Professional Documents
Culture Documents
Monetary
Fiscal
Direct Controls
Demand Pull Inflation
S s
P3
P2 P2
Price Level
d4
P1 P1
D2
s d3
D1
P d d2
D d1
M m m1 m3 m4 Output
Output
Cost Push Inflation
S
E1
P1
E
Price Level
S1
D
S
M1 M Output
INFLATIONARY GAP
Y=C+I+G
C’+I’+G’
EXPENDITURE
E1
C+I+G
E0 G
O Yo Y1
INCOME
Inflationary and Deflationary Gaps AS or
Inflationary Y=C+I+G
Inflationary gap occurs when AD gap
EXPENDITURE
exceeds AS at full employment
level of output. In this case, money AD or
(C+I+G)
rises to a higher equilibrium, but E C+I+G
real income being at full employment A
output level remains unchanged. As a
result there is an upward rise in prices
because the consumers compete for B
limited supply of output and bid prices Income (Y)
up. O Yf YO
AS or
Deflationary Y=C+I+G
EXPENDITURE gap B
Deflationary gap prevails when AD is
(C+I+G)
Income (Y)
O
YO Yf
Causes of Deflation
W3
Wage Inflation W2
W1
U
U3 U2 U1 U0 w
Wage Inflation
Rate
OUTPUT INSTABILITY
(BUSINESS CYCLES)
• J.M.Keynes says, “ A trade cycle is composed of periods of
good trade characterized by rising prices and low
unemployment percentages with periods of bad trade
characterized by falling prices and high unemployment
percentages.”
• Thus the period of high income, output and employment has
been called the period of expansion, recession, downswing or
depression. These alternating periods of expansion and
contraction in economic activity has been called as business
cycles.
Level of GNP
Ex
p an s
io n
Contr
ction a
Peak
Exp
an s io n
Depression
Contract
n io
Peak
Expa
n sion
C ont r
action
Peak
Ex
TIME
pan
sio
n
Contr
ction a
Peak
Exp
a
(BUSINESS CYCLES)
n si o
C on t r n
action
Peak
Depression
Exp
a ns io n
Contr
ction a
Peak
Phases of Business Cycles
Business Cycles has different phases.
2. Recession
3. Depression
4. Recovery Phase
Prosperity
According to Haberler the characteristic features of Prosperity are-
(i) A high level of output and trade
(ii) A high level of effective demand
(iii) A high level of employment and income
(iv) A high marginal efficiency of capital
(v) A price inflation
(vi) A rising structure of interest rate
(vii) A large expansion of bank credit
(viii) Overall business optimism
(ix) Tendency of the economy to operate at almost full capacity
along its production possibility frontier
Recession
• When prosperity ends, recession begins
• Recession relates to a turning point rather than a phase
• It lasts relatively for a shorter period of time
• Forces of contraction wins over the forces of expansion
• Liquidation in the stock market, repayment of bank loans
• Businessmen lose confidence
• Pessimistic wave prevails and industrial growth rate falls
• Banking run for liquidity
• Business orders are cancelled and workers are laid off
• There is decline in aggregate demand, in turn prices, profit and
business decline
Depression
According to Haberler the characteristic of Depression are-
1. Shrinkage in the volume of output, trade and transactions
2. Rise in the level of unemployment
3. Rise deflation
4. Fall in the aggregate income of the community
5. Fall in the structure of interest rates
6. Curtailment in consumption expenditure and reduction in the
level of effective demand
7. Collapse of the MEC and decline in the investment demand
function
8. Contraction of bank credit
Important Business Cycle Theories
1. Purely Monetary Theory-R.G.Hawtrey
2. Monetary Over-investment Theory-F.A.Hayek
3. Non-monetary Over-investment Theory (real capital/investment goods
rather than money)
4. Under-consumption theory ( or Over-Saving Theory)
5. Psychological theory-J.S.Mill & Pigou (Over optimism and Over
pessimism in the business community)
6. Innovation theory-J.A.Schumpeter (Introduction of new type of goods, new
methods of production, opening of new markets, new raw material source)
7. Keynes’s MEC theory
8. Hicks’s theory-Multiplier and Accleration Principle ( The acceleration
theory shows how the demand for capital goods changes as a result of
changes in the demand for consumption goods.
Anti Cyclical Policies
MONETARY
FISCAL
EXIM POLICY-DEVALUATION/APPRECIATION