BUSINESS CYCLE

INTODUCTION:

Business cycle is also called Trade Cycle. The business is never

steady. There are always ups and downs in economic activity.

This cyclical movement both upwards and downwards is

commonly called Trade Cycle. This is a wave like movement in

regular manner in business cycle. In business, there are

flourishing activities, which take economy to prosperity and

growth whereas there are periods when there is recession, which

leads to decline in the employment, income and output. When the

economy goes into downswing then there is a stage of recovery to

reach a new boom.

“Trade Cycle is composed of periods of good trade characterized

by rising price and low unemployment percentage altering with

periods of bad trade characterized by falling price and high

unemployment percentage.” In the simple words – Business Cycle

is a fluctuation of the economy characterized by periods of

prosperity followed by periods of depression.

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MEANING

The term business cycle (or economic cycle) refers to economy-

wide fluctuations in production or economic activity over several

months or years. These fluctuations occur around a long-term

growth trend, and typically involve shifts over time between

periods of relatively rapid economic growth

(an expansion or boom), and periods of relative stagnation or

decline (a contraction or recession).

Business cycles are usually measured by considering the growth

rate of real gross domestic product. Despite being termed cycles,

these fluctuations in economic activity do not follow a mechanical

or predictable periodic pattern.

The recurring and fluctuating levels of economic activity that an

economy experiences over a long period of time. The five stages of

the business cycle are growth (expansion), peak, recession

(contraction), trough and recovery. At one time, business cycles

were thought to be extremely regular, with predictable

durations, but today they are widely believed to be irregular,

varying in frequency, magnitude and duration.

The business cycle describes the phases of growth and decline in

an economy. The goal of economic policy is to keep the economy

in a healthy growth rate fast enough to create jobs for everyone

who wants one, but slow enough to avoid inflation. Unfortunately,

life is not so simple. Many factors can cause an economy to spin

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out of control, or settle into depression. The most important, over-

riding factor is confidence of investors, consumers, businesses and

politicians. The economy grows when there is confidence in the

future and in policymakers, and does the opposite when

confidence drops.

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THEORIES OF BUSINESS CYCLE:

Several theories of business cycle been propounded from time to

time. Each of these theories spells out the factor which causes

business cycle. Before explaining the modern theories of business

cycle we first explain below the earlier theories of business cycle

as they too contain important elements whose study essential for

proper understanding of the causes of business cycle.

REAL BUSINESS CYCLE THEORY :

 The one which currently dominates the academic literature on

real business cycle theory was introduced in their seminal 1982

work Time to Build and Aggregate Fluctuations. They envisioned

this factor to be technological shocks i.e., random fluctuations in

the productivity level that shifted the constant growth trend up or

down. Examples of such shocks include innovations, bad weather,

imported oil price increase, stricter environmental and safety

regulations, etc. The general gist is that something occurs that

directly changes the effectiveness of capital and/or labour. This in

turn affects the decisions of workers and firms, who in turn

change what they buy and produce and thus eventually affect

output. RBC models predict time sequences of allocation for

consumption, investment, etc. given these shocks.

But exactly how do these productivity shocks cause ups and

downs in economic activity? Let’s consider a positive but

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temporary shock to productivity. This momentarily increases the

effectiveness of workers and capital, allowing a given level of

capital and labour to produce more output.

Individuals face two types of tradeoffs. One is the consumption-

investment decision. Since productivity is higher, people have

more output to consume. An individual might choose to consume

all of it today. But if he values future consumption, all that extra

output might not be worth consuming in its entirety today.

Instead, he may consume some but invest the rest in capital to

enhance production in subsequent periods and thus increase

future consumption. This explains why investment spending is

more volatile than consumption. The life cycle hypothesis argues

that households base their consumption decisions on expected

lifetime income and so they prefer to “smooth” consumption over

time. They will thus save (and invest) in periods of high income

and defer consumption of this to periods of low income.

