Tuesday, February 25, 2014

BUSINESS CYCLE

BUSINESS CYCLE

Introduction

The economic progress the world has been achieved is not a steady and continuous movement forward. Economic activities faced fluctuations at more or less regular intervals .There were upward swings and downward swings. A period of prosperity was generally followed by a period of depression .These ups and downs in the economic activity moving like a wave at regular intervals is known as business cycle. Business cycle simply means the whole course of business activity which passes through the phases of prosperity and depression. Generally there are two broad phases, viz. prosperity and depression.

The movement is like the swing of a pendulum. A movement in one direction tends automatically to generate a movement in the opposite direction. The period of business prosperity alternate with period

of depression.   The period of
business  prosperity  contains within itself the seed of the coming period
of depression. Once depression
reached the  through, recovery starts  and  soon  grows  into  boom  or

prosperity. At the peak of the boom recession grips the economy which soon slides into depression. To be specific, there are four phase‟s .viz .recovery, boom recession and depression.

The Business cycle influence business decision. The cycles affect not only the economy in general, but each individual business firm . The period of prosperity promotes business. It provides new investment opportunities. Likewise, a period of depression slackens business. A manager who is always confronted with the problem of forward planning takes into consideration the phase of the business cycle. This helps to take advantage of the chance ahead or to reduce the chance of heavy losses to the firm

Phases of business cycle Boom

This is also known as prosperity phase. The products in this phase fetch an above normal price which is above higher profit. This attracts more and more investors. The existing production capacity is utilized at its full capacity. More and more new machines are made use of the business of the capital goods industry also shoots up. The price of the factors of production increases. Additional workers are employed at higher wage rate. The increasing cost tendency of the factors of production leads to a continuous increase in product cost. The fixed income group on the salaried class find it difficult to cope with this increase in prices. The income does not increase accordingly and they are now compelled to reduce consumption. The demand is now more or less stagnant or it even decreases. Thus boom or prosperity reaches its peak.

Recession
Once the economy reaches the peak- the course changes.  A downward tendency in demand is

observed
but the producers who are

not aware
of it goes on producing further.
The supply now
exceeds demand. Now the  producers
come to notice that their stock piling up . They are compelled to
give  up
the future investment plans.
The order
for new  equipments  and  raw materials
are
cancelled.  A business even cuts down
its existing business . Workers
are retrenched
Capital goods
producers who lose orders. Bankers
insist on  repayment . stock  accumulate and
Business   failure
increase investment
ceases and unemployment leads to fall in income ,expenditure ,prices , profits and
industrial
and trade
activities.  Desire
for liquidity increase all around
producers
are
compelled
to


reduce price so that they can find money to meet their obligations Consumers who expect a still further decline in prices postpone their consumption Stock goes on piling up . Some firms are forced into bankruptcy . The failure of one firm affects other firm with whom it has business connections. There is a general distress. This phase of the business cycle is known as the Recession .It is the period of utmost -suffering for a business.BUSINESS CYCLE

Introduction

The economic progress the world has been achieved is not a steady and continuous movement forward. Economic activities faced fluctuations at more or less regular intervals .There were upward swings and downward swings. A period of prosperity was generally followed by a period of depression .These ups and downs in the economic activity moving like a wave at regular intervals is known as business cycle. Business cycle simply means the whole course of business activity which passes through the phases of prosperity and depression. Generally there are two broad phases, viz. prosperity and depression.

The movement is like the swing of a pendulum. A movement in one direction tends automatically to generate a movement in the opposite direction. The period of business prosperity alternate with period

of depression.   The period of
business  prosperity  contains within itself the seed of the coming period
of depression. Once depression
reached the  through, recovery starts  and  soon  grows  into  boom  or

prosperity. At the peak of the boom recession grips the economy which soon slides into depression. To be specific, there are four phase‟s .viz .recovery, boom recession and depression.

