BUSINESS CYCLE

TRADE CYCLE
 BUSINESS CYCLE
• A Business cycle refers to wavelike fluctuations of
Business activity characterised by recurring phases of
expansion and contraction in periods varying from
three to four years.

• The fluctuations of a rhythmic nature which get

manifested in the form of expansions and contraction
of business activity is commonly called as ‘business
cycle’ or ‘trade cycle.’
• According to Prof. Schumpeter, a trade cycle
represents wave-like derivations in business activity
from the equilibrium or trend line.
 Features of Business Cycle
(1) A Business cycle consists of four phases, namely,
(1) Prosperity (2) Recession (3) Depression (4) Recovery.
(2) Trade cycles follow a regular order.
(3) Trade cycles are all-pervading.
(4) They differ in size but have all the four phases.
(5) They are a wave-like movement.
(6) There is a general consensus of opinion that the trade cycle
takes 7 to10 years to complete itself.
(7) Some trade cycles are small, medium size or big.
(8) The interval is not a precise one but the degree of regularity is
sufficient to demonstrate the periodicity of a trade cycle.
 The 4 phases are :
(1) Prosperity/Boom/Upswing/Peak expansion.
(2) Recession
(3)Depression/Slump/Slack/Trough/downswing
(4) Recovery/Revival.
 (1) Prosperity
1.Prosperity is the most desirable stage of a
business cycle.
2. During it, all the economic activities like
investment, production etc. are in full swing.
3.The atmosphere is full of optimism.
4.The business community expects rise in the
rate of return which Keynes calls as the
‘marginal efficiency of capital’ (MEC)
5.With the rise in the MEC investment increases
giving rise to production, employment and
income.
6.This further increases the demand for goods
and services as a result of which prices
increase. So again the MEC rises. Thus the
economy experiences expansion or the
‘multiplier effect’ in the forward direction.
This is the virtuous circle of prosperity.
7.There is interaction of multiplier and accelerator. They
produce the ‘leverage effect’ or the ‘super-multiplier
effect’.
8. the economy functions almost at the full employment
level. There may be frictional or structural
unemployment but it is short-live.
9.The entrepreneurs are confident and introduce new
schemes of production. Crowd at the stock exchange
increases.
10. People experience a betterment of their living
standards. Demand for comforts and luxuries
increases.
11.But this situation does not last long. Slowly the
demand gets saturated and stocks start piling up. The
second half of prosperity is associated with cost-push
inflation
12.As the economy functions almost at the full
employment level, the entrepreneurs have to revise
the wage rates and other factor rewards to get them.
This increases the cost of production. To cover the
increased costs, prices are raised.
13. There is over-trading. The boom conditions generate
their own checks. Profit margins are first narrowed and
then begin to disappear.
 (2) Recession
• This is a short-lived and temporary phase. The
economy goes at a rapid rate from prosperity
to depression. So it is also called as ‘the lower
turning point’
1.During recession, the prices start falling due to the
excess of supply over demand.
2. Orders get cancelled. The employers retrench the
workers. They stop ordering further equipment and
materials.
3. The bankers insist on repayment. The bottlenecks
appear and the stocks accumulate. The businessmen
lose confidence. Everybody feels pessimistic about the
future profitability of investment. So the investment
falls drastically.
4.Then there is the ‘multiplier effect’ in the reverse
direction.
5.Unemployment increases. Income declines. There is fall
in the level of effective demand.
6.The stock market experiences a downfall. People do not
turn to the stock market and hold cash. The liquidity
preference increases.
7. Bank credit gets contracted. Normally, during recession
banks and other financial institutions do not reach the
stage of bankruptcy. Whether the depression will be
reached by an orderly less trying transition or it will be
accompanied by an explosive financial panic depends
on the nature of previous boom, existing state of mind
of the people and the policies of the bankers.
 (3) Depression :
1.It is also known as slump or trough. Depression is
the most unwanted phase of a trade cycle.
2. Depression can be defined as forces of
depression are self-accumulating. There is
general distress in the economy. depression is
called as crisis- a point of critical convulsions.
Such crisis is the period of utmost suffering for
businessmen. During this phase, the most
deplorable conditions prevail in the economy.
3.Haberler says that, the features of depression
are the reverse of prosperity. The output
contracts, unemployment increases, prices
fall, investment contracts.
4.So we can say that depression and prosperity
differ in degree rather than in kind. The
economy is full of pessimism. The business
community does not see any ray of hope.
5.The overall picture of the economy is gray. The production declines and is
visible throughout the economy, but it is not uniform.
6. Agricultural activity is not much affected in terms of output and
employment. Retail business is little affected. There is substantial
reduction in output in manufacturing, mining and construction. The
industries producing machines, tools etc. are worst affected.
7.There is unemployment amongst the industrial workers leading to fall in
income, and demand for the consumer’s goods. The house holds curtail
their expenditure. They demand only the essential commodities; so
production and employment are little affected in the sector producing
these goods.
8.The declining prices continuously erode the profits. Some firms incur losses
and many are closed down. The volume of production as well as exchange
transactions suffer a substantial reduction. The velocity of circulation of
money falls. Distortions appear in cost-price relations. They worsen the
income distribution and often prolong the period of depression
 (4) Recovery or Revival :
1.The economy recovers when the forces that work
to restore the normal price relations and cost-
price relations start operating effectively. Like
recession, the phase of revival is a passing phase.
It is temporary and is always slow.
2.When the unsold stocks get cleared, the
producers feel like undertaking investment and
production. They see no risk in it. This stage reaches
faster in those fields where production can be
controlled easily.
3.The firms first start using the idle capacity to increase
employment and the income level.
4. Demand for capital goods, to replace the depreciated
equipment also increases. There is correction of
distortions in cost-price relations. The general level of
efficiency rises. Losses are replaced by profits.
5. In the course of depression. The cumulative process
builds up and the phase of prosperity is reached. The
wave of recovery once initiated, begins to feed upon
itself. The cycle at this stage is ready to repeat itself.
 Anti-cyclical Monetary and Fiscal
Policies
• 1) Monetary Measures
• Quantitative or general measures
• (1) Bank rate
• 2) Open market operations
• (3) Variable cash reserve ratio ( V.C.R.R) :
• (b) Qualitative or selective measures
• 2) Fiscal Measures
 Fiscal measures
• So to stabilize the economy these fiscal activities can be
used as the measures. During prosperity, Govt. should
curtail its expenditure and impose more direct taxes. Public
debt should be raised sot that the money in circulation gets
reduced & the effective demand declines.
• During depression the same measures should be adopted
in the opposite direction. That is
• public expenditure should be increased, public debt should
be repaid. The direct taxes decline automatically as the
base which is the income of the people declines. So the
taxes like income tax are called as the ‘built-in-stabilisers’.
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