The other decision is the labour-leisure trade-off. Higher

productivity encourages substitution of current work for future

work since workers will earn more per hour today compared to

tomorrow. More labour and less leisure results in higher output

today. Greater consumption and investment today. On the other

hand, there is an opposing effect: since workers are earning more,

they may not want to work as much today and in future periods.

However, given the pro-cyclical nature of labour, it seems that the

above “substitution effect” dominates this “income effect”.

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Overall, the basic RBC model predicts that given a temporary

shock, output, consumption, investment and labour all rise above

their long-term trends and hence formulate into a positive

deviation. Furthermore, since more investment means more

capital is available for the future, a short-lived shock may have an

impact in the future. That is, above-trend behaviour may persist

for some time even after the shock disappears. This capital

accumulation is often referred to as an internal “propagation

mechanism”, since it may increase the persistence of shocks to

output.

It is easy to see that a string of such productivity shocks will likely

result in a boom. Similarly, recessions follow a string of bad

shocks to the economy. If there were no shocks, the economy

would just continue following the growth trend with no business

cycles.

Essentially this is how the basic RBC model qualitatively explains

key business cycle regularities. Yet any good model should also

generate business cycles that quantitatively match the stylized

facts in Table 1, our empirical benchmark. Ryland and Prescott

introduced calibration techniques to do just this. The reason why

this theory is so celebrated today is that using this methodology,

the model closely mimics many business cycle properties. Yet

current RBC models have not fully explained all behaviour and

neoclassical economists are still searching for better variations.

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It is important to note the main assumption in RBC theory is that

individuals and firms respond optimally all the time. In other

words, if the government came along and forced people to work

more or less than they would have otherwise; it would most likely

make people unhappy. It follows that business cycles exhibited in

an economy are chosen in preference to no business cycles at all.

This is not to say that people like to be in a recession. Slumps are

preceded by an undesirable productivity shock which constrains

the situation. But given these new constraints, people will still

achieve the best outcomes possible and markets will react

efficiently. So when there is a slump, people are choosing to be in

that slump because given the situation, it is the best solution. This

suggests laissez-faire (non-intervention) is the best policy of

government towards the economy but given the abstract nature of

the model, this has been debated.

A pre-cursor to RBC theory was developed by monetary

economists Milton Friedman and Robert Lucas in the early 1970s.

They envisioned the factor that influenced people’s decisions to be

misperception of wages—that booms/recessions occurred when

workers perceived wages higher/lower than they really were. This

meant they worked and consumed more/less than otherwise. In a

world of perfect information, there would be no booms or

recessions.

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Calibration

Unlike estimation, which is usually used for the construction of

economic models, calibration only returns to the drawing board

to change the model in the face of overwhelming evidence against

the model being correct; this inverts the burden of proof away

from the builder of the model. In fact, simply stated, it is the

process of changing the model to fit the data. Since RBC models

explain data ex post, it is very difficult to falsify any one model

that could be hypothesised to explain the data. RBC models are

highly sample specific, leading some to believe that they have little

or no predictive power.

Structural variables

Crucial to RBC models, "plausible values" for structural

variables such as the discount rate, and the rate of capital

depreciation are used in the creation of simulated variable paths.

These tend to be estimated from econometric studies, with 95%

confidence intervals. If the full range of possible values for these

variables is used, correlation coefficients between actual and

simulated paths of economic variables can shift wildly, leading

some to question how successful a model which only achieves a

coefficient of 80% really is.

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MONETARY THEORY OF BUSINESS CYCLE:

In the monetarist theory of business cycle the basic cause of

the business cycle is because of excessive or restrictive money

supply by the financial authorities and is caused by economic

shocks, which are caused not by economic system failure but

by external factors and excessive political and social policies of

the government. That is, the business cycle is not caused by

inadequate aggregate demand but by money supply in the

economy and excessive government intervention or in appropriate

polices to manage the economy.