The Business cycle influence business decision. The cycles affect not only the economy in general, but each individual business firm . The period of prosperity promotes business. It provides new investment opportunities. Likewise, a period of depression slackens business. A manager who is always confronted with the problem of forward planning takes into consideration the phase of the business cycle. This helps to take advantage of the chance ahead or to reduce the chance of heavy losses to the firm

Phases of business cycle Boom

This is also known as prosperity phase. The products in this phase fetch an above normal price which is above higher profit. This attracts more and more investors. The existing production capacity is utilized at its full capacity. More and more new machines are made use of the business of the capital goods industry also shoots up. The price of the factors of production increases. Additional workers are employed at higher wage rate. The increasing cost tendency of the factors of production leads to a continuous increase in product cost. The fixed income group on the salaried class find it difficult to cope with this increase in prices. The income does not increase accordingly and they are now compelled to reduce consumption. The demand is now more or less stagnant or it even decreases. Thus boom or prosperity reaches its peak.

Recession
Once the economy reaches the peak- the course changes.  A downward tendency in demand is

observed
but the producers who are

not aware
of it goes on producing further.
The supply now
exceeds demand. Now the  producers
come to notice that their stock piling up . They are compelled to
give  up
the future investment plans.
The order
for new  equipments  and  raw materials
are
cancelled.  A business even cuts down
its existing business . Workers
are retrenched
Capital goods
producers who lose orders. Bankers
insist on  repayment . stock  accumulate and
Business   failure
increase investment
ceases and unemployment leads to fall in income ,expenditure ,prices , profits and
industrial
and trade
activities.  Desire
for liquidity increase all around
producers
are
compelled
to

reduce price so that they can find money to meet their obligations Consumers who expect a still further decline in prices postpone their consumption Stock goes on piling up . Some firms are forced into bankruptcy . The failure of one firm affects other firm with whom it has business connections. There is a general distress. This phase of the business cycle is known as the Recession .It is the period of utmost -suffering for a business.
Depression

Underemployment of both men and material is the characteristics of this phase. General demand falls faster than production. Producers are compelled to see their goods at a price which will not even cover the full cost. Manufactures of both producer‟s goods and consumers goods are forced to reduce the volume of production. As a result workers are thrown out . The remaining workers are poorly paid

.The  demand for bank credit  is at its lowest  which results  in idle funds .The interest rates also decline
.The firms that cannot pay of their debts are wound up. Prices of shares and securities fall down.
Pessimism prevails in the economy the less confident investors are not ready to take up new investment projects The aggregate economic activity is at its bottom.

Recovery

Depression phase does not continue indefinitely. Depression contains in itself the gems of recovery. The rule workers now come forward to work at low wages. As the prices are at its lowest the consumers, who postponed their consumption expecting a still further fall in price , now starts consuming .The banks, with accumulated cash reserves, now come forward to gives loans at easier terms and lower rates. As demand increases the stock of goods become insufficient. The economic activity now starts picking up . Investment pick up .Employment and output slowly and steadily begins to rise. Increased income increases demand, resulting in rise in prices, profits investment, employment and incomes. The wave of recovery once initiated soon begins to feed upon Itself .Stock markets become live thus hastening the revival. Optimism develops among the entrepreneurs. Bank loans and demand for credit starts rising. The depression phase at its through then given way to recovery.


Characteristics of a business cycle

1.    The cycle is synchronic .The upward and downward movements tend to occur at all the same period in all industries . The wave of prosperity or depression generate a wave in other industries. When

industry pick up  to  provides
more
employment , more income etc.  to   workers and it gives  new
orders for raw materials and
capital
goods. This help other firms also to prosper.

2.    A business cycle is a wave-like movement. The period of prosperity and depression can be alternately seen in a cycle.

3.    Cyclical fluctuations are recurring in nature . The various phases are repeated is followed by depression and the depression again in followed by a boom.
4.    Business cycles are cumulative and self –reinforcing in nature. Each movement feeds on itself and keeps up the movement in the same direction. Once booms starts it goes on growing till forces accumulate to reverse the direction.

5.    There can be no indefinite depression or eternal boom period .Each phase contain in itself the seed for other phase. The boom, when it reaches its peak, turns to recession.

6.    Business cycles are pervasive in their effects . The cyclical fluctuations affect each and every part of

the economy..Depression
or prosperity
felt  in one part  of  the economy makes its
impact  in other
part  also .  The
cyclical
movements
are even   international in  character . The
mechanism  of
international trade
makes the boom or depression in one country shared by other countries also.

7.     Presence of a crisis. The up and down movements are not symmetrical. The downward movements are not symmetrical .The downward movement is more sudden and violent than the upward movement.

