BUSINESS

CYCLES
Unit – 8
Group – 8

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CONTENTS
Concept Rupali

Causes of Business Cycles Ria

The Business Cycle Reeta & Ritesh

Measure to control Business Faiz

Cycles

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The period of high income , output
and employment has been called the
period of expansion, upswing or
prosperity.

The period of low income, output and

employment has been described as
contraction, recession , downswing.

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These alternating period of
expansion and contraction in
economic activity have been called
BUSINESS CYCLE

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PHASES OF BUSINESS CYCLE

EXPANSION(Boom, upswing)
PEAK(Upper turning point)
CONTRACTION(Downswing ,
recession)

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Causes of business cycle
The Economy
◦ Is like a Roller Coaster it has it’s
ups and downs
◦ These ups and downs are called
the Business cycle
The Business Cycle brings the
goods times and the bad times.

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Causes of the Business Cycle
◦ High consumer demand causes
expansion of the economy
◦ Once people begin to spend less
this causes a recession
◦ Government policy can also
cause the economy to expand
or recess

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Inflation
◦ Prices of various good’s are always
going up or down
◦ However when the prices of a large
number of goods goes up this is
called inflation
◦ Inflation can be a serious concern
because most people’s pay checks
do not go up as fast as inflation .

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Deflation
◦ During deflation most things
cost less however, wages can
fall too.
◦ Falling wages can result in
unemployment

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MONETORY POLICY
Variations in the nation’s monetary
policies, independent of changes
induced by political pressures are
an important influence in
business cycle as well.
Such as increased government
policy, change in fiscal policies
etc.

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Fluctuations in exports and
imports
The difference between exports and
imports ins the net foreign demand for
goods and services also called as net
exports. Because net exports are a
component of the aggregate demend
in the economy, variations in exports
and imports can lead to business
fluctuations aswell. There are many
reasons for variations in exports and
imports over time. Growth in gross
domestic product of an economy is the
most important determinant of its
demand for imported goods-as
people’s
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 Incomes grow, their appetite for
additional goods and services,
including goods produced abroad
increases.

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Technological innovations
Technological innovations can have an
acute impact on business cycles.
The personal computer industries,for
instance have undergone immence
technological innovations in recent years.
And this has lead to a pronounced impact
on the business operations of countless
organisaions.

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 Keynes
ian Mod
el
le
Real Business Cyc
Ration
al E
ions
New Classi
ca l Model

odel
t
Mone

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• The interpretation of the labor market: Do
fluctuations in employment reflect voluntary changes
in the quantity of labor supplied?
• The importance of technology shocks: Does the
economy’s production function experience large,
exogenous shifts in the short run?
• The neutrality of money: Do changes in the
money supply have only nominal effects?
• The flexibility of wages and prices: Do wages
and prices adjust quickly and completely to balance
supply and demand?

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 • Real business cycle theory emphasizes
the idea that the quantity of labor supplied
at any given time depends on the
incentives that workers face.
• The willingness to reallocate hours of
work over time is called the intertemporal
substitution of labor.

nsider this example:

W1 be the real wage in the first period.
W2 be the real wage in the second period.
r be the real interest rate.
ou work in the first period, and save your earnings, you will have
+ r)W1 a year later. If you work in period 2, you will have W2.

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 Critics of the real business cycle theory believe:
• Fluctuations in employment do not reflect changes in the
amount people want to work.
• Desired employment is not sensitive to the real wage and the
real interest rate– unemployment fluctuates over the business
cycle.
• The high unemployment in recessions implies that markets
don’t clear and that wages do not equilibrate labor demand
and labor supply.
Criticisms of

eal business cycle theorists reply: Real

Business
Unemployment Cycle Theory

atistics are difficult to

terpret.
Simply because
employment rate is high
es not mean that
tertemporal substitution
labor is unimportant.

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 Real Business
Cycle Theory

Real business cycle theory assumes that our economy

experiences fluctuations in technology, which
determine
our ability to turn inputs (capital and labor) into output
(goods and services), and that these fluctuations in
technology cause fluctuations in output and
employment.