In essence monetarist theory explain business cycle by in

appropriate monetary policy and other external factors and

economic shocks and it is temporary and the rational behaviour

of the market will automatically move the economy towards full

employment and if government intervenes it will cause excessive

inflation and will make the full employment unachievable. In

addition, in their view it is also caused by rigid

labour market practices and inflexible wage fixing systems and

Union power in the labour market and imperfection and anti-

competitive practices in the goods market. In summary,

according to monetarist the business cycle is not inherent

weakness of the market economy but is caused by monetary

factors and excessive government intervention in the economy or

inappropriate economic and social policies of the government and

rigidity in the labour market and the role unions play in the

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labour market as well as imperfections in the goods market by

anti-competitive practices and over regulation of business activity

by government.

PURE MONETARY THEORY OF BUSINESS CYCLE :

According to Prof. R. G. Hawtrey, a British economist, there is

direct relationship between volume of money supply and the

economic activity. Wherever there is change in the flow of money

or money supply changes, there will be business fluctuations.

Here, he means the credit creation by the banking system i.e.,

expansion in bank credit leads to demand and so the upswing of

business cycle starts. On the other hand, when there is decrease in

money supply through contraction of bank credit, it leads to down

swing and thus leads to depression.

Expansion of bank credit happens when interest rates are

reduced, which means, the loans are cheaper. Due to liberal loans,

the profit margins change as they are very sensitive to the change

in interest rate.

Thus, investment increases and so the employment, which in turn

increase the income and demand. This increase in demand leads

to increase in price and profit margins. Therefore, the upward

trends start i.e., the upswing starts. But as each phase has the

germs of other phase, the turning point starts. When bank

changes its policy of credit expansion, the cash reserve with the

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bank reduces.

The leading rates are increased to discourage the demand for

fresh loans and they start calling to return loans. The producers

start disposing off their stock to repay loans. The restricted policy

on credit and high rate of interest discourages a new investment,

which leads to downswing. The income falls and cash starts

coming back to the bank. But as the cash reserve with the bank

improves, again the bank starts using liberal attitude towards

credit creation and so the revival starts. This takes the economy

to expansion or prosperity. According to R G Hawtrey flow of

money supply is the sole cause for business fluctuations. This

theory was not unchallenged.

Limitations

Business cycle is a very complex phenomenon and we cannot

attribute it completely to credit creation by banking system. Bank

plays an important role in the financing of business but it cannot

be the only reason for business crisis. It can just aggravate the

situation. Too much of importance is given to bank credit. Many

times traders don’t borrow from bank but plough back their

profit.

Investment not only depends on interest rates but on the rate of

return also. This theory has totally ignored the non monetary

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factors like innovation, climatic conditions, psychological factors

etc.

COBWEB THEORY OF BUSINESS CYCLE :

The cobweb model is based on a time lag between supply and

demand decisions. Agricultural markets are a context where the

cobweb model might apply, since there is a lag between planting

and harvesting. Suppose for example that as a result of

unexpectedly bad weather, farmers go to market with an

unusually small crop of strawberries. This shortage, equivalent to

a leftward shift in the market's supply curve, results in high

prices. If farmers expect these high price conditions to continue,

then in the following year, they will raise their production of

strawberries relative to other crops. Therefore when they go to

market the supply will be high, resulting in low prices. If they

then expect low prices to continue, they will decrease their

production of strawberries for the next year, resulting in high

prices again.

This process is illustrated by the diagrams on the right.

The equilibrium prise is at the intersection of the supply and

demand curves. A poor harvest in period 1 means supply falls to

Q1, so that prices rise to P1. If producers plan their period 2

productions under the expectation that this high price will

continue, then the period 2 supply will be higher, at Q2. Prices

therefore fall to P2 when they try to sell all their output. As this

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process repeats itself, oscillating between periods of low supply

with high prices and then high supply with low prices, the price

and quantity trace out a spiral. They may spiral inwards, as in the

top figure, in which case the economy converge to the equilibrium

where supply and demand cross; or they may spiral outwards,

with the fluctuations increasing in magnitude.

.

