Business Cycles

Dr. Ashok Panigrahi

 Definition of 'Business Cycle'

The business cycle or economic cycle refers

to the fluctuations of economic activity about its
long term growth trend. The cycle involves
shifts over time between periods of relatively
rapid growth of output (recovery and
prosperity), and periods of relative stagnation or
decline (contraction or recession). These
fluctuations are often measured using the real
gross domestic product.
'Business Cycle'
Four Phases of Business Cycle
 Prosperity Phase
When there is an expansion of output, income, employment, prices and
profits, there is also a rise in the standard of living. This period is termed as
Prosperity phase.
The features of prosperity are :-
High level of output and trade.
High level of effective demand.
High level of income and employment.
Rising interest rates.
Inflation.
Large expansion of bank credit.
Overall business optimism.
A high level of MEC (Marginal efficiency of capital) and investment.
Due to full employment of resources, the level of production is Maximum
and there is a rise in GNP (Gross National Product). Due to a high level of
economic activity, it causes a rise in prices and profits. There is an upswing in
the economic activity and economy reaches its Peak. This is also called as
a Boom Period.
 Recession Phase
The turning point from prosperity to depression is termed as
Recession Phase.
During a recession period, the economic activities slow down.
When demand starts falling, the overproduction and future
investment plans are also given up. There is a steady decline in
the output, income, employment, prices and profits. The
businessmen lose confidence and become pessimistic (Negative).
It reduces investment. The banks and the people try to get
greater liquidity, so credit also contracts. Expansion of business
stops, stock market falls. Orders are cancelled and people start
losing their jobs. The increase in unemployment causes a sharp
decline in income and aggregate demand. Generally, recession
lasts for a short period.
 Depression Phase
When there is a continuous decrease of output, income, employment, prices and
profits, there is a fall in the standard of living and depression sets in.
The features of depression are :-
Fall in volume of output and trade.
Fall in income and rise in unemployment.
Decline in consumption and demand.
Fall in interest rate.
Deflation.
Contraction of bank credit.
Overall business pessimism.
Fall in MEC (Marginal efficiency of capital) and investment.
In depression, there is under-utilization of resources and fall in GNP (Gross
National Product). The aggregate economic activity is at the lowest, causing a
decline in prices and profits until the economy reaches its Trough (low point).
 Recovery Phase
The turning point from depression to expansion is termed as
Recovery or Revival Phase.
During the period of revival or recovery, there are expansions and
rise in economic activities. When demand starts rising, production
increases and this causes an increase in investment. There is a steady
rise in output, income, employment, prices and profits. The
businessmen gain confidence and become optimistic (Positive). This
increases investments. The stimulation of investment brings about
the revival or recovery of the economy. The banks expand credit,
business expansion takes place and stock markets are activated.
There is an increase in employment, production, income and
aggregate demand, prices and profits start rising, and business
expands. Revival slowly emerges into prosperity, and the business
cycle is repeated.
Thus we see that, during the expansionary or prosperity phase, there
is inflation and during the contraction or depression phase, there is
 Four main stages in a trade cycle or business cycle.
Growth GDP is rising
Unemployment is falling
Business are experiencing rising profits
Feel good factor among the people as their incomes are rising.

Boom Results from too much spending.

Economy experiences rapid inflation
Factors of production become expensive

Recession Results from too little spending.

GDP is falling
Demand in the economy will fall leading to closure of firms and
unemployment

Slump High level of unemployment.

Business will rapidly close down creating serious consequences for the
economy.
 Before, understanding Recession,
we need to understand the market
economy;

A] TWO STAGES OF MARKET ECONOMY

B] TWO FACTORS OF MARKET; - DEMAND & SUPPLY

A] TWO STAGES OF MARKET ECONOMY

A1] Growing Market Economy

A2] Declining Market Economy

 A1] Growing Market Economy

Starting Point = Willingness to buy

 A2] Declining Market Economy
Starting Point = Unwillingness to buy
B] TWO FACTORS OF MARKET; - DEMAND & SUPPLY

Producer wants his demand always to be high

Consumer wants his buying cost always to be low
Actually, Demand is the price at which
consumer is ready to buy and
producer is ready to sell;
Usually, we think;
Demand = Quantity
But, here Demand = Price;
This is because,
Price decides the Quantity of Sales;
Producer Price
Competitive Price = More Demand;
Consumer Price
In competitive Price = Less Demand;
 C] What is Recession?

Recession is the economy shrinking for two

consecutive quarters (=6 months) with a
decrease in the GDP (=Gross Domestic Product)

GDP = Value of all the reported goods and services

produced by the people operating in the country

GDP = MONEY VALUE OF {C + I + G + (X M)}

C = Consumables, I = Gross Investments, G = Government Spending,

X = Exports, M = Imports
 C] What is Recession?
GDP is a good indicator of economy; Other
indicators could be;
-Unemployment Rate
-Consumption Rate
-Actual Personal Income
-Etc..

If GDP is growing, then market is growing due to

increased demand;
 C] What is Recession?
GDP is a good indicator of economy; Other
indicators could be;
-Unemployment Rate
-Consumption Rate
-Actual Personal Income
-Etc..

If GDP is growing, then market is growing due to

increased demand;

Note: If the recession continues for next quarter, (>6

months) then we go through DEPRESSION
Economy;
 C] What is Recession?

There is a joke that economists quote to explain the

Difference between Recession & Depression

RECESSION

= WHEN YOUR NEIGHBOR LOSES HIS JOB

DEPRESSION

= WHEN YOU LOSE YOUR JOB

 D] What is a Business Cycle?

What goes up; Has to come Growing economy has to

down; come down if the
production
rate of goods & services was
more than the actual
consumption;
 E] Why Recession happens?

