16. Trade Cycles-Meaning, Definition and Phases Objectives: After studying this lesson, you will be able to understand,
•
The meaning of trade cycles.
•
The different phases of trade cycles
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The meaning of Boom
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The meaning of Depression
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The meaning of Recovery
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The meaning of Recession
16.1 Introduction
16.2.Definition of Inflation
16.3 Phases of Trade Cycle
16.3.1 Slump or Depression
16.3.2 Recovery
16.3.3 Boom or Prosperity
16.3.4 Recession
16.4
Summary
16.5 Check your progress
16.6 Key concepts
16.7 Self Assessment questions
16.8 Answers to check your progress
16.9 Suggested Readings
16.1 Introduction:
We covered quantity theories of money in earlier lessons. In the present lesson, our attention will be on Trade cycles or Business cycles and their meaning, Phases and their import importance ance in an economy economy.. Trade Trade cycles cycles are a promin prominent ent featur featuree of the capita capitalis listt economies. Cycles refer to the regular fluctuations in economic activity in the economy as a whole. The expansions, recessions, contractions and revivals of aggregate economic activity activity occur and recur in an unchanged unchanged sequence. These business business cycles cycles are affected business business firms different differently ly by cyclical cyclical fluctuatio fluctuations ns owing to the differing nature of their businesses. Moreover, the effects on the business firms during the expansion phase differ from the effects in the contraction phase. Similarly other phases also will have effect on business. The measures, which can be employed to solve the problems arising out of business cycles, are discussed under two. First one is preventive measures are those steps which are designed to prevent the individual concern from suffering serious losses during the recess recession ion and contrac contracti tion on phases phases of cycles cycles.. Secondl Secondly y Relief Relief measur measures es are those, those, which are designed to quicken the recovery following a period of contraction.
16.2 Meaning of Trade Cycles:
There are different versions given by various groups of economists about the meaning of trade cycles.
However, Clement Juglar was the first economist who was statistically established the presence of business cycles in the latter half of the 19th century. Since then extensive research has been conducted on the subject and there has been much difference of opinion among economists in respect of its definition.
According According to W C Mitchell Mitchell and A F Burns “ Business cycles cycles are a type of fluctuation fluctuation found in the aggregate economic activity of nations that organize their work mainly in business business enterprises: enterprises: a cycle consists consists of expansions expansions occurring occurring at about the same time in many economic activities activities followed by similarly similarly general recessions, recessions, contractions contractions and revivals revivals which merge into the expansion expansion phase of next cycle: this sequence of change is recurrent but not periodic: in duration business cycles vary from more than once year to ten or twelve years: they are divisible into shorter cycles with amplitudes approximating approximating their own”.
In Keynes words, “A Business cycles is composed of periods of good trade characterized by rising prices and low unemployment percentages alternating with periods of bad trade characterized by falling prices and high unemployment percentages”. Thus, a marked feature of a business cycle is the boom being followed by a depression, a recovery and again boom conditions in a free enterprise economy which is highly industrialized.
According to R A Gordon, Business cycles consist of recurring alternations of expansion and contrac contracti tion on in aggregat aggregatee econom economic ic activi activity, ty, the altern alternati ative ve moveme movements nts in each each direction direction being self-reinfor self-reinforcing cing and pervading virtually virtually all parts of the economy”. economy”. In other words, business cycles are regular fluctuations in income, output and employment, which trend to be self-reinforcing or cumulative. Once a change starts, it tends to gather speed fast.
In A H Hansen’s view, “business cycle is a manifestation of the industrial segment of the economy from which prosperity or depression is redistributed to other groups in the highly interrelated modern society”. We can thus say that a trade cycle invariably starts in the industrial sector and then spreads itself over the other sectors quickly because in modern economy, the different sectors are interrelated.
John Tin Bergen considered the cyclical fluctuations as the “interplay between erratic shocks and an economic system’s ability to perform cyclical adjustment movement to such shocks”
Ragnar Frisch has echoed the same expression in the following words. ”Impulses from outside operate upon the economy causing it to move in a wave-like manner, just as an external shock will set a pendulum swinging”.
In brief the above definitions of trade cycles, reveals some important characteristics of trade cycles, they are: (A) A business cycle is an economy-wide phenomenon. When depression sets in the industrial sector, it cannot be restricted there. Soon it spreads to agriculture, trade and transport sectors; so is the case during boom. (B) A business cycle shows shows a wave-l wave-like ike variat variation ion in econom economic ic activi activity ty.. The expansi expansion on or prospe prosperit rity y is followed by a depression and so on the economy moves from one extreme to another almost like a pendulum. (C) Business fluctuations tend to recur; they come again and again after the lapse of some time. The time or periodicity is not always the same. Nor are the causes always the same. Some trade cycles may last only two or three years while others may be of six to eight years in duration. (D) Trade cycles are self-reinforcing or cumulative. Once, the cyclical movement starts in one direction, it tends to feed on itself. The force of the economic crisis tends to increase. Once the prosperity phase starts, it tends to run out of control of the policy markers.
