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• Business cycle or trade cycle is a part of the capitalistic
• The business cycle refers to fluctuation in economic
activities such as levels of income, employment, prices and
output, occurs more or less in regular time sequences.
• Business cycle is characterized by upward and downward
movement of economic activities.
• In a business cycle, there are wave-like fluctuations in
aggregate employment, income output and price level.
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• The short-term variations in economic
activity are known as BUSINESS CYCLE.
• Economic history shows that the economy
never grows in a smooth and even
• Upward and downward movements in
output, inflation, interest rates, andemployment form the
Business Cyclesthat characterizes all market economies
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• Business Cycles are the irregular expansions and contractions in
• Business Cycles are economy-wide fluctuations in total National
Output, Income, and Employment, usually last for a period of 2 to 10
years, marked by widespread expansion or contraction in most sectors
of the economy.
Features of Business Cycles
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a) The phases of business cycle recur with some sort of
regularity and are uniform in case of different cycles.
b) In case of developed countries the cycle length is short
(around 4.5 years) than the developing countries (around 7.5
c) Amplitude of a business cycle is the maximum extent of
departure from long run trend in either direction.
d) All economic variables are affected by the business cycles.
Phases of business cycle
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Business Cycle is typically divided
into four phases:
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Recession merges into depression when there is a general decline in economic
There is considerable reduction in the production of goods and services,
employment, income, demand and prices.
The general decline in economic activity leads to a fall in bank deposits.
When credit expansion stops, even business community is not willing to
Thus, a depression is characterized by mass unemployment – general fall in
prices, wages, profits, interest rate, consumption expenditure, investment –
bank loans and advances falling – factories close down – capital goods industries
are also closed down.
During this phase, there will be pessimism leading to closing down of business
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Recovery denotes the turning point of business cycle from
depression to prosperity.
There is a slow rise in output, employment, income and
price – demand for commodities go up steadily.
There is increase in investment – bank and financial
institutions are also willing to granting loans and advances.
Pessimism gives way to optimism.
The process of recovery becomes combative and leads to
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In this period, demand, output, employment and income are at a high
level, they tend to raise prices.
But wages, salaries, interest rates, rentals and taxes do not rise in
proportion to the rise in prices.
The gap between prices and cost increases - the margin of profit
The increase of profit and the prospect of its continuance commonly
cause a rapid rise in stock market values.
The economy is engulfed in waves of optimism.
Larger profit expectation further increase – investment which is helped
by liberal bank credit.
This leads to peak or boom.
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Recession starts downward movement of economic activities
It is a state in which there is general deceleration in the
economic activity resulting in cuts in production and
employment falling prices of stock market.
Banking and financial institutional loans and advances beginning
As a result profit margins decline further because costs starts
Recession may be mild/severe – it lead to a sudden explosive
situation emanating from banking system and stock markets.
Such experience of the United States in 1873, 1893, 1907,
1933 and 2007.
Control of business cycle
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Economic stabilization is one of the main remedies to
effective control of business cycle.
Economic stabilizations is not merely confined to single
sector of an economy but embraces all the sectors.
There are three ways by which a business cycle can be
1. Monetary Policy
2. Fiscal Policy
3. Automatic Stabilisers
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Monetary policy as a method to control business fluctuations is
operated by the central bank of country.
Monetary policy mainly concerned with money supply, bank credit and
The central bank can adopts a number of methods to control the
business cycle with the help of quantitative and qualitative credit
Dear money policy – during boom/peak it raises its bank rate
policy, sells securities in the open market operation and raises the
cash reserve ratio and adopts number of selective credit control.
Cheap money policy – during recession/depression – reduces the
bank rate policy and interest rates of banks – and also buys securities
in the open market, reduces cash reserve ratio etc.
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Monetary policy alone cannot check business cycle. Therefore, economists
like JM Keynes and Hansen & many others have recommended that fiscal
policy can be bring about stabilisation of business cycle.
Fiscal policy is a policy of government which is concerned with public
expenditure, taxation and public borrowing.
These three instruments have to be effectively utilised to control the
severity of boom and depression.
During the period of recession and depression, government should reduces
taxation substantially, increases of public expenditure – public works –
social and economic infrastructure. Repayment of loans to public - deficit
In times of boom, government should raises tax rates, levy new taxes,
reduces public spending and public borrowing – following surplus
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When economics fluctuation takes place in the economy,
the available monetary policy and fiscal tools cannot be
geared quickly to set right the imbalance. Then automatic
stabilizers become the prominence.
Automatic stabilizers should be used as supplemented with
fiscal and monetary policies.
Automatic stabilizers are also called as built-in-stabilizers –
it is proportion to the rise and fall of economic activity.
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The progressive taxation and unemployment insurance schemes are
the two important tools measures the automatic stabilizers in
During periods of prosperity or boom the employers pay taxes
more and withdrawing unemployment benefits.
While, during period of depression – government allowed to
provision of unemployment benefits, and lowers the taxes and
increasing public expenditure.
Thus, the flow of money is regulated automatically from the
people to the government in times of both boom and
17 Theories of Business Cycle: Multiplier
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Income depends upon Investment.
For a given level of aggregate output to be maintained, investment activity
must be maintained at certain level.
Current Investment depends upon the change in aggregate output from
previous year to this year.
For a constant level of investment to be maintained output must grow at a certain rate.
•Accidental increase in investment set up cumulative upward
movement of output.
•To generate business cycle two more ingredients are
a) Ceiling: beyond which real output cannot grow.
b) Floor: Below which the gross investment cannot fall.
Business Cycles Indicators
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a) Monetary and Fiscal Policies which seek to combat these cyclical movements
are called stabilization policies
b) Business Cycle Indicators
i. Leading Indicators: includes measures that generally indicate business
cycle peaks and troughs three to twelve months before they actually occur.
ii. Coincident Indicators: contains measures that indicate the actual incidence
of business cycle peaks and troughs at the time they actually occur. The
number of employees on payrolls, industrial production etc are examples.
iii. Lagging Indicators: measures that generally indicate business cycle peaks
and troughs three to twelve months after they actually occur. Labour cost per
unit of output in manufacturing, the interest rate, outstanding commercial and
industrial debt, the Consumer Price Index etc.
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a) Used as a barometer to point out condition of economy
b) Unemployment is the result of deficiency of effective demand
c) Nature of unemployment in LDC’s are different than DCs
d) In LDCs unemployment is the result of inadequate capital
equipment while in DCs it is the result of deficiency in
The Concept of Full Employment
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a) Full employment is the level of employment that results when the
rate of unemployment is normal.
b) At a given point of time there is some natural rate of
unemployment in the dynamic exchange economy.
c) Natural rate of unemployment is the long run average of
unemployment cause due to frictional and structural changes in
d) Policies the encourage workers to reject job offers and prohibit
employer from offering appropriate wage rates increase natural
rate of unemployment.
e) Actually rate of unemployment generally rise above the natural
rate during recession and vice versa.