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Critics of the real business cycle theory:
• Are skeptical that the economy experiences large technology
shocks, and propose that technological improvements happen
more gradually.
• Believe that technological regress is especially implausible.

Real business cycle theorists Criticisms of

reply: Real

• Adopt a broader view of shocks Business

Cycle Theory

to technology.
• Events, although not
technological, have a
similar affect on the
economy (i.e. weather,
regulations, oil prices).

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 Real business cycle theory assumes that money is neutral, even in
the
short run. That is, it is assumed not to affect real variables such as
output and employment.
Critics argue that the evidence does not support short-run
monetary
neutrality. They point out that reductions in money growth and
inflation are almost always associated with periods of high
unemployment.
cates of real business cycle argue that their critics confuse the
tion of causation between money and output. They claim the
ey supply is endogenous: fluctuations in output might cause
uations in the money supply. For example, when Y rises, because
ech shock, the quantity of money demanded rises. The Fed may
increase the money supply to accommodate greater demand.
gives the illusion of non-money neutrality.

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Real business cycle theorists believe that the assumption of
flexible prices is superior methodologically to the assumption
of sticky prices.

Critics point out that wages and prices are not flexible. They
believe that this inflexibility explains both the existence of
unemployment and the non-neutrality of money.

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 Some new Keynesian economists suggest that recessions result
from a
failure of coordination. Coordination problems can arise in the
setting
of wages and prices because those who set them must anticipate
the
actions of other wage and price setters.

veryone in the economy sets new wages and prices at the same
Instead, the adjustment of wages and prices throughout the
my is staggered. Staggering slows the process of coordination and
adjustment. Staggering makes the overall level of wages and prices
gradually, even when individual wages and prices change a lot.

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MEASURES TO CONTROL
BUSINESS CYCLES
 Thereare 3 major techniques available :
monetary policy, fiscal policy and
incomes policy.
 Monetary policy involves controlling the
money supply and interest rates.
These determine the availability and
costs of loans to businesses. Tightening
the money supply theoretically helps to
counteract inflation; loosening the
supply helps recovery from a recession.

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Contd….

 Fiscal measures include increased

taxation of the wealthy.
 Income policy seeks to hold wages
and prices down to a level that
reflects productivity growth.
 Monetary and Fiscal policy acts as a
measure to reduce the impact of
business cycles. These are pursued
by the state to combat the
inflationary and deflationary
tendencies in the economy.
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Monetary Policy
It refers to the credit control
measures adopted by the central
bank of an economy. These are of
two kinds Quantitative or
general controls and Qualitative
or selective controls.

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 Qualitative includes bank rate
variations, open market
operations and varying reserve
ratios. They aim at regulating the
overall level of credit in the
economy through the commercial
banks.
 Reduction of money supply in the
economy results in reduction of
price level in the economy.
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Selective credit controls are used
to encourage or discourage
specific types of credit for
particular purpose. In order to
check the speculative activity in
the economy the central bank
changes the margin requirements
to be charged by the commercial
banks on these activities.

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Fiscal Policy
It refers to the deliberate
changing of taxes and
government spending for the
purpose of keeping the actual
GNP close to the potential full
employment GNP. If the potential
GNP exceeds it causes inflation
and if actual GNP is lower it
causes recessionary conditions.

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 When inflation is due to excess
purchasing power in relation to the
amount of goods and services
available, the basic remedy for
controlling inflationary conditions
is to drain any excess purchasing
power. In such a case, fiscal policy
should aim at taking rupees out of
the income-expenditure steam.

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There are 2 ways of doing it :
1)To restrain or reduce government
spending and create surplus budget
where tax revenue exceed government
expenditure. The reduction in
government expenditure would reduce
aggregate demand in the public sector
and its spillover effect would dampen
aggregate demand.

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2)To increase taxes on business
and consumers without
increasing government
expenditure.

These approaches can be used

simultaneously.

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