of living and depression sets in.
The features of depression are :-
Fall in volume of output and trade.
Fall in income and rise in unemployment.
Decline in consumption and demand.
Fall in interest rate.
Deflation.
Contraction of bank credit.
Overall business pessimism.
Fall in MEC (Marginal efficiency of capital) and investment.
In depression, there is under-utilization of resources and fall in GNP (Gross National Product). The
aggregate economic activity is at the lowest, causing a decline in prices and profits until the economy
reaches its Trough (low point).
RECOVERY PHASE
The turning point from depression to expansion is termed as Recovery or
Revival Phase.
During the period of revival or recovery, there are expansions and rise in economic
activities. When demand starts rising, production increases and this causes an
increase in investment. There is a steady rise in output, income, employment, prices
and profits. The businessmen gain confidence and become optimistic (Positive). This
increases investments. The stimulation of investment brings about the revival or
recovery of the economy. The banks expand credit, business expansion takes place
and stock markets are activated. There is an increase in employment, production,
income and aggregate demand, prices and profits start rising, and business expands.
Revival slowly emerges into prosperity, and the business cycle is repeated.
FEATURES OF TRADE CYCLE
Movement in Economic Activity : A trade cycle is a wave-like movement in
economic activity showing an upward trend and a downward trend in the economy.
Periodical : Trade cycles occur periodically but they do not show the same
regularity.
Different Phases : Trade cycles have different phases such as Prosperity, Recession,
Depression and Recovery.
Different Types : There are minor and major trade cycles. Minor trade cycles
operate for 3-4 years, while major trade cycles operate for 4-8 years or more.
Though trade cycles differ in timing, they have a common pattern of sequential
phases.
FEATURES OF TRADE CYCLE
Duration : The duration of trade cycles may vary from a minimum of 2 years to a
maximum of 12 years.
Dynamic : Business cycles cause changes in all sectors of the economy. Fluctuations
occur not only in production and income but also in other variables like employment,
investment, consumption, rate of interest, price level, etc.
Phases are Cumulative : Expansion and contraction in a trade cycle are cumulative, in
effect, i.e. increasing or decreasing progressively.
Uncertainty to businessmen : There is uncertainty in the economy, especially for the
businessmen as profits fluctuate more than any other type of income.
International Nature : Trade Cycles are international in character. For e.g. Great
Depression of 1930s.
TYPES OF TRADE CYCLE
Dynamic forces operating in a capitalist economy create various kinds of economic
fluctuations. These fluctuations can be classified as follows :-
Short-Time Cycle : This trade cycle occur for a short period of time. It is also
known as minor cycles. It lasts for about 3-4 years.
Secular Trends : This trade cycle occurs for a long period of time and is known as
Long term cycle. It lasts for about 4-8 years or more. It is also known as major cycle.
Seasonal Fluctuations : This refers to trade cycles, which take place due to seasonal
changes in the economy. For e.g. failure of monsoon can cause a downtrend in the
economy which may be followed by a good monsoon and up to trend.
TYPES OF TRADE CYCLE
Irregular or Random Fluctuations : These trade cycles are unpredictable and occur
during a period of strikes, war, etc., causing a shock to the economic system.
Cyclic Fluctuation : These fluctuations are wave-like changes in economic activity
caused by recurring phases of expansion and contraction. There is an upswing from a
trough (low point) to peak and downswing from the peak to trough caused due to
economic changes in demand, or supply or various other factors.
CAUSES OF TRADE CYCLE
external internal
 War  Psychological Factors
 Post war period  Money supply
 Scientific breakthrough  Over investment
 Gold discoveries
 Marginal efficiency of
 Growth of population
capital
 Government policies
 Aggregate market
 Surplus exports and foreign
aid
 Weather
 Political cycle
CONTROL OF TRADE CYCLES
1. Fiscal Measures: During the period of boom, decrease in public
expenditures, increase in taxes and increase in public debt. On the other hand, during
the period of depression, the policy of increase in public expenditures, decrease in
taxes.
2. Monetary Measures: Monetary measures mean that control of money and credit
supply in the country. When we are facing boom or inflation, the central bank
reduces the total quantity of money in circulation. The bank can adopt different
measures like bank rate policy, open market operations and rationing of credit etc. 
On the other hand, incase of depression, the central bank can increase the quantity of
money by lowering the bank rate or purchasing the securities
and discounted the bills of exchange.nd decrease in public debt is adopted by the
government.
