BUSINESS CYCLE.
Definitions.Features.Types of Business Cycles .Hayek's Over Investment Theory Of Trade Cycle.Monetarist Interpretation of Trade Cycle.MONETARY POLICY.INSTRUMENTS OF MONETARY POLICY.LIMITATIONS OF MONETARY POLICY.FISCAL POLICY AND STABILISATION OF ECONOMIC ACTIVITIES.FISCAL POLICY A...
MACROECONOMIC INSTABILITY AND POLICY
BUSINESS CYCLE
Business cycles or trade cycles are recurrent fluctuations in economic activity that occur
around the secular trend of GNP over a period of several years. Business cycle is an important
feature of a capitalist economy.
Definitions
Samuelson and Nordhaus "A business cycle is a swing in total national output, income, and
employment, usually lasting for a period of 2 to 10 years, marked by a widespread expansion
or contraction in most sectors of the economy"
Keynes, "a trade cycle is composed of periods of good trade characterised by rising prices and
low unemployment, altering with periods of bad trade characterised by falling prices and high
unemployment ".
Benham"A trade cycle may be defined, as a period of prosperity followed by a period of
depression. It is not surprising that economic process should be irregular, as trade being good
at sometime and bad at others".
In short, business cycle refers to a period of high growth and prosperity in the economy
followed by a period of sharp economic slowdown and depression.
During the period of prosperity, there is a high growth rate of national output above the
potential growth rate.
During the period of depression, growth rate of national income turns to be negative; business
activities decline sharply, rate of employment declines, and price level goes down resulting in
deflation. So a regular periodic recurrence of growth and recession makes the business cycle.
Features
A trade cycle has certain important characteristics.
1. The economy as a whole is affected by a trade cycle because all the industries are
interrelated in terms of inputs and outputs.
2. A trade cycle exhibits a wave-like movement and different trade cycles resemble one
another.
3. The extent to which industries affected differs from one to other.
4. A trade cycle is international in character. Booms and depressions in one country spread
to others in due course of time.
5. Profits fluctuate by a much larger percentage than other types of income.
6. Prices and production generally rise or fall together.
Causes of Business Cycles
(i) Psychological factors or future expectations: Business cycles appears in the economy due
to the optimistic and pessimistic behaviour of the entrepreneurs.
, macroeconomic instability and policy-2
If the entrepreneurs are optimistic about future market conditions they undertake more and
more investments and the economy leadsto boom.
Pessimism about profits in future results in contraction of business activities, reduces
investment, production, employment, etc., which initiate recession in economy.
(ii) Money and credit supply: Trade cycle occurs mainly due to the changes in the money and
credit supply in the economy.
An increase in the money supply causes expansion in aggregate demand and economic
activities. On the other hand decrease in the supply of money initiates recession in economy.
(iii) Marginal Efficiency of Capital (MEC): Keynes opined that changes in the rate of
marginal efficiency of capital is one of the main causes of business cycles in every economy.
If the rate of MEC is higher, it is profitable for the businessmen to undertake more
investments, and the expansionary phase of the business cycle commences and if the rate is
low the contractionary phase of the cycle starts.
(iv) Interest rate: If the monetary authorities reduce interest rate, it leads to a fall in the cost
of borrowing. As a result more investments take place in the economy.
New investment projects creates more employment opportunities, which leads to increase in
income in the hands of the people which in turn increases consumer spending. The opposite
will happen if the interest rate is raised.
(v) Multiplier effect: The multiplier effect states that a fall in injections into the economy may
cause a bigger final fall in real GDP. For example, if thegovernment cut public investment,
there would be fall in aggregate demand and a rise in unemployment.
(vi) Accelerator effect: This states that investment depends on the rate of change of economic
growth. If the growth rate falls, firms reduce investment because they don't expect output to
rise as quickly.
(vii) Natural factors: Trade cycles may take place due to certain natural reasons. During the
period of heavy rain falls agricultural productivity is badly affected. It causes shortage of raw
materials to agrarian based industries. Which leads to a fall in industrial production.
On the other hand better weather conditions leads to an increase in agricultural activities
which pushes the entire economy towards an upswing.
(viii) Wars; During war, economic activities slow down resulting in recession whereas after
the war more investment is encouraged due to more demand in the economy.
(ix) Political factors: In developing countries governments change frequently. The new
government formulates new policies and abandons the policies of previous governments. This
creates uncertainty in the economy and causes business activities to slow down.
(x) Population explosion: When population increases at higher rate than increase in national
output, unemployment becomes a severe problem. Such a situation usually brings about
recession in economy.
(xi) International factors: All the countries of the world are economically interdependent.
Any economic fluctuations in big economies affect the economies of the rest of the world.
, macroeconomic instability and policy-3
(xii) Economic policies: If businessmen found that Government's economic policies are
against their business interests, they may transfer their capital toother countries. Due to these
unemployment increases in the economy and business activities fall causing recession.
Types of Business Cycles
There are four main types of business cycles
1. Kitchin Cycle was invented by the British economist Joseph Kitchin in 1923. He made a
distinction between a minor cycle and a major cycle. The minor cycle is of approximately 40
months duration. The major cycle is composed of two to three minor cycles.
2. Juglar Cycle was identified by the French economist Clement Juglar. Recovery and
prosperity are associated with increases in productivity, consumer confidence, aggregate
demand and prices.
The growth periods of the cycles usually ended with the failure of speculative investments
built on a bubble of confidence that bursts. The periods of contraction reflect the exit of
unsuccessful enterprises. Because resources are transferred by market forces from less
productive uses to more productive uses. The duration of the cycle is 7 to 11 years.
3. Kuznets Cycle This cycle was identified by the American economist Simon Kuznets in
1930. The duration is 15 to 25 years. Kuznets connected these cycles with the construction
intensity caused by immigrant inflows/outflows. That is why the cycles were termed as
'building cycles'.
4. Kondratieff Cycle was identified by the Russian economist Nikolai Kondratieff in 1925.
His study was based on prices, inflation and interest rates. Kondratieff cycle affects all the
sectors of an economy and concerns mainly output rather than prices. It is more visible in
international production data than in individual national economies. Kondratieff identified
three phases in the cycle: expansion, stagnation and recession. The duration of the cycle is 45
to 60 years.
According to some writers, the Kondratieff cycle is composed of four seasons, Kondratieff
Spring (improvement or plateau) Summer (acceleration or prosperity) of the ascendant period
Kondratieff Fall (recession or plateau) Winter (acceleration or depression) of the downward
period.
Phases of a Business Cycle
A business cycle is composed of four phases.
1) Prosperity or expansion or upswing
2) Recession
3) Depression or contraction or downswing and
4) Recovery or revival.
Peaks (Booms) are upper turning points where the cycle reaches the top of expansion.
Troughs are the lower turning points where the cycle reaches the bottom of its contraction.
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