Business Cycles/ Trade Cycles

Definition


The recurrent ups & downs in the level of economic activity in an economy

Definition by Burns & Mitchell

Business Cycles are a type of fluctuations found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions & revivals which merge with the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic; in duration business cycles vary from more than one to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximating their own
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Definition by Keynes


A trade cycle is composed of periods of good trade characterized by rising prices 7 low unemployment percentages altering with periods of bad trade characterized by falling prices & high unemployment percentages

Definition by Schumpeter


A business cycle represents wave like fluctuations in the level of business activity about the equilibrium or trend line

Features of Business Cycles



 

They are fluctuations in aggregate economic activity which can be represented by the levels of total output, income, employment, prices, profits etc in the economy. Output, income, employment, prices, etc move together. They go up during upswings & go down during the period of downswings There are recurring phases of expansion & contraction in the level of economic activity There is an automatic mechanism through which phases of expansion & contraction of the level of economic activity automatically come after one another

Features of Business Cycles contd..



The phases of expansion & contraction in cyclical fluctuations are recurrent but there is nothing periodic about them Business cycles also vary in their amplitudes. The difference between the peak & the bottom levels reached by the aggregate economic activity during the full course of a complete trade cycle is called the amplitude of the trade cycles A business cycle affects the entire economy. All sectors & all industries are affected by it but they are not equally affected The cyclical fluctuations are internationally propagated through international trade; but all the countries are not equally affected by a trade cycle originated in a country
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Different phases of a Trade Cycle

There are four interrelated phases of a trade cycle. According to Burns & Mitchell these areRevival Expansion Recession Contraction The peak & trough are the critical mark-off points in the cycle
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Different phases of a Trade Cycle contd..

The greater part of the cycle is divided into Expansion phase which extends from trough to peak Contraction phase which from peak to trough In addition there are upper & lower turning points. At the lower turning point, revival starts & the economy moves into the expansion phase from that point At the upper turning point recession takes hold of the economy & after that point the economy moves into the contraction phase
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a.

b.

Different phases of a Trade Cycle according to Schumpeter

 

He does not start from a trough (peak) and end up with the next trough (or peak) According to him a trade cycle starts with the neighbourhood of equilibrium (critical mark-off points) preceding prosperity & end up with the neighbourhood of equilibrium following revival. In his theory the critical mark-off points are found at or near the points of inflection A business cycle according to Schumpeter represents wave-like deviations in the level of business activity from equilibrium or trend line
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Different phases of a Trade Cycle according to Schumpeter

Peak Level Of NI 1st phase 2nd phase Recession Prosperity A Depression 3rd phase O Recovery 4th phase Trough Time B C Trend

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Explanation of the figure



The wavy curve showing the movement in the level of business activity over time cuts the trend line at points A, B & C. These are the points of inflection. The neighborhoods of equilibrium cluster around these points As economy moves from A to B, economic activity runs above normal & as it moves from B to C the economic activity is below normal
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Phases of business cycle according to Schumpeter



Business cycle is broadly divided into two parts- the upper half & the lower half In the upper half part of the cycle the level of economic activity is above the normal & in the lower half the level of economic activity is below normal The upper half part of the cycle which extends from A to B is divided into prosperity & recession The lower half which extends from B to C is divided into depression & recovery

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Phases of business cycle according to Schumpeter

 

The four phases of business cycle in the Schumpeterian model are Prosperity here income & employment continue to increase but at diminishing rates until the peak is reached Recession here income & employment fall at increasing rates until the next point of inflection is reached i.e. until the level of economic activity reaches the normal level from the above normal level Depression here income & employment still go on decreasing but at diminishing rates, until the cycle trough is reached Recovery income & employment increases at increasing rates until they reach normal levels
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Theories of business cycles



Earliest theory rests on the interaction between the multiplier & the accelerator

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Multiplier theory


Multiplier theory states that income is determined by investment. This implies that
For a given level of aggregate output to be maintained investment must be at a certain level

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The accelerator theory



This hypothesizes that current investment depends upon the change in aggregate output from previous year to this year Thus
For

a constant volume of investment to be maintained output must grow at a certain rate

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Two more ingredients to generate cycles are



Ceiling beyond which output cannot grow - this is given by the full employment of labour force There must be a floor this is provided by the fact that gross investment cannot be negative

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How are cycles generated?