CONTROL OF TRADE CYCLES
3. International measures: Today every country has trade relation with other countries. If
there is inflation or deflation in one country, it can be easily be carried top other countries,
the example of great depression can be given. Business cycle is an international
phenomena and it should be tackled on international level. Different measures have been
suggested by theeconomists to control the business fluctuations effectively. Such as: 
(a). Control of international production.
(b). International bill stock control and international investment control.

4. State control of private investment: If the govt. controls the private

investment, cyclical fluctuations can be controlled within limits while the
other economists who this agree with the above view, they say that private investment will
be discouraged. But J.M. Keynes says that if we adopt the middle way we can control the
fluctuations.
THEORIES OF TRADE CYCLE
1. PURE MONETARY THEORY:
The monetary theory states that the business cycle is a result of changes in monetary
and credit market conditions. Hawtrey, the main supporter of this theory, advocated
that business cycles are the continuous phases of inflation and deflation. According
to him, changes in an economy take place due to changes in the flow of money.
For example, when there is increase in money supply, there would be increase in
prices, profits, and total output. This results in the growth of an economy. On the
other hand, a fall in money supply would result in decrease in prices, profit, and total
output, which would lead to decline of an economy.
When an organization increases its production, the supply of its products also
increases to a certain limit. After that, the rate of increase in demand of products in
market is higher than the rate of increase in supply. Consequently, the prices of
products increases. Therefore, credit expansion helps in expansion of economy. On
the contrary, the economic condition is reversed when the bank starts withdrawing
credit from market or stop lending money.
2. MONETARY OVER-
INVESTMENT THEORY:
Monetary over-investment theory focuses mainly on the imbalance between actual and desired
investments. According to this theory, the actual investment is much higher than the desired
investment. This theory was given by Hayek.
In an economy, generally, the total investment is distributed among industries in such a way that
each industry produces products to a limit, so that its demand and supply are equal. This implies
that the investment at every level and for every product in the whole economy is equal. As a result,
there would be no expansion and contraction and the economy would always be in equilibrium.
According to this theory, changes in economic conditions would occur only when the money
supply and investment-saving relations show fluctuations. The investment-saving relations are
affected when there is an increase in investment opportunities and voluntary savings are constant.
Investment opportunities increase due to several reasons, such as low interest rates, increased
marginal efficiency of capital, and increase in expectations of businessmen. Apart from this, when
banks start supporting industries for investment by lending money at lower rates, it results in an
increase in investment.
This may result in the condition of over­investment mainly in capital good industries
3. SCHUMPETER’S THEORY
OF INNOVATION:
The other theories of business cycles lay emphasis on investment and monetary
expansion. The Schumpeter’s theory of innovation advocates that business
innovations are responsible for rapid changes in investment and business
fluctuations.
According to Schumpeter, innovation refers to an application of a new technique of
production or new machinery or a new concept to reduce cost and increase profit. In
addition, he propounded that innovations are responsible for the occurrence of
business cycles. He also designed a model having two stages, namely, first
approximation and second approximation.
4. KEYNES THEORY
Keynes theory was developed in 1930s, which was the period when whole world
was going through great depression. This theory is the reply of Keynes to classical
economists. According to classical economists, if there is high unemployment
condition in an economy, then economic forces, such as demand and supply, would
act in a manner to bring back full employment condition.
In his theory of business cycles, Keynes advocated that the total demand helps in the
determination of various economic factors, such as income, employment, and output.
The total demand refers to the demand of consumer and capital goods.
5. SAMUELSON’S MODEL OF
MULTIPLIER ACCELERATOR
INTERACTION:
The economists of post-Keynesian period emphasized the need of both multiplier and
accelerator concepts to explain business cycles. Samuelson’s model of multiplier
accelerator interaction was the first model that represents interaction between these two
concepts.
In his model, Samuelson has described the way the multiplier and accelerator interact with
each other for generating income and increasing consumption and demand of investment.
He also describes how these two factors are responsible for creating economic fluctuations.
Multiplier and accelerator theory: that explains the emergence of different phases of
business cycle. The multiplier tell us that the change in the level of autonomous investment
bring about relatively greater change in the level of national income. The accelerator theory
state that the current investment spending depend positively on the expected future growth
of real GDP.
INTERACTION BETWEEN
MULTIPLIER AND
ACCELERATION
Increase in Aggregate
Increase in Increase in induce demand in
autonomous income through investment income increase
investment multiplier through by an even larger
accelerator amount
“The End”