Business Cycles | UGC NET Economics – Notes

Introduction

• Rapid economic growth witnessed by many developed economies during the past two centuries has not been a smooth one. There have been periodical ups and downs in the GDP levels of these countries. Along with output, there have been fluctuations in various economic aggregates such as income, employment and prices and their long term trends. These economies have experienced phases of expansion and contraction in output and other economic aggregates alternatively. These alternating phases of upswings and downswings are known as business cycles.

• Theoretical explanations of business cycles evolved in the early 20th century. Periods of expansion and contraction in an economy exhibited a remarkable degree of regularity. The characteristics of these phases are carefully documented by economists like Wesley Mitchell, Simon Kuznets and Frederick Mills. Mitchell documented the co-movement of variables over the cycles; Mills documented the co-movement of prices and quantities over expansions and contractions, while Kuznets studied the patterns of both growth and fluctuations.

• The 1930s was a very active period of business cycle research as the National Bureau of Economic Research (NBER) continued its program (begun by Mills and Mitchell) of empirically documenting the features of business cycles. However, interest in business cycles waned after the publication of Keynes’ General Theory which turned attention away from Business cycles to short run management of the economy. Interest in business cycles revived in the 1970s when the prevalent economic crisis in many countries could not be explained by Keynesian model.

Features of Business Cycles

• Business cycles are economy-wide fluctuations in output, unemployment, prices, revenue, profits, and interest rates, among other variables. These fluctuations occur across the economy and over a number of years. Fluctuations always take place in an economy. Business cycles, however, do not refer to fluctuations that are specific to one geographic region or industry within an economy. To identify business cycles, we must look at factors that can have an effect on the entire economy.

• Business cycles consist of recurrent alternating phases of expansions and contractions in a number of economic variables including employment, production, real income, and real sales. Business cycles involve multidimensional processes, in which quantities and prices, stocks and flows, outputs and inputs, real, monetary, and financial variables all tend to move together. These are asymmetric in the sense that expansions typically exceed contractions in size and duration. Business cycles can be distinguished from the other fluctuations in that they are usually larger, longer, and widely diffused.

The major features of business cycles are as follows:

1. Though business cycles do not show the same regularity, they have some distinct phases such as expansion, peak, recession, trough and recovery. The duration of cycle can vary between two years to twelve years.

2. Business cycles are synchronic. Depression or contraction occurs simultaneously in most industries or sectors of the economy. Recession passes from one industry to another and chain reaction continues till the whole economy is in the grip of recession. Similarly, expansion spreads through various linkages between industries or sectors.

3. Fluctuations occur simultaneously in the level of output as well as employment, investment, consumption, etc.

4. Consumption of durable goods and investment are affected the most by cyclical fluctuations. As stressed by Keynes, investment is very unstable as it depends on profit expectations of private entrepreneurs. Any change in these expectations makes investment unstable. Thus the amplitude of fluctuation in the case of durable household effects is higher than that of GDP.

5. Consumption of non-durable goods and services do not vary much during the different phases of business cycles. Past data of business cycles reveal that households maintain a great stability in the consumption of non-durable goods. Thus the amplitude of fluctuations in the case of non-durable consumption goods is lower than that of GDP.

6. The immediate impact of recession or expansion is on the inventories of goods. When recession sets in, inventories start accumulating beyond the desired level. It leads to cut in production of goods. In contrast, when recovery starts, the inventories go below the desired level. It encourages business houses to place more orders for goods which boost production and stimulates investment.

7. Profits fluctuate more than any other type of income as the occurrence of business cycles causes lot of uncertainty for the businessmen and makes it difficult to forecast economic conditions. During depression, profits turn negative and many businesses go bankrupt.

8. Business cycles are international in character. That is, once started in one country, they spread to other countries through contagion effect. The downslide in financial market, for example, in one country spreads rapidly to other country as financial markets are linked globally through capital flows. Further, recessions in one country, say the United States can spread to other country as the imports of the U.S.A. will decline. Countries which are major exporter to the U.S. will witness a decline in their exports and may witness recession.