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Business Cycle

Business Cycle
It is important feature of Capitalist Economy.
It means alternating periods of prosperity and depression is
the country. It has been defined as alternative expansion and
contraction in overall business activity.
As evidenced by fluctuation is measures of aggregate
economic activity. Such as the gross produce The industrial
production, employment and income.
Cyclical fluctuations have a tendency towards simultaneous
appearance in all the branches of national economy.
Sometimes they may be confined to individual industry.
Circling foliation is referred as specify cycle.
Phases of trade cycle
Depression.
Recovery (or revival)
Prosperity (or full employment)
Boon (or over full employment)
Recession.
Depression
In the first stage of trade cycle
It is protected period is which business activity in a country
is for below the normal. It is characterized by sharp
reduction of production, Mass unemployment falling profits,
Low wages, contraction of credit, a rate of business failures
And an atmosphere of all- round pessimism and despair.
A decline in output or production is automatic by reduction in
volume of employment. All construction activities come to a
more or less complete standstill during a depression.
The consumer goods industries such as food & clothing are
so much affected by unemployment as the basic capital
goods.
The prices of manufactured goods fall to low levels. Since
the cost are sticky and do not full as rapidly as prices the
manifestoes suffer huge locus. Many of the firms have to
close down on account

Recovery
It implies increase in business activity after the lowest point of
depression has been reached. During this phase there is a
slight improvement in economic actins to start with. The
entrepreneurs began to feel that the economic situation was
after all not as bad as it was in the preceding stage.
Leads to further improvement in business activity. Industrial
promotion picks up slowly and gradually. The Volume of
employment also increases steadily. There is a slow but sure
rise in prices accompanied by small rise in profits. The wage
also rises though they do not rise in the same proportion in
which the prices rise.
Attracted by rising profits new investment take place in capital
goods industries.
The banks expand credit. The business inventions also start
rising slowly. Recovery continues until business activity reaches
approximately the same level that it had achieved before the
decline set in. The ratio of recovery is generally related directly
to that of the preceding depression. The more severe the
depression the more rapid the recovery will be.

Prosperity (Or Full Employment)
Increased production, high capital
investment in basic industries, expansion of
bank credit, high prices, and high profit, high
rate of formation of new business
enterprises and full employment characterize
this stage. There is a general feeling of
optimism between businessman and
industrialists.
Boom (Or Overfull Employment)
It is the stage of rapid expansion in business activity to new
heights resulting in high stocks and commodity prices, high
profits and over all employment. Prosperity phase of the
trade cycle does not end up with a stable stage of full
employment it leads to the emergence of boom.
The continuance of investment even after the stage of full
employment results in a sharp inflationary rise of prices.
This causes undue optimism between businessman and
industrialist who make additional investments in the various
branches of the economy.
This puts additional pressure on the factors of production
that are already fully employed causing sharp rise in their
prices. Soon the situation develops in which the number of
jobs exceeds the number of worker available in the market.
Such a situation is known as overfull employment.
Attracted by rising profit the businessmen further
increase their capital investments.
Ran away inflation raises its head in all it ugliness.
Prices rise sky-high.
There is an atmosphere of over optimism all around.
But the developing boom comes with the seed of
self-destruction. Factors of production become
scarce causing spurt in their prices. The cost
calculations are upsetting; this makes the
businessmen over cautious. They now begin to
stay away from new projects and even stop the
existing units. This prepares the ground for
succeeding stage. A bust immediately follows a
boom.
Recession

A feeling of over policeman of the earlier period is replaced
now by over pessimism. Characterized by fear and
hesitation on the part of the businessmen. Failure of some
businesses creates panic among businessmen.
The banks go panicky and began to withdraw loans from
business enterprises. More business enterprises fail. Prices
collapse and confidence is rudely shaken. Initial
unemployment spreads to other industries.
Unemployment leads to fall in income, expenditure price,
and profit. Once a recession stats it goes on gathering
momentum and finally assumes the shape of full-fledged
depression and the first stage of trade cycle is complete.
PM is the full employment line
Above this line we have 2 stages of the trade cycle.
A boom in the upswing.
A Recession is the Downswing
Below this line again we have two stages a Recovery in the
Upswing and a Depression in the downswing. Thus the
trade cycle follows 5 stages - Recovery, Prosperity, Boom,
Recession and Depression.
Depression
Prosperity Employment Boom Recession.
Number of Years
Two well-marked characteristics of trade cycle
Periodicity: - The trade cycle operates periodically at
regular interval of 10 12 years. Depression comes after
every 10-12 years. There is a fair regularity is the
occurrence of a boom and a depression.
Synchronism: - It means that the trade cycle is of an all-
embracing nature .It engulfing all industries, all occupation
including Agriculture and all areas in a country. Sometimes
it embraces the whole world like the great depression of 19
29.

