Business Cycles

By Group 8 Anurag Rekhi Arpitha S George Pallath Lakshmi Priya Rohan Nair Vishal Singh

A business cycle is an alternate expansion and contraction in the overall business activity as evidenced by fluctuations in the measures of aggregate economic activity such as:  Gross Product  Industrial Production  Employment & Income

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Cyclical & Periodic in nature Embraces the entire economy Cumulative & Self reinforcing Similar but not identical

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Major Cycles: 8-10 years Minor Cycles: 2-3 years Long Waves Cycles: 50-60 years

Level of economic activity

Full Employment line

Time

The lowest point of a business cycle is known as Depression and is characterized by:

The phase of transition from a pessimist economy to an optimist economy is termed as Revival/Recovery.  Banks expand credit  Production slowly increases  Demand for capital, raw material and labour also increases  Inventions and innovations characterize this phase

The prosperity(Expansion) phase refers to a state where the economy attains maximum growth with full employment and the movement of the economy is beyond full employment.  The investment activity picks momentum  Stock markets start functioning vigorously  Prices & Profits also rise influencing further investment  Economy experiences Full employment

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Attracted by high profits, businessmen increase investment activities Additional pressure on existing resources which are fully employed Sharp rise in prices Costs gradually rise and overtake prices and profits Economy plunges into darkness

The transition from boom to depression is called Recession.  Profits decrease so business activities reduce  Unemployment increases  Demand decreases  Income, expenditure and prices decrease  Leads to a decline in overall business activity

Full Employment line

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n sio

ival

ce s Re

Level of economic activity

Boom

Prosperity

Depression Time

CAUSES OF BUSINESS CYCLES

Revival Expansion

BOOM

Recession Depression

Innovation in business is the main cause of increase in investments & business fluctuations.

Multiplier Theory - Propounded by Keynes - Autonomous Investment: Investment undertaken due to new production techniques, new markets etc. Accelerator Theory - Propounded by Clark - Derived Investment: Increased income leads to higher demand thus forcing more investment to meet the demands.

ASSUMPTIONS:

No excess productivity No government interference or foreign trade 1 year lag between income and consumption Lag between consumption and investment Income of any year can be estimated by knowing the incomes of the previous two years, marginal propensity of consumption and the output-to-capital ratio.

Autonomous investment is a function of current output Induced investment depends on the equilibrium growth rate The income is bounded by a ceiling and a floor

SAMUELSON’S MODEL Simple in nature Unrealistic & does not confirm with the real world Assumes capital-output ratio constant Fixed rate of autonomous investment & savings

HICKS MODEL Complex in nature Real world theory Autonomous investment as a function of current output Equilibrium rate of growth- Rate of autonomous investment and savings

Both models use the same consumption function – 1 year lag between income and consumption

RELIEF MEASURES

PREVENTIVE MEASURES

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Avoid undue increase in investment Avoid decrease in production and maintain steady employment Do not stock excess inventories

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Reduce the costs of production Profit ploughing Adopt cyclical pricing policy Improve the quality of goods to increase demand

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Monetary measures

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Fiscal measures - Taxation measures - Public expenditure - Borrowing

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Administrative measures