Trade Cycle or Business Cycle

Meaning or definition of trade circle:

According to Oxford dictionary, “Trade cycle is defined as a tendency for alternating periods of
upward and downward movements in aggregate level of output and employment relative to their
long term trend.”

Capitalist economy?
Economy having absence of central planning and having private sector as decision maker.

So, Trade cycle or business cycle i.e. fluctuation in economic activities is common and natural in
capitalist economy.

In socialist economic system there is less chance of trade cycle since there is pre plan of the
government regarding economic decision.

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Will trade or business move smoothly in same trend for a long time?

The answer is certainly ‘No’.

There is frequent ups and down in business, it is common experience.

Sometimes business or economic activities expanded to a great extent where as the same will be
contracted to a great extent because of various causes.

This phenomenon of expansion and contraction of business or economic activities is termed as trade or
business cycle in very common sense.

The phenomenon was observed and explained by William Petty during the year 1623 to 1687 AD, it is said.

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“Business cycle is the wave like phenomenon in the level of business activities from the
equilibrium or trend line.” Economist Schumpeter has said.

Keynes argues, “A trade cycle is composed of period of good trade characterized by rising
prices and low unemployment alternating with periods of bad trade characterized by falling
prices and high unemployment.”

According to Prof. Benham, “Trade cycle refers to the period of prosperity followed by the
period of depression.”

On the basis of these definitions trade or business cycle refers to

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Trade cycle or business cycle is common and natural wave like
phenomenon , specially of free or open capitalist economy, where
expansion (upswing) in economic activities or macro economic
variables like income, employment, output, investment, demand,
prices, profit etc. and contraction (downswing) in those take place
alternatively and rhythmically.

Can it be said?

Any other logic?

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 Major characteristic of trade cycle:
Regularity: Takes place again and again regularly, specially in free enterprise
economy, but cannot be said the exact time.

Synchronism or co-movement: Fluctuation of one sector affects another

sector directly or indirectly and national economy as a whole becomes
affected.

Alteration of expansion and contraction: Economic activities expanded and

contracted alternatively i.e. after achieving boom through prosperity,
recession and depression is inevitable and after reaching at trough through
depression recovery and prosperity takes place.
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Self reinforcing or cumulative :Economic activities are self reinforced to make their own path
themselves and those activities are cumulated. That means, when downswing starts, economic
variables themselves feed to swing the situation even down and when upswing takes place,
economic variables feed to swing the situation even higher.

Universal or international: Because of high degree of globalization, trade cycle of an economy

directly or indirectly affects other so many nations and the phenomenon becomes universal or
international.

Different speed of different phase: Generally downswing is very faster than that of upswing.

Unequal effect: Trade cycle affects people of all segment of society but different people of society or
different agent of the market will be affected differently. Impact of trade cycle becomes vary from
people to people.

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 Types of trade cycle:
Major types of trade cycle are:
Short run Kitchin Cycle:
Introduced by British economist Joseph Kitchin in 1923.
Made distinction between minor and major cycle.
Minor cycle: approximately is of 40 months
Major cycle: Composed of 2 or 3 minor cycle.
The Long Jugler Cycle:
Introduced by French economist Clement Jugler in 1960
Indicates that after each phase of prosperity, depression and recovery lingers
on an average of 9 to 10 years.
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Very Long Kondratieff Cycle:
Long run wave cycle, propounded by Russian economist N.D.
Kondratieff in 1925.
He said, there are longer waves of cycle of more than 50 or up to 60
years duration. It is made of six Jugler cycle.

Kuznet Cycle:
Propounded by American economist Simon Kuznet.
The time period of cycle is from 16 to 22 years.

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 Phases of trade cycle:
Broadly speaking there are 2 phases of trade cycle:
1. Expansion phase or upswing phase
2. Contraction phase or downswing phase.
These 2 phases are broken out into following 4 phases:
I. Prosperity phase
II. Recession phase
III. Depression phase
IV. Recovery or revival phase.

But there is no any certainty regarding starting of the phase i.e. any of the phase can
take the place first.
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Graphically:

Peak or Boom
Y
*
Economic Trend line
Prosperity
Activities
*
Recession

Recovery
Average growth
Depression *

O Trough X
Time

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 1. Prosperity
Prosperity is the phase of business cycle in which there is rising trend of demand, output,
employment and income.

There is rise in price but wage, salaries, interest, rental and taxes do not rise in same
proportion.

The gap between price and cost widens and level of profit rises.

Optimism among businessmen rises highly.