Role of Hicks in Trade Cycle
A new trend is being discovered in business Cycle. Some
leading economists have sought to explain business
cycle: in terms of twin concept of Multiplier & Accelerator.
The multiplier accelerator interaction explains these
economists to the combined effect of the Multiplier and the
Accelerator attribute business fluctuation in a Capitalist
Economy .The business fluctuation in the economy.
According to Hicks there are two types of
Investments
Autonomous Investment Induced Investment

It is determined independently of existing
economic conditions, such as the level of
National Income or Consumption

Determined by the past changes in the
levels of Income or Consumption

It is an Exogenous factor arising from
Technological change from increase in
population or from Public Investment

It is a reaction to increase or decrease in
the aggregate demand of aggregate
consumption, It is an endogenous factor,
A reaction to changes included by
Autonomous Investment

It is the Autonomous investment, which
starts on expansion of employment and
output.

Its force is expressed in the accelerator
Its force is expressed in the multiplier. Both cause cyclical fluctuations in Business
activity
The economic system, which is in equilibrium, is suddenly
solicited to disturbance.
Then the income and output will expand to the degree
indicated by the multiplier.
This expansion of income and output will result in induced
investment via the accelerator.
This gives rise to further expansion of income (multiplier) &
further induced investment (accelerator) and so on.
Thus the output rises faster than the equilibrium rate.
Investment also increases beyond its normal rate.
The expansion of income & output with continue. Till it
reaches the upper level or ceiling determined by full
employment.
As expanding income & output hit the ceiling their
expansionist force is bound to be checked.

The rate of expansion is slowed down to the natural rate,
which it has been exceeding up till then.
The rate of induced investment is also reduced because
the spurt of Autonomous investment was short lived.
But now the multiplier accelerator mechanism sets in the
reverse order falling investment, reducing income & so
on.
The output may plunge downwards ward below the
equilibrium level to a greater extent.
Then it rose above it on account of the revenue working
of the multiplier and the accelerator.

Multiplier tells that a small increment in investment will
increase the income of the society hence employment. It
accordingly gives brief measure of change in investment
goods industry as a result of change in consumer good
industry
INVESTMENT &
NATIONAL INCOME
TIME
O
P
2

Q
1

Q
2

Q
0

P
0

P
1

A
L
F
E
F
E
L
A
There is a very close relationship between the level of money income
and the volume of investment. The former depends upon the latter.
For every level of investment there is the corresponding level of
money income the ratio of money income to investment is determined
by the combined action of the Multiplier and the Accelerator.

Autonomous investment grows annually at a rate given by slope of
AA. Given the size of the marginal propensity to consume the simple
investment multiplier can `be determined. The multiple and the
autonomous investment together determine the equilibrium level of
income represented by LL. Hicks refer to LL as floor line. When the
nation grows along the line LL, there is bound to be some induced
investment viz. the working of the accelerator.

The line EE shows the equilibrium time- path of national income
determined by autonomous investment and the leverage. FF line
represents the full employment ceiling this line shows the maximum
national income or output at any period of time. The economy starts
from E and will be moving along the path EE. The growing level of
autonomous investment and the leverage will determine its
equilibrium.
Suppose the economy reaches point Po along the EE path. At
this point there is some outburst of investment activity due to
certain innovation or sudden jump in Government Expenditure.
This outburst of automatic investment will push the economy
above EE path after point Po. This increase in National income
will cause further increase in induced investment through the
working of accelerator. The increase in induced investment will
cause the national income to increase by a magnified amount
through the multiplier.

On account of the combined effect of the multiplier and the
accelerator the national income will rapidly expand along the
time path Po P1. This expansion will stop at P1 because P1 is
located on the FF line, which is employment ceiling.
National income cannot expand beyond the FF line because
that represents full employment. Hick assumes that full
employment ceiling FF grows at the same Rate as autonomous
investment AA.
This is why FF slopes upwards in a gentle manner whereas Po P1
slopes upwards in a steep manner. When Economy reaches P1 of FF
hence it will grow at the same rate at which autonomous investment
increases. For a time the economy with creep along FF line. The
decline in induced investment initiates in a contraction in the level of
income investment Activity.
From P the level of national income moves downwards to EE.
Investment now falls off rapidly and the multiplier starts working in the
Reverse direction.
The fall in National Income will not stop on touching the line EE but
will continue mooning downwards till it reaches the pint Q1. But it will
not slip down beyond Q1 because the floor has now been reached.
The economy may creep along the floor line LL from Q1 to Q2 .In this
process there is a growth in the level of National Income. The rate of
growth once again induced investment.
The multiplier and the accelerator both come into operation.
The economy will once again move in upward direction towards
Q3 and the full employment ceiling FF.

