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OBJECTIVE OF CHAPTER
1 - Meaning and Definition of Trade Cycle.
2 - Nature of Trade Cycle.
3 - Causes of Trade Cycle.
4 - Effects of business cycle
5 - Measures To Control Trade Cycle
1. MEANING OF TRADE CYCLE
➢ The trade cycle refers to the ups and downs in the level of economic activity which extends over a period of several years. ➢ If we examine the past statistical record of the business conditions, we will find that business has never run smoothly for ever. ➢ There are many fluctuations in the period. Some times prosperity is followed by adversely. In Economics this tendency of the business activities, to fluctuate from prosperity to adversely is called business cycle.
DEFINITION OF TRADE CYCLE
A trade cycle is composed of periods of bad trade characterized by falling prices and high unemployment percentages while a period of good trade is characterized by rising prices and high employment.
2. NATURE OF TRADE CYCLE:
1 - BOOM/ PEAK
Peak or prosperity phase: 1 - Real output in the economy is at a high level 2 - Unemployment is low 3 - Domestic output may be at its capacity
4 - Inflation may be high
2 - RECESSION
Contraction or recession phase: 1 - Real output is decreasing 2 - Unemployment rate is rising. 3 - As contraction continues, inflation decrease. 4 - If the recession for long time, price may decline (deflation) 5 - The government determinant for a recession is two consecutive quarters of declining output.
3 - DEPRESSION
depression phase: 1 - Lowest point of real GDP 2 - Output and unemployment “bottom out” 3 - This phase may be short-lived or prolonged 4 - There is no precise decline in output at which a serious recession becomes a depression.
4 - EXPANSION (RECOVERY)
Expansionary or recovery: 1 - Real output in the economy is increasing. 2 - Unemployment rate is declining. 3 - The upswing part of the cycle.
3. CAUSES OF BUSINESS CYCLE
Main causes of the cycle 1 - Changes in Demand 2 - Fluctuations in Investments 3 - Macroeconomic Policies 4 - supply of money External Causes of Business Cycles 1 - Wars 2 - Technology Shocks 3 - Natural Factors 4 - Population Expansion
1] CHANGES IN DEMAND
Keynes economists believe that a change in demand causes a change in the economic activities. When the demand in an economy increases the firms start producing more goods to meet the demand. There is more output, more employment, more income, and higher profits. This will lead to a boom in the economy. But excessive demand may also cause inflation. On the other hand, if the demand falls, so does the economic activity. This may lead to a bust, which if it continues for a longer period of time may even lead to depression in the economy.
2] FLUCTUATIONS IN INVESTMENTS
Just as fluctuations in demand, fluctuations in investment is one of the main causes of business cycles. The investments will fluctuate on the basis of a lot of factors such as the rate of interest in the economy, entrepreneurial interest, profit expectation, etc. An increase in investment will lead to an increase in economic activities and cause expansion. A decrease in investment will have the opposite effect and may cause a trough or even depression.
3] MACROECONOMIC POLICIES
The monetary policies and the economic policies of a nation will also result in changes in the phases of a business cycle. So if the monetary policies are looking to expand economic activities by promoting investment, then the economy booms. On the other hand, if there is an increase in taxes or interest rates we will see a slowdown or a recession in the economy.
4] SUPPLY OF MONEY
There is another belief that says that business cycles are purely monetary phenomena. So changes in the money supply will bring about the trade cycles. An increase of money in the market will cause growth and expansion. But too much money supply may also cause inflation which is adverse. And the decrease in the supply of money will cause a recession in the economy.
EXTERNAL CAUSES OF BUSINESS CYCLES
1] WARS
o During times of wars and unrest, the economic resources are put to use to make special goods like weapons, arms, and other such war goods. o The focus shifts from consumer products and capital goods. This will lead to a fall in income, employment, and economic activity. So the economy will face a downturn during war times. o And later post-war the focus will be on rebuilding. Infrastructure needs to be reconstructed (houses, roads, bridges, etc). o This will help the economy pick up again as progress is being made. Economic activity will increase as effective demand will increase.
2] TECHNOLOGY SHOCKS
o Some exciting and new technology is always a boost to the economy. o New technology will mean new investment, increased employment, and higher incomes and profits. o For example, the invention of the modern mobile phone was the reason for a huge boost in the telecom industry.