Investment will be encouraged and the activities are self feeding from which upswing
becomes cumulative.
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Major characteristics of this phase are:
High level of income, output, trade and employment.

High level of marginal efficiency of capital i.e. IRR and high investment.

Rising trend of price, interest, credit, wages, and profit as well.

Increase in business optimism and economy is in nearer to full employment.

Prosperity reaches at its peak called boom.

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Just after achieving at peak or boom, seeds for downturn are spread.
At peak or boom, economy may not survive for long time and down turn starts.
But why?
Because ;
there is scarcity of labor and raw materials from which cost rises rapidly,
Capital starts to be scarce and interest rises rapidly and investment becomes non profitable,
Consumption demand declines due to high rise in price and inventories rises.
These factors become cumulative and over optimism changes in to pessimism.
Peak or boom becomes upper turning point.
e.g. Man can climb mount Everest and can reach at highest peak or point but how long he or she can
stay there?
For very short time, ultimately he or she must have to fall down other wise nature takes some action.

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 2. Recession
Recession starts from upper turning point, called boom.
In this phase,
There is contraction of credit supply, prices and profit.
Which leads to reduction in investment and it again leads to reduction in income and
employment as well.
Reduction in income brings reduction in effective demand from which again price and profit falls.
Pessimism among the businessmen becomes widespread and all these phenomena become
cumulative because of their self feeding nature.
Problem becomes severe and severe.
According to Lee, “A recession once started tends to build upon itself as much as forest fire once
under way tends to create its own draft and gives internal impetus to its destructive ability.”

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 3. Depression
When recession becomes severe and severe it changes in to depression.
In depression phase, income, output, employment and investment declines
substantially.
General decline in income leads to decline in bank deposit and businessmen becomes
unable to make repayment of debt. There is chance of failure of banking system and
great shortage of capital .
Decline in all macro economic phenomenon takes place like;
Reduction in level of output, income, employment, price, profit, stock price,
investment, bank deposit, credit supply, interest rate and pessimism among the
businessmen becomes common.
All these are cumulative and self feeding. Which leads to economic darkness in the
economy and economy reaches at trough.
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If so, what is difference between recession and depression?

In both economic activities are falling down but depression is more

severe than recession.

It is said that, in recession Your neighborer loose his or her job but in
depression you yourself loose your job.

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But when economy fall in to trough (Lowest point of economic depression), all agent of the
economy like consumer, producer and government also try to get rid of from the situation.
In this phase, consumers postpone consumption of durable consumer goods and business men
postpone their investment.
But for how long?
Slowly and slowly demand of durable goods starts to take the place and the demand gradually
accumulated.
Which will give encouragement for businessmen to invest since they accept less profit in place of
loss because they have previously invested in fixed capital.
Again to minimize loss,
Business sector tries to innovate new strategies to reduce cost and to encourage demand.
From which output, employment and income starts to rise, pessimism is replaced by optimism
and economy moves toward recovery or revival phase.

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 4. Recovery
This stage starts in the economy when demand of capital goods
improved in the economy.
To meet increased demand of capital goods, investment rises,
employment rises and which leads to rise in income level.
Increase in income is fuel to increase effective demand which leads to
rise in price and profit as well.
Gradually stock price also rises, deposit and bank credit rises and all of
them show cumulative effect or once the wave of recovery initiated it
begins to feed upon itself.
From which economy turns in to prosperity phases.
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 Measures of economic stabilization
(or Counter cyclical measures)
Trade cycle is common phenomenon in capitalist economy.
In capitalist economy also there is presence of government as regulator,
facilitator or stabilizer of the economy.
Because, instability in economy affects each and every segment of society
and there is chance of collapse of economy or failure of the state.
Mainly government takes following three measures :
1. Monetary measures
2. Fiscal measures
3. Other measures.

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1. Monetary measures:
In phase of contraction (or depression), expansionary monetary policy like
Decrease in bank rate
Decrease in CRR
Purchase of securities
Increase in money supply.
In phase of Expansion, contractionary monetary policy like
Increase in bank rate
Increase in CRR
Selling of securities
Decrease in money supply.

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2. Fiscal measures:
In phase of contraction (or depression), expansionary fiscal policy like
Decrease in tax rate
Increasing in public spending
Repayment of public debt
Deficit financing
In phase of Expansion, contractionary fiscal policy like
Increase in tax rate
Decrease in public spending
Increase in public borrowing
Surplus budget.

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3. Other measures:
Licensing ,
Control over price,
Control over foreign exchange,
Export duties etc.

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 The End
Thank you for your
patience.
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