This is how leverage causes fluctuation in Economy. This
is Hicks theory of Business cycle.
Monetary Theory Of Business Cycle (R.G. Haw Trey)

According to him the business cycle is purely a monetary
phenomenon. Being elastic the supply of money expands and
contracts. Such expansion & contraction of money supply.
When it occurs it leads to expansion & contraction of business
activity or to the operation of business cycle. Money inflation
and money deflation causes fluctuation in business activity.
An increase in supply of money accompanied by increase in the
velocity of circulation initiates the period of prosperity. An
increase in money supply results in increased customer outlay,
which cause upswing of business cycle. A decrease in the
money supply is accompanied by a decrease in its velocity of
circulation. It initiates the period of depression .A decreased
money supply results in decreased consumer out lays. Which
cause the downswing of the business cycle. Since the
expansion and contraction of money supply is brought about
through the expansion & contraction of bank credit .The
banking systems infact is responsible for operation of the
business cycle.
Criticism
This theory does not furnish a comprehensive explanation of the business
cycle.
It is not correct to say that business fluctuations are caused by the action of
the banks. The expansion or the contraction of credit it is pointed out does
not cause either the boom or the depression. But once the boom or
depression has taken place the expansion or contraction of credit only
serves to accentuate it.

It is pointed out that the mere expansion of credit cannot cause a boom. If
that were so a country could get rid of the depression merely through
expansion of bank credit. So long as the businessmen do not acquire the
necessary confidence, more expansion of bank credit will not pull the
economy out of depression.

The theory exaggerates the importance of bank credit as a means of
financing the development and expansion of business firms. It does not play
an imp. Role in initiating the boom as theory assumes.

More contraction of credit through high interest rate will note generate
depression. If the businessman will continue to expand output and
investment despite the high interest rate if they feel that future prospects are
bright.
Innovation Theory (Joseph Schumpter)
Theory is associated with name of Joseph Schumpter. He
has explained Business cycle in terms of innovation that
take place in the Economic system of a capitalist country
from time to time. He means introduction of something new
that changes the existing methods of production.

It may mean one of the following:
Introduction of a mechanical invention.
Introduction of a new product.
Introduction of new technique of production.
Development of new market for existing product.
Dev. of new sources of raw maternal for existing
entrepreneurs.
Development of new types of raw material in place of old.
Introduction of changes in the forms of Business organization.
Introduction of new method of management in business.
Innovation Is Of Two Types
Greater waves of Innovation or long waves
Cause the long business cycle
Smaller waves of Innovation lead to short
business cycle.
Schumpeter explains the upswing and the
downswing in terms of innovations
Where ever as innovation takes place it causes
disequilibria in the existing economic system.
The disequilibrium continues till there is
readjustment at some new equilibrium position.
Upswing
Schumpter assumes that the economy is in a state of full
employment. Suppose some innovation takes place and some
new product in introduced by business headers. Thus
establishment of an altogether new industry in the economic.
Since all the factors of production are already fully employed.
The new industry will have its quota of factors by withdrawing
them from the existing industries. Through promises of higher
reward to them. The higher rewards of the factor will increase the
production cost in the existing industry. In addition to this the
output of existing industry will also decline for the simple reason
that the less of the productive factors. They are now available to
it than before for the purpose of production.

The establishment of new industry will be financed through the
expansion of bank credit. The workers employed in the new
industry will have now larger purchasing power, which they would
spend. On buying the goods produced by excising industries.
The demand for the products of the existing product would group
the output of these products will have diminished on account of
the reduced supply of producer factors to them.
The result will be a sharp rise in price profits of the existing
industries. It is attracted by high profits the enterprises in the
existing industries will be financed through expansion of bank
credit. This process will be repeated till inflationary conditions
develop is the economy .The new industry will of course take
some time to establish itself.

During the interim period the new industry will act as an
inflationary force for the simple reason that While it has put
additional purchasing power in the hands of the worker. It has
not yielded on equivalent output is the Market to absorb the
increased purchasing power. Ever after the new industry maker
available its output to the market it shall not cause to be on
inflationary force for the economy.

Attracted by the high profit made by the pioneering forms
certain other firms will join the new industry. The activities of
these firms will be financed by additional expansion of bank
credit. This process will repeat itself till the economy finds itself
in the upswing of the business cycle
The economy passes from period of prosperity
(upswing) to a period of depression (downswing) by:
As the product of the new industry comes in to the market
it competes with the products of the old industries. The
consumer will buy the new products by postponing their
demand for the old products To the extent the demand for
the products of the old industry will decline and the prices
of the products of there industries will register a fall.
The firms in the new industry will begin to repay out of their
profit the loans, which they had borrowed from the bank.
This reduces the supply of bank credit that has a
deflationary effort on the economy. In view of the decline in
demand the firm in the old industries begins to reduce their
output by lying off worker & other factor of producing.
The unemployed workers having no purchasing power
reduce purchaser of the good of not only the old industries.
But of new industry as well, the demand for goods
diminished still further.
Criticism
It is unrealistic.
It assumes that there is already a full
employment situation in the economy.
The theory assumes that every innovation is
business is financed through expansion of bank
credit which ultimately results in an inflationary
station but this assumption is also not wholly
true