3] Natural Factors
o Natural disasters can cause damage to the crops and huge losses to the agricultural sector. o Shortage of food will cause increase in prices and high inflation. o Capital goods may see a reduction in demand as well.
4 ] Population Expansion
o If the population growth is out of control that might be a problem for the economy. o Basically of the population growth is higher than the economic growth the total savings of an economy will start decrease. o Then the investments will reduce as well and the economy will face depression or a slow down.
4. EFFECTS OF BUSINESS CYCLE:
A- EFFECTS OF BUSINESS CYCLES DURING EXPANSION
1 - High growth : large investments, increase in employment, income and expenditure 2 - Inflation: Increase in investment forces more money supply in the system, demand for factor inputs increases, hence their prices increase which increases cost of production. So wages and prices of goods also increase. 3 - Severe Competition: Firms resort to large amount of non productive expenditure on advertisements and publicity.
E- REORGANIZATION OF ECONOMIC SYSTEM
o Some economists suggest that there should be complete reorganization of the whole economic system to control of business cycle fluctuation. o The capitalistic system of production should be replaced by the socialistic system of production. o In socialistic economy, there are few chances of cyclic fluctuations. o In 1930, when all capitalist countries of the world were suffering from depression, it was only socialist countries which were free from such crisis.
Test bank
1 - Macroeconomics distinguishes between the real economy and the ... a) monetary economy. b) virtual economy. c) normative economy. d) underground economy. 2 - During business cycles the opposite of a trough is... a) an inflation b) a hyperinflation. c) a trend. d) a peak 3 - According to the analysis of the British economist Keynes a) markets coordinate supply and demand so that a policy of laissez-faire would prevent recessions. b) economic fluctuations were the cumulative result of mistakes made by businesses and households in an uncertain world. c) government demand could be used to smooth fluctuations in aggregate output and income. d) supply creates its own demand through the circular flow of economic activity 4 - In order to influence spending on goods and services in the short-run, monetary policy is directed at directly influencing... a) unemployment rates. b) inflation rates. c) interest rates. d) economic growth rates. 5 - unemployment is low and Inflation may be high in : a) PEAK b) RECESSION c) DEPRESSION d) RECOVERY 6 - An important indicator of a nation's well-being is... a) gross domestic product (GDP) b) gross national product (GNP) c) gross national income (GNI) d) the growth rate of GDP or GNP
True or false
7 - trade cycle refers to the ups and downs in the level of economic activity which extends over a period of several years. 8 - Real output in the economy is at a high level in peak level. 9 - the price may decline in peak level of trade cycle. 10 - Lowest point of real GDP in DEPRESSION. 11 - A trade cycle is composed of periods of good trade characterized by falling prices and high unemployment percentages. 12 - peak is characterized by low Unemployment and low inflation. 13 - Effects of business cycles during recession are high growth, inflation, severe competition. 14 - Effects of business cycles during recession are Excess inventory, Unemployment,Below capacity operations and liquidation of firms. 15 - Causes of business cycle are changes in demand, supply of money, technology shocks wars, and population expansion. 16 - New technology will mean new investment, increased employment, and higher incomes and profits. 17 - More output, more employment, more income, and higher profits lead to a boom in the economy. 18 - Fluctuations in demand, or Fluctuations in Investment is not one of the main causes of the business cycle. 19 - Natural disasters can cause damage to crops and huge losses to the agricultural sector. 20 - Some economists have suggested that if a government takes control of private investment is a tool to control of business cycle fluctuations that can be controlled within the limits. 21 - An increase in investment will lead to an increase in economic activities and causes depression. 22 - Every country has trade relations with the rest of the world. If there is inflation or deflation in one country, it can be easily carried to other countries. 23 - A decrease in money in the market will cause growth and expansion. 24 - An increase in taxes or interest rates leads to a slowdown or recession in the economy. 25 - In case of inflation the growth of the total savings of an economy will start to increase. 26 - Basically if the population growth is higher than the economic growth the total savings of an economy will start to increase. 27 - Monetary policy is not considered as a measure of controlling business cycle fluctuation. 28 - Fiscal policy is a powerful anti-cycle weapon in the hands of the government that involves the process of shaping the public finance. 29 - The bank can adopt different measures for this purpose, like increase in the bank rate , selling of securities in the market , increasing the reserve ratio of the member banks.