 

 

A disturbance such as an accidental increase in investment sets up a cumulative upward movement of output This continues till output hits the full employment ceiling beyond which it cannot grow As output stops growing there is no addition to capital stock and investment falls off This in turn leads to contraction of output This continues till gross investment falls to zero beyond which it cannot fall. Income then stops falling Once the excess capacity has been worked off there is no need for further negative net investment Net investment rises from its negative level &pulls up income with it & starts the upturn again

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Other theories


There are host of other theoriesthey concentrate on behaviour of inventories, cycles in public expenditure & behaviour of money supply

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Stabilization policy


Fiscal & Monetary policies which seek to combat the business cycles are referred to as stabilization policies These policies try to counteract reduction in private expenditures either by increasing public expenditures or by stimulating private expenditures through tax cuts, lower interest rates etc & viceversa

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Business cycles & stabilization policies are not important in developing countries- why?


The cyclical movements in these countries are caused by highly unpredictable factors such as droughts, contraction of exports, etc The remedy against these do not lie in conventional stabilization policies Example: ups & downs in industrial production & its growth rate in India is caused by performance of the agricultural sector, ad hoc & unpredictable changes in industrial policies
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Unemployment -definition


Technically speaking this is defined as a state of affair when in a country there are a large number of able-bodied persons of working age who are willing to work but cannot find work at the current wage levels

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Rate of unemployment


This is one of the key indicators of the conditions prevailing in the economy It is given by the percent of persons in the existing workforce who are not employed. Mathematically, it is equal to: Number of persons unemployed X 100

Number in civilian labour force

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Types of Unemployment
Three main types: Frictional unemployment Structural unemployment Cyclical unemployment

  

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Frictional unemployment
 

This is caused by constant changes in the labour market It occurs due to a. employers not fully aware of all available workers & their job qualification b. available workers not fully aware of the jobs being offered by employers The basic cause of this form of unemployment is imperfect information Found in both developed & developing countries. The period of such unemployment is short in developed countries.
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Structural unemployment
 

Occurs due to structural changes in the economy. There is a mismatch between the unemployed persons & the demand for specific types of workers for employment Occurs due to changes in the structure of demand for the industrial products or due to the changes in technology that take place in an economy Also occurs because of mismatch between the location of job-vacancies of the expanding industries & the present location of the unemployed workers
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Natural rate of unemployment



Frictional & structural types of unemployment together constitute the natural rate of unemployment Note: Full employment is said to prevail despite the existence of natural rate of unemployment which is unavoidable in a changing economy

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Cyclical unemployment


Arises when there is a general downturn in the business activity During recessionary business conditions since fewer goods are produced, fewer workers are required to them. Employers therefore lay-off workers & cut back employment

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Disguised Unemployment
 

Found in agricultural sector in LDCs Surplus workers in less developed countries are often engaged in agricultural production but without contributing anything to the production process If they are transferred to some other sectors then it would help in raising national production increase countrys savings favourable impact on countrys development
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Keynesian concept of unemployment



Unemployment arises from the deficiency of effective demand If level of effective demand is sufficiently high the production of goods & services could be sustained Refers to cyclical unemployment which is found in developed countries This may be curbed by providing incentives to investors
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Is Keynesian concept of unemployment applicable to developing countries?



In developing countries the problem of unemployment (both open & disguised) is chronic. Here unemployment is not the result of deficiency of effective demand It is a consequence of inadequate capita equipment or other complementary resources to support the existing workforce

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Nature & trends of unemployment in India



Refer text

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Consequences of Unemployment
  

GDP loss Income redistribution Control on wage-price

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Okuns Law


An employed person is engaged in some productive activity. Accordingly unemployment leads to the loss of production directly The exact determination of the production loss due to unemployment is not possible Nevertheless, empirical research has been carried out to estimate the same in this respect Arthur Okuns research (1962) on the United States data is the most significant one
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Okuns Law stated



A. Okun was the first to estimate a negative relationship between the rate of change in GDP & the rate of change in unemployment rate For the United States data of 1930s to 1980s the results on the Okuns law are

g = 3.0 2

Where g rate of change in GDP (%) & u rate of change in unemployment rate (%)

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