The convergent case: each new outcome is successively closer to

the intersection of supply and demand.

The divergent case: each new outcome is successively further

from the intersection of supply and demand.

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Simplifying, the cobweb model can have two main types of

outcomes:

If the supply curve is steeper than the demand curve, then the

fluctuations decrease in magnitude with each cycle, so a plot of

the prices and quantities over time would look like an inward

spiral, as shown in the first diagram. This is called the stable

or convergent case.

If the slope of the supply curve is less than the absolute value of

the slope of the demand curve, then the fluctuations increase in

magnitude with each cycle, so that prices and quantities spiral

outwards. This is called the unstable or divergent case.

Two other possibilities are:

Fluctuations may also remain of constant magnitude, so a plot

of the outcomes would produce a simple rectangle, if the

supply and demand curves have exactly the same slope (in

absolute value).

If the supply curve is less steep than the demand curve near the

point where the two curves cross, but more steep when we

move sufficiently far away, then prices and quantities will

spiral away from the equilibrium price but will not diverge

indefinitely; instead, they may converge to a limit cycle.

In either of the first two scenarios, the combination of the spiral

and the supply and demand curves often looks like a cobweb,

hence the name of the theory.

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ELASTICITIES VERSUS SLOPES:

The outcomes of the cobweb model are stated above in terms of

slopes, but they are more commonly described in terms of

elasticises. In terms of slopes, the convergent case requires that

the slope of the supply curves be greater than the absolute value

of the slope of the demand curve:

In standard terminology from microeconomics, define

the elasticity of supply as , and

The elasticity of demand as . If we evaluate these two

elasticises at the equilibrium point,

That is   and , then we see that

the convergent case requires

Whereas the divergent case requires

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In words, the convergent case occurs when the demand curve is

more elastic than the supply curve, at the equilibrium point.

The divergent case occurs when the supply curve is more elastic

than the demand curve, at the equilibrium point

SAMUELSON THEORY OF BUSINESS CYCLE :

Samuelson’s theory is regarded as the first step in the direction of

integrating theory of Multiplier and the principle of Acceleration.

His model shows how the multiplier and acceleration interact

with each other to generate income, to increase consumption and

investment, demand more than expected and how this causes

economic fluctuations.

To understand Samuelson’s model, let us first understand derived

investment. Derived demand is the investment in capital

equipment, which is undertaken due to increase in consumption

making new investment necessary. We will try to understand this

interaction briefly. When autonomous investment takes place in a

society, income of the people rises and the process of Multiplier

start increasing the income, which leads to the increase in demand

for consumer goods depending on the marginal propensity to

consume.

If there is excess production capacity, the existing stock of capital

would prove inadequate to produce consumer goods to meet the

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rising demand. Producers trying to meet the growing demand

undertake new investments. Thus, increase in consumption

creates demand for investment.

This marks the beginning of Acceleration process, when derived

investment takes place income increases further, in the same

manner as it happens when the autonomous investment takes

place. With increase in income, demand for consumer goods rises.

This is how the Multiplier and the Accelerator interact with each

other and make the income grow at a rate much faster than

expected. With the help of both the Multiplier and Acceleration

principle, Samuelson tried to relate the upswings and downswings

of business cycle. There are some criticisms regarding the

assumptions, they are as follows –

Though many economists had different approaches, some

attribute business cycle to expansion and contraction of money

supply some say it is due to the interaction of Multiplier &

Acceleration which changes the aggregate demand and leads to

fluctuations but some attribute it to the innovations in one sector

which spreads to the rest of the economy that causes recession

and boom.

There are other economists, who attribute fluctuation of business

cycle to the politicians manipulating economic policies and some

say supply shocks for e.g., 1970’s sharp increase in oil prices,

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increased inflation. All these theories have elements of truth. But

they are not valid in all the places and time. The key is to

understand them and combine these theories and use the

knowledge of macro economics to decide when and where to

apply it.

