Business Cycle Phases and Causes PDF

BUSINESS CYLE – PHASES AND ITS CAUSES Business Cycle, also known as the economic cycle or trade cycle, is the fluctuations in economic activities or rise and fall movement of gross domestic product (GDP) around its long-term growth trend. The change in business activities due to fluctuations...

BUSINESS CYLE – PHASES AND ITS CAUSES Business Cycle, also known as the economic cycle or trade cycle, is the fluctuations in economic activities or rise and fall movement of gross domestic product (GDP) around its long-term growth trend. The change in business activities due to fluctuations in economic activities over a period of time is known as a business cycle. Business cycle is also called trade cycle or economic cycle. There have been periodical ups and downs in the GDP levels of these countries. Along with output, there have been fluctuations in various economic aggregates such as income, employment and prices and their long-term trends. These economies have experienced phases of expansion and contraction in output and other economic aggregates alternatively. These alternating phases of upswings and downswings are known as business cycles. PHASES OF BUSINESS CYCLE There are four phases of a business cycle, viz., expansion, recession, depression and recovery. A. EXPANSION PHASE In the expansion phase, there is an increase in various economic factors, such as production, employment, output, wages, profits, demand and supply of products, and sales. An expansion stage can begin as the result of many forces, including willingness of financial institutions to lend more and willingness of business houses to borrow more. Economic growth in the expansion phase eventually slows down and reaches its peak. During the peak of a business cycle, economic variables such as production, profits, sales and employment are high; but do not accelerate further. B. RECESSION PHASE In recession phase, all the economic variables such as production, prices, saving and investment, starts decreasing. Generally, in the beginning of the downturn, producers are not aware of the decrease in the demand for their products and they continue to produce goods and services. In such a case, the supply exceeds demand and there is accumulation of inventories. During the recession phase, producers usually avoid new investments which lead to the reduction in the demand for factors of production, and consequent decline in input prices and unemployment. Social unrest and crimes tend to rise during recession. C. DEPRESSION PHASE When recession continues further, economic growth rate may be negative also. This phase is sometimes termed as ‘depression’. During depression, there is not just a decline in the growth rate; there is a decline in the absolute level of GDP. As sales declines, business houses find it difficult to repay their debts. As business sentiments are low enough to carry out new investments, demand for credit declines. Banks also become cautious in their lending as the chances of default on repayment increases. D. RECOVERY PHASE After an economy sit in a depression, economy however revives its growth rate over a period of time and optimism build up in certain sectors of the economy. This leads to reversal of the recession phase and the recovery phase starts. Individuals and organizations start developing a positive attitude towards the various economic factors, such as investment, employment and production. In the recovery phase, there is an increase in consumer spending and demand for consumer goods. E. EXPANSION PHASE In the ‘recovery phase, some of the depreciated capital goods are replaced by producers and some are maintained by them. As a result, investment and employment by organizations increases. As this process gains momentum, an economy again enters into the phase of expansion. Thus, the business cycle gets completed. INFLATION and DEFLATION Inflation is defined as a persistent rise or, a tendency towards persistent rise in the general level of prices. Inflation is a macroeconomic phenomenon and is not concerned with the rise in the price of a particular commodity, or, a small group of commodities. Depending upon the initial process, inflation are classified into two types – demand pull or demand-side inflation and cost-push or supply-side inflation. Deflation is a situation where there is a consistent decline in price level. Decline in price of a single commodity cannot be terms as deflation. A situation of deflation arises when aggregate demand is lower than aggregate supply. Thus, deflation is characterized by a decrease in output, increase in unemployment, and general slowing down of the economic activities. CAUSES OF INFLATION Demand-pull inflation If the economy is at or close to full employment, then an increase in aggregate demand (AD) leads to an increase in the price level (PL). As firms reach full capacity, they respond by putting up prices leading to inflation. Also, near full employment with labour shortages, workers can get higher wages which increase their spending power. Demand-pull inflation can be caused by factors such as - Higher wages, Increased consumer confidence and Rising house prices – causing positive wealth effect.  Cost-push inflation If there is an increase in the costs of firms, then businesses will pass this on to consumers. Cost- push inflation can be caused by many factors – i) Rising wages: If trades unions can present a united front, then they can bargain for higher wages. Rising wages are a key cause of cost-push inflation because wages are the most significant cost for many firms. ii) Import prices: Increase in import prices of commodities can greatly affect cost of procuring goods from foreign countries. Since, most of the nations including India shell out a big chunk of resources for import, rise in import prices can greatly cause inflation. iii) Raw material prices: Increase in the raw material prices also create cost-push inflation. The best example is the price of oil. If the oil price increase, then this will have a significant impact on most goods in the economy and this will lead to cost-push inflation. Printing more money If the Central Bank prints more money, there would be rise in inflation. This is because the money supply plays an important role in determining prices. If there is more money chasing the same amount of goods, then prices will rise. Hyperinflation is usually caused by an extreme increase in the money supply. Profit Push Inflation When firms push up prices to get higher rates of inflation. This is more likely to occur during strong economic growth. Higher taxes If the government put up taxes, such as VAT and Excise duty, this will lead to higher prices, and therefore CPI will increase. REMEDIAL MEASURES OF INFLATION Monetary Measures: Monetary measures aim at reducing money incomes and include the following- (a) Credit Control: One of the important monetary measures is monetary policy. The central bank of the country adopts a number of methods to control the quantity and quality of credit. For this purpose, it raises the bank rates, sells securities in the open market, raises the reserve ratio, and adopts a number of selective credit control measures, such as raising margin requirements and regulating consumer credit. (b) Demonetisation of Currency: One of the monetary measures is to demonetise currency of higher denominations. Such a measures is usually adopted when there is abundance of black money in the country. (c) Issue of New Currency: The most extreme monetary measure is the issue of new currency in place of the old currency. Under this system, one new note is exchanged for a number of notes of the old currency. The value of bank deposits is also fixed accordingly. Such a measure is adopted when there is an excessive issue of notes and there is hyperinflation in the country Fiscal Measures Monetary policy alone is incapable of controlling inflation. It should, therefore, be supplemented by fiscal measures. Fiscal measures are highly effective for controlling government expenditure, personal consumption expenditure, and private and public investment. (a) Reduction in Unnecessary Expenditure: The government should reduce unnecessary expenditure on non-development activities in order to curb inflation. This will also put a check on private expenditure which is dependent upon government demand for goods and services. (b) Increase in Taxes: To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be so high as to discourage saving, investment and production. (c) Increase in Savings: Another measure is to increase savings on the part of the people. This will tend to reduce disposable income with the people, and hence personal consumption expenditure. But due to the rising cost of living, people are not in a position to save much voluntarily. (d) Surplus Budgets: An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the government should give up deficit financing and instead have surplus budgets. It means collecting more in revenues and spending less.