16.3 Phases of a Trade Cycle:
A business cycle is a short –term picture of the behavior of real output in a private enterp enterpris risee econom economy. y. Indust Industria rializ lized ed economi economies es having having free free market market mechan mechanism ism have economic growth over the long period. But the process of economic growth is often shaken by business cycles, which show up-turn and downturn of income, output and employment. A business cycle can be shown to be a wave-like path of the economy’s real output. Economists often describe a business cycle with the help of distinct phases or stages. The four phases of a business cycle are: a) Slump b) Recovery c) Boom d) Deflation These have demarcated in the diagram, now we can describe the four phases of a typical trade cycle as follows:
16.3.1 Slump or Depression:
This This is the most criti critical cal and fearfu fearfull stage stage of a trade trade cycle. cycle. Haberler Haberler has described described depression as “ a state of affairs in which real income consumed or volume of production per head and the rate of employment are falling and are sub-normal in the sense that there are idle resources and unused capacity, especially unused labor”. A Slump or depression shows itself first in a substantial decline in general output and employment. The decline in economic activity is not, of course, uniform. Contraction in output might be much more more in manufa manufactu cturin ring g such such as machin machinery ery and equipm equipment ent,, mining mining,, constr construct uction ion and transport than in retail trade or agriculture.
While output and employment tend to fall fast during the slump, prices and wages continu continuee to declin decline. e. This This is really really agonizing agonizing experie experience nce for both the produc producers ers and workers.
Prices decline because of the expectations of producers in general that these would continue to fall in spite of all governmental efforts. While the producers try to dispose of
their stocks at the current market prices, the consumers tend to post pone their purchases in the hope that the prices would fall further and they would be able to benefit from it. Scared by the general slump in the economy, the financial institutions press the producing firms to return their advances according to the contract. This forces the producers to meet their contractual obligations through unintended sales of their inventories in a market where prices are already declining. This deepens the depression further. Most firms redu reduce ce thei theirr outp output ut and and as such such are are forc forced ed to laylay-of offf work worker ers. s. As unem unempl ploy oyme ment nt increases, the wages tend to fall under its pressure. However, the fall in wages is less than the fall in prices. This is because workers’ unions strongly oppose wage reductions. The rate rate of fall fall in pric prices es of agri agricu cult ltur ural al raw raw mate materi rial alss is gene genera rall lly y more more than than that that of manufactured products. This is because the producers are not prepared to lift off the supplies of the raw materials, which causes a sharper fall in their prices than the prices of manufa manufactu ctures res.. The wholesa wholesale le prices prices fall fall faster faster than than the retail retailss prices prices.. These These sudden sudden changes in the relative price structure of the economy cause dislocations in production and exchange. Depression or slump leads to redistribution of the national income. Profits and wages fall faster relatively to rent and other fixed incomes. Incomes of shareholders go down fast. This reduces the deposits with banks and other financial institutions. They, in turn, follow the policy of credit contraction. While producers are reluctant to borrow because of dull trade conditions, the financial institutions are hesitant in lending for fresh investments. This causes the depression to persist for a longer period than it would have losted on its own.
16.3.2 Recovery:
Recovery shows the upturn of the output and employment of the economy from the state of depression. Recovery is most probably the result of the fresh demand for plant and equipment arising from the consumer goods industries, which has been postponing this investment investment during depression. depression. The replacement replacement demand starts starts the recovery recovery process. process. Wages and other incomes show a noticeable rise. Profits also start rising, which spurs the producers to float fresh investment proposals in the stock market. It must be pointed out here that a non-intervention policy from the government fails to start the recovery phase. Recovery is a slow and halting process. The government has to pursue stabilization policies and show special initiatives in dispelling the pessimistic mood of the investors. The economic system, system, left to itself, is likely to stagnate stagnate in the state of depression depression for an intolerably long period for the working class.
16.3.3 Boom or Prosperity:
During the recovery phase, rise in output and incomes of the people induce substantial increase increase in aggregate aggregate spending. This has a multiplier multiplier effect. This cumulative cumulative process process of
rising investment and employment forges ahead. As investors become more confident, expanding productive activity takes the economy to a boom or prosperity phase. It means that there is a state of enthusiasm in the business community. Industrial and commercial acti activi vity ty,,
both both
spec specul ulat ativ ivee
and and
nonnon-sp spec ecul ulat ativ ive, e,
show showss
rema remark rkab able le
expa expans nsio ion. n.