HICKS THEORY OF BUSINESS CYCLE:

Hicks put forward a complete theory of business cycle bases on

the interaction between the multiplier and accelerator by

choosing certain values of marginal prosperity to consumers and

capital –output ratio which we thinks are representative of the

real world situation. According to hicks the value of marginal

propensity to consume and capital –output ratio fall in either

region. The theory of business cycles has been in a peculiarly

unsettled position since Keynes' General Theory first appeared.

The older students of the subject were, as a rule, concerned with

the fluctuations in business activity at large—not with the

movements of a particular economic factor such as production,

employment, prices, or incomes. Keynes shifted the emphasis

violently in two directions. First, he made the level of employment

his major interest. Second, he concentrated on the factors that

tend to make this level at one time higher or lower than at

another. Thus the fundamental unit of analysis became the

'volume of employment at any time' rather than 'the business

cycle.' This shift of emphasis was well suited to the thirties, when

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unemployment overshadowed every other economic and political

problem. Before long Keynes' theory was eagerly embraced and

ingeniously simplified. Not only business cycle theory but the

theory of value itself fell for a time by the wayside. For if Keynes

was able to explain what determines the volume of employment

without troubling much about the cost-price structure, some of

his followers could do so without troubling about it at all. But

economic life does not stand still and ever)' change in its

underlying conditions sooner or later stimulates fresh economic

thinking. Under the impact of war and inflation during the

forties, theoretical interest in the behaviour of prices, production,

efficiency, and the business cycle has slowly remerged. Hicks'

recent book on the 'trade cycle' is a significant expression of

renewed concern with the cycle, in contrast to the level of

employment. A fundamental task of modern economics, as Hicks

sees it, is to pass from the Keynesian theory of employment to a

theory of business cycles. And that is what he has set out to do. "It

is . . . a mistake," he tells us, "to begin one's investigation with a

definition of the kind of fluctuation which one is going to regard

as basic deciding whether one is going to regard the cycle as being

fundamentally a fluctuation in employment, or output, or prices,

or interest rates, or money supplies. It is better to allow the

definition to emerge as the theory develops". This suggests that

the interdependence of the money supply, costs, prices, profits,

income disbursements, consumer spending, investment,

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employment, and other economic factors will be fully displayed in

unfolding the drama of the cycle. And if this suggestion carries a

promise of useful achievement, so too does Hicks' awareness of

the hard road that must be travelled in building knowledge. For

while he believes he has found the "main part of the answer" to

the puzzle of business cycles, he candidly describes his work as

"little more than an untested hypothesis" which will need to be

tested "against the facts" before it can be accepted as a basis for

prescriptions of policy.

PROFITABILITY IN BUSINESS CYCLE THEORY AND

FORECASTING:

According to RBC theory, business cycles are therefore "real" in

that they do not represent a failure of markets to clear but rather

reflect the most efficient possible operation of the economy, given

the structure of the economy. RBC theory differs in this way from

other theories of the business cycle such as Keynesian economics

and Monetarism that see recessions as the failure of some market

to clear. Given the important connections among profitability,

investment, and economic activity, a profitability indicator can be

used to assess where the economy is in the business cycle. Rising

profitability suggests that the economy is on a secular growth

path, while a peak or fall in profitability suggests that growth is

slowing and the economy is headed for recession. One measure of

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profitability is to divide total business sector profit by total wages

paid to labour. Let this variable be called the PW ratio.

This paper's research shows that the PW ratio leads recessions,

and that it takes two to six quarters of decline in PW before the

onset of recession. PW clearly peaks in stage three of the business

cycle. The evidence demonstrates that the PW ratio compares

favourably with other indicators used by forecasters. The paper

concludes that wages are not responsible for squeezing profits

until stage seven on average, and fluctuations in profit over the

cycle exceed that of wages and the gap grows in late expansive.

