BUSINESS CYCLES

The business cycle is the upward and downward movement of economic activity or real GDP that occurs around the growth trend.

Since the late 1940s, :Downturns and panics have generally been less severe. The duration of business cycles has

increased. The average length of expansions has

increased while the average length of contractions has decreased.

The Phases of the Business Cycle A peak is the top of the business

cycle. A trough is the bottom of the

business cycle. A boom is a very high peak. A downturn is when economic

activity starts to fall from a peak. A upturn is when economic activity

starts to rise from a trough.

The Phases of the Business Cycle

Hence the four main phases are: Recession Depression Recovery Boom Recession occurs faster while

recovery is a slower process.

Cyclical nature:Boom

Secular growth trend

DownturnUpturn

Trough

Peak

GDP

time

RECESSION: Consumer demand falls Investment already undertaken

appears unprofitable New investment is unlikely Production and employment fall General price level likely to fall DEPRESSION: In the absence of any stimulus, to

aggregate demand, depression sets in.

RECOVERY: Business confidence returns Production, sales and profits increase Employment increases Price levels start increasing New technology is adopted BOOM: Output levels increase to go beyond

the trend to a boom.

Full utilization of capacity High investment expenditure High profits High business expectations New investment is profitable

Limits to the Business Cycles: Ceilings: When full employment level of output is

reached, total volume of output is restricted to limited availability of labour.

Floors: At its worst level, business confidence is

so low that there is no investment at all.

ACCELERATOR & MULTIPLIER:

The level of investment depends on rate of change of national income

IT = a.dy IT = dk a = dk/dy a: accelerator coefficient

If there is an initial injection, multiplier action will start, which will cause output to increase and hence through the accelerator, the investment will increase and setoff another chain of multiplier reaction.

If, however, the full employment level is reached and output cannot increase any further, the investment does not take place and the ceiling is reached.

Multiplier & Accelerator:

Sales 1000 1000 2000 3000

3500 3500

3400

machines 10 10 20 30 35 35 34

Induced INV.

0 10 10 5 0 0

Replacement INV.

1 1 1 1 1 0

Total Inv.

1 11 11 6 1 0

Indicators:indicator recovery boom

Industrial production.

Gradual increase

high

Commodity prices

-do- -do-

Cost of production

Increases but slower than commodity prices

Increase faster than recovery

profits satisfactory high

Investment Replacement High

Employment Gradual increase

Rapid increase

Bank loans Liberal High demand for advances

Speculation Increases high

Inventory stocks

Fall Zero

Business failures

Rare Zero

Business expectations

Cautious but optimistic

optimistic

Leading Indicators

Leading indicators tell us what's likely to happen in the economy 12 to 15 months from now.

The are indicators rather than predictors because they are only rough approximations of what’s likely to happen in the future.

Indicators: Leading indicators include the following:

Average workweek for production workers in manufacturing.

Unemployment claims. New orders for consumer goods and

materials. Stock prices Residential construction Capacity utilization Interest rate spread. Changes in the money supply.

Indicators:

Coincident indicators are business investment expenditure, industrial production

Lagging indicators are job vacancies, unit labour costs etc

Procyclical vs countercyclical

Variables which move in the same direction as the GDP over the business cycles are procyclical.

E.g consumption Variables which move in the

opposite direction to GDP are countercyclical

E.g unemployment

Variables:

Pro-cyclical Countercyclical

Industrial production Unemployment

Commodity prices Inventory stocks

Cost of production Business failures

Profits

Investment

Wages

Bank loans