Constr Construct uction ion activi activity ty gets gets a bog boost. boost. Share Share market marketss reflec reflectt the genera generall state state of exuberation of the investors. Financial institutions tend to expand credit as the interest rates and discount rates go up. Thus, everyone seems to be happy during the state of prosperity, which ultimately, of course, proves to be short-lived.
16.3.4 Recession:
The end to prosperity phase comes because of certain tendencies in the private-enterprise economy prevalent during the boom conditions. They are: a) as prices rise, wages tend to lag behind. As a result, purchasing power of workers, who form a majority of the people, tend tendss to lag lag behi behind nd the the supp supply ly of consu consume merr goods goods.. b) Expa Expans nsio ion n of prod produc ucti tion on is hamper hampered ed by shorta shortages ges of some some inputs inputs and bottle bottlenec necks ks in product production ion.. c) Excess Excessive ive demand for labor and materials materials pushes up both the factor and the product prices prices but in a disproportionate fashion. d) The non-availability of credit beyond a particular rate of expansion might also act as a serious break on prosperity. Financial institutions including banks cannot expand credit beyond a limit put by their reserve requirements. As this limit is reached, they start recovering their loans. Shortages of finance crop up. Firms are forced to liquidate their stocks when most firm try to sell there output at the same time, the price level starts falling. When some firms get involved in losses in this way, a wave of pessimis pessimism m runs runs through through the share markets. markets.
Product Production ion schedule scheduless by firms firms are
curtailed; workers are laid off and outstanding orders for raw materials are cancelled. In this way the wave of pessimism gets transmitted to other sectors of the economy. The whole economic system thereby runs into a crisis. Thus the next stage of the trade cycle, called recession of deflation starts.
When sure signs of recession appear on the stock and financial markets, over-pessimism, nervou nervousn snes esss and and fear fear born born out of unce uncert rtai aint nty y overt overtak akee the the busin busines essm smen en.. In this this
atmosphere, new projects are shelved. Even the projects in hand may be abandoned. Some firms go sick. Others simply go bankrupt. All this hastens the process of economic contraction. The fall in the purchasing power of the general public reduces demand for consumer goods, which aggravates the slackening demand for machines and equipment. The business would goes panicky. What was recession or deflation fore some time now converts itself into depression.
16.4
Summary
Trade cycles are a prominent feature of the capitalist economies. Cycles refer to the regular fluctuations in economic activity in the economy as a whole. The expansions, recessions, contractions and revivals of aggregate economic activity occur and recur in an unchanged sequence. A business cycle can be shown to be a wave-like path of the economy’s real output. Economists often describe a business cycle with the help of distinct phases or stages. They are, Slump or Depression, Recovery, Boom or Prosperity and Deflation. A Slump or depression shows itself first in a substantial decline in general output and employment. The decline in economic activity is not, of course, uniform. Recovery shows the upturn of the output and employment of the economy from the state of depression. During the recovery phase, rise in output and incomes of the people induce substantial increase in aggregate spending. This has a multiplier effect. As investors become more confident, expanding productive activity takes the economy to a boom or prosperity phase. In the pessimistic atmosphere, new projects are shelved. Even the projects in hand may be abandoned. Some firms go sick. Others simply go bankrupt. All this hastens the process of economic contraction. This is the stage of recession. These variou variouss types types of busine business ss cycle cycle are affect affected ed busine business ss firms firms differ different ently ly by cyclic cyclical al fluctuations owing to the differing nature of their businesses. Moreover, the effects on the business firms during the different phases are certainly hav ing different effects. Therefore governments have to take required actions to come out of them and should see that the economy run smoothly.
16.5 16.5 Chec Check k your your pro progr gres esss State whether the following statements are True or False
1. Business cycles are affected business firms 2. Business cycle shows a wave-like variation in economic activity. 3. Slump or depression shows a substantial rise in general output and employment. 4. Recovery shows the upturn of the output and employment of the economy from the State of boom 16.6 Key concepts
Business cycles Boom Recovery Depression Deflation Stabilization policies
16.7 Self Assessment questions
1. Defi Define ne the the busi busine ness ss cyc cycle less 2. Explai Explain n the differ different ent phase phasess of Trade Trade Cycles Cycles 3. What What are are the the effec effects ts of of Trade Trade cycl cycles es
16.8 Answers to check your progress
1. True 2. True 3. False 4. False
16.9 Suggested Readings
Ackley Gardner:
Macro economic theory
Ward R A:
Monetary theory and policy
Rana & Verma:
Macro economic analysis
Hajela TN:
Monetary economics
Ghatak:
Monetary economics in developing economies