UNDER CONSUMPTION THEORY OF BUSINESS CYCLE:

 Under consumption Theories (International Publishers, 1976)

Michael Blamey defined two main elements of classical (pre-

Keynesian) under consumption theory. First, the only source of

recessions, stagnation, and other aggregate demand failures was

inadequate consumer demand. Second, a capitalist economy tends

toward a state persistent depression because of this. Thus, under

consumption is not seen as part of business cycles as much as

(perhaps) the general economic environment in which they occur.

Compare to the Marxian tendency of the rate of profit to fall,

which has a similar belief in stagnation as the natural (stable)

state, but which is otherwise distinct and in critical opposition to

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under consumption theory. In under consumption theory

in economics, recessions and stagnation arise due to inadequate

consumer demand relative to the amount produced. The theory

has been replaced since the 1930s by Keynesian economics and

the theory of aggregate demand, both of which were influenced by

under consumption.

Under consumption theory narrowly refers to heterodox

economists in Britain in the 19th century, particularly 1815

onwards, which advanced the theory of under consumption and

rejected classical economics in the form of Ricardian economics.

These economists did not form a unified school, and their theories

were rejected by mainstream economics of the time.

Under consumption is an old concept in economics, going back to

the 1598 French mercantilist text Les Tensors et richesses pour

metre l'Estat en Splendour (The Treasures and riches to put the

State in Splendour), if not earlier. The concept of under

consumption had been used repeatedly as part of the criticism of

until under consumption theory was largely replaced by

Keynesian economics which points to a more complete

explanation of the failure of aggregate demand to attain potential

output, i.e., the level of production corresponding to full

employment.

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One of the early under consumption theories says that because

workers are paid a wage less than they produce, they cannot buy

back as much as they produce. 

KEYNESIAN THEORY OF BUSINESS CYCLES:

Keynes response to classical theory of trade cycle. The Keynes

theory of business fluctuations was developed during the Great

Depression of the 1930 s it was in response to the classical theory

that the economy is self correcting. The classical economists were

of the view that if at any time excessive unemployment occurs in

the economy market forces automatically restores the economy to

its full employment level in the long run.

J. M. Keynes, however, disagreed with the above view He

presented a new theory which is based on a demand side

explanation of business cycles.

According to Keynes in the short run, the level of income, output

and employment is determined by the level of aggregate effective

demand. Aggregate demand is composed of demand for

consumption goods and demand for investment goods. If the

expenditure on goods and services and investment is large, then

greater quantity of goods will be produced. This will create more

employment and income if the aggregate demand is low then

smaller amount of goods and services will be produced. A lower

level of aggregate, demand thus results in smaller output, income

and employment. J.M. Keynes is of the view that it is the changes

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in the level of aggregate demand which bring about fluctuations

in the level of income output and employment. Now what causes

changes in aggregate demand?

The fluctuation in economic activity says Keynes is due to

fluctuations in investment demand. The investment demand is

determined by expected rate of profit from the investment on the

one hand and the rate of interest on the other hand.

Investment demand

Lord Keynes defines marginal efficiency of capital as the expected

rate of profit between the prospective yield of that type of capital

and the cost of producing that unit If the prospective rate of

return of capital used in the business is higher than the current

rate of interest the entrepreneurs are encouraged to increase

investment spending on construction, equipment, and inventories.

Marginal efficiency of capital depends upon two factors: (1)

Expected return from capital assets and (2) The supply price or

replacement cost of the assets. Marginal efficiency of capital is

raised by opening of a new investment a new product a new

method of production a major change in the organization of

business and by the expectation of rising prices It is lowered by

failing prices rising costs productive difficulties and a decline in

investment. A rise in the marginal efficiency of capital relatively

to the current rate of interest leads to a burst in investment. The

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volume of employment and income increases. The demand for

consumer goods goes up which leads to further increase in

investment goods industries.

Expansion phase of the business cycle:

During the expansion of trade cycle the investors have an

optimistic outlook. They in enthusiasm over estimate the expected

rate of return from the investment projects. The expansion of the

economy goes on automatically till full employment of resources is

reached. The movement of the economy towards full employment

is called a boom fl the boom phase the investors ignore the fail in

the marginal efficiency of capital. The rate of interest also does

not act as a brake on rising investment. The over investment n the

economy raises the cost of production of goods and begins to

reduce profits on investment.

