CA Foundation Classes Business Cycles

Business Cycles

Meaning

Business

A person’s regular occupation or profession

Cycle

A series of events that are regularly repeated in the same

order

Concept

Rhythmic fluctuations in aggregate economic activity that an economy experiences

over a period of time

Also known as trade cycle

In other words, business cycle refers to alternate expansion and contraction of overall

business activity as manifested in fluctuations in measures of aggregate economic activity,

such as, gross national product, employment and income.

Features

Originate in free market economies

Distinct phases

Occur periodically

Duration varies

Intensity of fluctuations also vary

Contagious & international in character

Occur due to external /internal causes

Difficult to predict

Serious consequences on the well being of the society

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Phases of Business cycles

Trend represents the steady growth line or the growthof the economy when there are no business cycles .

Phases of Business Cycles

Expansion

Characterised by increase in economic activity

Continues till there is full employment of resources &

production at is at its maximum level

Involuntary unemployment=0. Only frictional/structural

unemployment exists.

Prices & Costs tend to rise faster. Net Investments also.

Demand rises

Increasing prosperity & people enjoy high standard of living.

Growth rate eventually slows down & reaches its peak.

Peak

Means TOP

Inputs are difficult to obtain, as their availability is less than requirement and therefore

Input Prices increase.

Output prices rise, leading to increased cost of living.

Consumers begin to review their consumption expenditure.

Actual demand- Stagnates

Peak occurs when economic growth has reached a point where it will stabilise for a

short time, & then move in the reverse direction.

Contraction

Arises since the economy cannot continue to grow endlessly or indefinitely.

Once peak is reached, increase in demand is halted & starts decreasing in certain sectors. There is fall in the levels of investment & employment.

Mismatch between demand & supply

Producers respond by holding back future investment plans.

Decrease in input demand pulls input prices down

Producers lower their prices to dispose off the inventories & to meet their financial obligations.

Consumers expect further decrease in prices & postpone

their purchases

Business firms become pessimistic about the future

state of the economy and there is a fall in profit expectations which induces them to reduce

investments.

Bank credit shrinks as borrowings for investment

declines, investor confidence is at its lowest, stock prices fall and unemployment increases despite fall in wage rates.

The process of recession is complete and the severe

contraction in the economic activities pushes the economy into the phase of depression.

Trough

It is characterised by extremely sluggish economic

activities.

Growth rate becomes negative

Level of National Income & Expenditure declines

Demand decreases, prices are at lowest & decline rapidly.

Forcing firms to shut down

More bankruptcy & closure of firms

Unemployment increases

Fall in interest rate

Despite lower interest rates, the demand for credit declines due to reduction in investor’s

confidence, or possible banking or financial crisis.

Indicators

Meaning

Economists use changes in a variety of activities to measure the business cycle & to predict where the economy is headed

towards. These are called Indicators.

Types

Leading

It is a measurable economic factor that changes before the

economy starts to follow a particular pattern or trend.

It represents Variables that change before the real output

changes, i.e. prior to large economic adjustments.

Not always accurate

Lagging

reflect the economy’s historical performance and changes in

these indicators are observable only after an economic trend

or pattern has already occurred.

In other words, variables that change after the real output changes are called ‘Lagging

indicators’.

If leading indicators signal the onset of business cycles,

lagging indicators confirm these trends.

consist of measures that change after an economy has

entered a period of fluctuation.

Coincident/Concurrent

coincide or occur simultaneously with the

business-cycle movements.

these indicators give information about the rate of change of the expansion or

contraction of an economy more or less at the same point of

time it happens.

Causes of Business Cycle

Internal

Price Fluctuations (Nicholas Kaldor)

Innovations (Schumpeter’s)

Macro-economic policies

Money Supply (Hawtrey)

Psychological factors (Pigou)

Fluctuations in

effective demand (Keynes) Investment Govt. Spending

External

Population

Natural Factors

Technology Shocks

Wars

Post War Reconstruction

International Trade

Other factors

.

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