E2] LOW
E1] OVER
CONFIDENCE
PRODUCTION
LEVEL
 E] Why Recession happens?

E1] OVER
PRODUCTION

PSEUDO DEMAND A situation in which the

ACTUAL NEED WAS supply exceeds the nations
NOT THERE; ability to consume what has
WRONG PROJECTIONS
been produced;
COMPANIES
PRODUCED Supply > Demand
MORE
 E] Why Recession happens?

E2] LOW E2.1] Word of mouth

CONFIDENCE
LEVEL
E2.2] Assignable Cause

E2.1] Word of mouth

Low Confidence Level Consumers are fearing that they may

of Millions of lose their jobs; So, they have less
consumers and confidence to spend money and buy
producers after they goods; This will result in reduction
hear many job cuts, in demand in the market; Consumers
Demand coming down, start saving money instead of spending
Companies bankruptcy, money; This is a downward spiral in
etc the economy;
 E] Why Recession happens?

E2] LOW E2.1] Word of mouth

CONFIDENCE
LEVEL
E2.2] Assignable Cause

E2.1] Word of mouth

Low Confidence Level Consumers are fearing that they may

Producers do not stock materials, they
of Millions of lose their jobs; So, they have less
reduce their productions, gets into the
consumers and confidence to spend money and buy
cost reduction activities, worried
producers after they goods; This will result in reduction
about
hear many job cuts, in demand in the market; Consumers
the profitability, etc
Demand coming down, start saving money instead of spending
Companies bankruptcy, money; This is a downward spiral in
etc the economy;
 E] Why Recession happens?
E2.2] Assignable Cause
Bad Incidences Happening;

Example: September 11 Terrorist Attack in US;

International Airport block in Thailand;
Mumbai Attacked in India;
etc

Series of such incidences

leading into a kind of War

Please see next slides, for details on business impact;

 Terrorists Attack on 11th September in US

Created fear in people

People cancelled their travel plans

Resulted in low occupancy rates

Airlines & Hotel Industries badly hit

Airline & Hotel Industries offered discounts,

gift coupons, to attract people
But, still, no improvement in occupancy
rate
Airline & Hotel Industries started
CONTINUED
Cost Reduction activities
IN NEXT SLIDE
 Terrorists Attack on 11th September in US

Airline & Hotel Industries started

Cost Reduction activities

iii] Salary reduction to

i] Reduce No. of flights ii] Lay off people
Not laid off people

Low or No income to They became careful due

In flight meals reduced
spend and buy goods to the fear of loss of job

Meals supplying company Demand for other goods Started saving money
got the hit come down instead of spending

Catering company now, Demand for other goods

lays off people come down
So, you can see how the hit on Airline and Hotel
industries can affect Un-related industries
in the end;

One industry can hit many other industries when the

confidence level of millions of consumers & producers
drastically comes down;
 F] How to know recession?

Indicators to say a nation is in recession;

- People buying less stuff

- Decrease in factory production
- Growing unemployment
- Slump in personal income
- An unhealthy stock market
 G] How to come out of recession?

It is unhealthy for any nation to be in Recession;

So, Government will take certain countermeasures
to eliminate or reduce the Effect of recession for turnaround;
Important Point:
Today, it is a market Economy

Producers; Consumers;
Can produce and Can decide to
sell at their prices buy or not;

Both Producers and Consumers are free to act; Not a forced action
 G] How to come out of recession?
Hence, Government does not have direct control on Producers & the
Consumers behavior; But, they can influence millions of Producers &
Consumers with Governments policies;

Government has 2 plans

Fiscal Policies Monetary Policies

(By Govt.) (By RBI)

Government influences the RBI manipulates

economy by changing how the available supply of
it (Government) spends money in the country
and collects money
 G] How to come out of recession?

Fiscal Government influences the economy by changing

Policies how it (Government) spends and collects money

1] Tax cuts for More money

businesses or available for
for individuals spending

2] More Spending Individuals get Demand picks

by Govt. to salary and spend up; Market
create jobs money can recover;
3] Automatic
Some income to
fiscal policy;
unemployed
Unemployment
people to spend
Insurance
 G] How to come out of recession?

Monetary Government manipulates the available supply

Policies of money in the country

More money
1] Reduce reserve
available for bank
ratio
to give loans

What is Reserve Ratio?

Demand picks
up; Market
Each bank has to keep a high % of their assets in
RBI (Reserve Bank of India). These assets do not
can recover;
earn any interest to banks. This money kept in
RBI is called Reserves; RBI sets certain ratio
of this reserves and it is called Reserve Ratio
 G] How to come out of recession?

Monetary Government manipulates the available supply

Policies of money in the country

More money
11] Reduce reserve
available for bank
ratio
to give loans

2] Lower the Individuals take

Demand picks
interest rates more loan up; Market
can recover;
 G] How to come out of recession?

Monetary Government manipulates the available supply

Policies of money in the country

More money
1] Reduce reserve
available for bank
ratio
to give loans

2] Lower the Individuals take

Demand picks
interest rates more loan up; Market
can recover;
3] Use its own It becomes an
reserved income to Govt.
money to buy to inject money
Govt. bonds into the market
 I] WOW!!!!!!!!

RBIs Power or Governments Power is double-edged

sword; Sometimes, their policies to recover from recession
can be counter-productive and it may further worsen the
situation;

If we advise our people to save money, then, the multiplication effect is that
the demand will not pickup and recession will continue; Very peculiar!!!!! But, I
am not misguiding you; Just think from a macro level, if everybody in the
country stops spending, what will happen?

Nations recession is controlled by the actions of

everybody living
in that country;
Thanks