Recession and Depression:

The contraction phase of the business cycle is brought about by a

fall in the marginal efficiency of capital relatively to the

prevailing rate of interest when all the remunerative channels for

investment are fully utilized then the scope for further investment

declines. Due to excessive demand for loadable funds, the reserves

of the banks get depleted. The market rate of interest goes up.

The higher rate of interest induces people to save more money.

The higher liquidity preference or the increasing demand for

money to hold reduces the demand for consumer goods. When the

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business prospects appear bleak the investors are then not

prepared to renew or extend their capital equipment. Due to

excess of savings over-investment the income and employment

decline we are then in a phase of recession which finally results in

depression.

It may be remembered here that J M Keynes has used three

psychological propensities in formulating his theory of business

cycle. They are (i) propensity to consume (ii) propensity to save

and (iii) the marginal efficiency of capital Lord Keynes also

introduced the concept of multiplier in order to show the effect of

increase in total income due to increase in investment. Keynes is

of the view that upswing of business cycle is caused by a rise in

the marginal efficiency of capital. When the entrepreneurs find

that the opportunities for profitable investment exist they repair

the existing plants and install the new ones. The money spent by

the investors goes into the pockets of wage earners. They then

increase their orders of consumption goods. The total receipts of

the entrepreneurs go up. They being encouraged to high profits

place more orders for consumption and capital goods industries.

The volume of employment and income increases. The multiplier

is then at work.

Recovery is a slow process

According to Keynes the recovery after depression is a slow

process. How much time the economy takes to recovery depends

upon three factors:

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i) Rate of growth of the economy.

Ii) Time period of the wearing out of the capital goods.

Iii) Time taken to dispose of the stocks of the boom period.

Keynes theory dominated economic thinking from late 1930’s to

early 1970’S. Criticism of Keynes Theory of Trade Cycle.

The Keynesian theory of business cycle is criticized on the

following grounds:

(i) it offers half explanation Keynes theory offer half explanation

of the business cycle. It fails to explain the periodicity of the trade

cycles.

(ii) Neglect of the role of accelerator J M Keynes explained the

process of downswing and upswing of trade cycle through the

concept of investment multiplier. The fact however is that

multiplier alone does not offer satisfactory explanation of the

business fluctuations. It is the multiplier acceleration interaction

which brings about expansion or contraction of the economic

activity.

(iii) Psychological theory Keynes theory of trade cycle is very near

to the psychological theory of the Classical economists. It does not

explain the real factors which cause changes in business

expectations.

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BUSINESS AND GROWTH RATE CYCLE :

Business and growth rate cycles with special reference to the

Indian economy. It uses the classical NBER approach to

determine the timing of recessions and expansions in the Indian

economy, as well as the chronology of growth rate cycles, viz., the

timing of speedups and slowdowns in economic growth. The

reference chronology for business as well as growth rate cycles is

determined on the basis of the consensus of key coincident

indicators of the Indian economy, along with a composite

coincident index comprised of those indicators, which tracks

fluctuations in current economic activity. Finally, it describes the

performance of the leading index – a composite index of leading

economic indicators, designed to anticipate business cycle and

growth rate cycle upturns and downturns

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Conclusion.

Most economists explain business cycles in terms of the sticky

price model we have been discussing.  That is, there is a short run

aggregate supply curve so that when aggregate demand

fluctuates, there is a fluctuation in total output.  The model

doesn’t work perfectly, and economists would like an alternative. 

In recent years, many economists have begun to suggest an

alternative model, that business cycles are due to fluctuations in

the aggregate supply curve.

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BIBLIOGRAPHY:

References:

H.L. Ahuja for macro economics

Steven M. Sheffrin (2003) - Economics: Principles in action.

www.wikipedia.com

www.investopedia.com

www.businesscycle.com

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