Unit 6

 Introduction
 Phases of Business Cycles
 Causes of Business Cycles
 Effects of Business Cycles
 Controlling Business Cycles
 Monetary Measures
 Fiscal Measures
 To examine the intricacies of business
cycles, causes of such cycles, and their
effects.
 To comprehend the measures of controlling
business cycles.
 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.
 Phases of Business Cycle
Peak Four phases:
GNP (%) Expansion
G
C D G’ Expansion, B to C
Expansion and From F
Peak, (Boom) C to D
Contraction F
E
Slump Contraction D to E
G
Contraction A B (recession),
Trough Trough (Slump/
Time Unit (years) depression) A to B and
E 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.
 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.
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.
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.
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.
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.
 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.
 The global recession originated in the US—
the richest and the strongest economy of the
world— in the later half of 2008 and spread
to almost all major economies of the world.

 The economic recession in the US was caused

by a financial crisis, widely known as sub-
prime crisis. The financial crisis in the US was
caused by the burst of the housing boom.

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 IMF, WB and UN bodies have given their estimates
of impact of the US economic recession in terms
of:
◦ Decline in global growth rate
◦ Decline in world trade
◦ The global loss of trade

 Countries affected most by the Global Recession

◦ US, UK, Japan, Germany and Euro Area

 The two least affected economies- China and India

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 Most developed and developing economies
affected by the global recession have adopted
economic stimulus schemes.

 The stimulus packages aimed at

i. preventing further failure of banks and
companies and reviving the financial market,
ii. creating job opportunities for jobless, and
iii. generating additional income, with the purpose
of reviving plunging demand.

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 Over-investment theory of business cycle
appears to offer a reasonable explanation to
the global crisis.

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1. Fiscal policy; and
2. Monetary policy.

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Fiscal Policy measures deals with
1. Public expenditure and GDP
2. Taxation and GDP
3. Counter-cyclical fiscal policy: Automatic and
Discretionary changes

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1. Open Market Operations
2. The Bank Rate and Repo Rate
3. The Cash Reserve Ratio (CRR)

And
 Selective Credit Control Measures
 Moral Suasion

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