Business Cycle

In last two years due to US slowdown many Indian IT, pharmaceutical and textile companies faced difficulties in running their operations and also offered pink slips to their employees.

And then the phrase was coined when US sneezes India catches cold

Why is it so?

Business Cycle

Business cycle is periodic up and down movement in economic activities The cyclical movement is characterized by alternative waves of expansion and contraction, and it is associated with alternate periods of prosperity and depression.

Features of Business Cycle

Periodicity Synchronization Self Reinforcing

Phases of Business Cycle

Peak Peak
Level of Real Output

Peak

Trough Trough
Time

Phases of Business Cycle

Expansion all macro economic variables increase, self reinforcing factors pushes the economy up Peak Highest point of growth, no further expansion is possible and turning point towards slow down

Phases of Business Cycle

Contraction Slowing down process of all economic activities. Thus increasing unemployment and reducing income and consumption, marks the onset of recession Trough Slump or depression, next turning point where new growth process starts

Multiplier

Multiplier depicts relationship between changes in national income due to change in autonomous investment Income is composed of consumption and saving
Y

=C+S

MPC & MPS

Marginal propensity to consume change in consumption expenditure due to a change in income

MPC

= dC/dY

The value of MPC lies between zero and unity As Y increases C also increases, but increase in C is less than increase in Y

MPC & MPS

Marginal propensity to save measure of the effect of change in total income on the keenness of people to save
MPS

= dS/dY

MPS also lies between Zero and unity MPS and the MPC is equal to one Therefore, MPS = 1 MPC

Multiplier
Y=C+S dY = dC + dS 1 = dC/dY + dS/dY 1 = MPC + MPS

Multiplier is change in income due to change in saving

k = dY/dS = 1/MPS

In other words, multiplier is reciprocal of MPS

Accelerator

Acceleration Principle Changes in demand for consumer goods brings about wider changes in the production of appropriate capital goods Changes in aggregate demand induces investors to invest more

Accelerator

K t = v Yt

Kt Capital stock Yt level of aggregate demand at time t V optimal stock of capital per unit flow of output at a time period t

Multiplier & Accelerator

As into multiplier, if there is a change in autonomous saving, national output increases by the multiplier effect As per accelerator principle, change in national output thereby aggregate demand also brings about a change in induced investment. Because as the production increases, investors are induced to invest more, which again goes through the multiplier effect

Hicks Theory
Three concepts play an important role

Warranted rate of growth Autonomous and induced investment Multiplier & Accelerator

Hicks model Interaction of Multiplier & Accelerator

Perd 1 2 Autonomous Investment 100 100 Induced Cnsumpt 0 67 Induced invtmnt 0 133 Increase in Income 100 300 Expansion Business Cycle Phase

3
4 5 6

100
100 100 100

200
378 556 674

267
356 356 237

567
833 1011 1011 Full Emplymnt

7
8 9 10

100
100 100 100

674
516 200 -221

0
-316 -632 -843

774
300 Contraction -332 -964

Effects of Business Cycles

Expansion

Inflation Severe Competition

Recession

Excess Inventory Retrenchment

Controlling Business Cycles

At the Firm Level

Investments Inventory Products Pricing

Controlling Business Cycles at Government Level

Monetary Measures Rediscount rate Reserve ratios Open market operations Selective credit control

Controlling Business Cycles at Government Level

Fiscal Measures Public expenditure Public revenue