Types of Business Cycle
Prof .James Arthur classified business cycle into 3 parts as follows:

1. Major and Minor Trade Cycles: Major trade cycles are those the period of which is very large . Minor trade cycles are those which occur during the period of a major cycle. Prof. Hanson determines the period of a major cycle between8 years and 33 years. Two or three minor cycles occur during the period of a major cycle . Period of a minor cycle is 40 months.

2.    Building Cycle: Building Cycles are those trade cycles which are related with construction industry . period of such cycle range from 15 to 20 years

3.    Long Waves: Period of a long wave is of 50 years . It was discovered by a Russian economist Kondratief. One or two major trade cycle occur during the period of a long wave.

Schumpeter distinguished 3 types of trade cycle as follows:
1.    Short Kitchin Cycle: The period of this cycle is very short, approximately 4 months duration.

2.    Longer juglar cycle: This cycle has an average 9.5 years duration.

3.    Very long Kondratief Wave: It takes more than 50 years to run its course.

Causes of Business Cycle

Two kinds of element or forces bring about business cycle. They are internal and external. Internal forces are elements within the very sphere of business activity itself and include such things as production ,income,demand, credit, interest rates, and inventories. External forces are elements outside the normal scope of business activity and include population growth ,wars, basic changes in the nation‟s currency and national economic policies. As well as floods, droughts and other catastrophes that have effect on business activity.

Important causes giving birth to business cycle may be summarized as follows:

1.      Expansion of loans and contraction of loans by banks:

2.      Monetary disequilibrium

3.      Change in the volume of investment or decrease in the marginal efficiency of capital

4.      Under consumption or excessive saving

5.      Lack of adjustment between demand and supply

6.      Dealings of entrepreneurs

7.      Innovation

8.      Seasonal fluctuations
Control of Business Cycle

The business cycle leads to greater unemployment and poverty. The various steps that can be taken to achieve economic stability are (i) monetary policy and (ii) fiscal policy.

Monetary Policy
Monetary policy refers to the programs adopted by the central bank to control the supply of money. The

central  bank  may  resort to  open market  operations, changes
in
bank  rate  or  changes  in  the
variable reserve ratio.  The open market  implies
the  purchase
and
sale of  government  bonds
and
securities.  In the boom  period  the  central bank
sells  government
bonds and securities to the public
which  helps to  withdraw  money  from  the  public.  During periods
of depression  the   central
bank

purchases government securities which increase the cash supply in the economy. This helps to increase investment. The central bank purchase government securities which increase the cash supply in the economy. This helps to increase investment . The central bank may change the bank rate or rediscount rate. The bank rate is the rate at which commercial banks borrow from central bank. When the central bank increases the bank rate the commercial banks in turn will raise their discount rates for the public. This discourages public borrowing and it reduces investment. During the depression the bank rate is lowered which will end up the increased investment. The central bank can regulate the money

supply by  changing the variable reserve ratio.   When the central
bank  wants to reduce the credit
creation capacity of commercial banks, it   will increase  the ratio
of the deposits to be held by the
commercial bank as reserve with the central bank.


Fiscal Policy

This implies the variation in taxation and public expenditure programme by the government to achieve certain objectives. Taxation helps to withdraw cash from the public. An increase in tax results in reduction of private disposable income. Taxes should be reduced during the depression will stimulate private sector. During boom periods public expenditure must be curtailed ,so that cash flow can be reduced. The fiscal policy of the government to regulate purchasing power to control business cycle

is known as counter the cyclical fiscal policy.  Counter-cyclical fiscal policy in the boom period
implies
a reduction  in the public expenditure and heavy taxes and a surplus budget. The budget surplus
can be

used to eliminate previous deficits .This implies an increase in public expenditure, reduction in taxation and deficit budgeting during the depression. The monetary policy proves more effective to control boom than to depression. A proper mix of fiscal and monetary policy will be more fruitful in the control of business cycles.

Business Forecasting

A forecast of sales of depends upon economic forecasts. This is because the sales of almost every firm is affected by the state of general business. Periods of depression and boom have an influence on the sales value .Sales may be at an increase during the prosperity but might decline during the depression. The businessman should take into consideration the business cycle he is facing so that he can have an effective forecast of sales. The important methods of forecasting are (1) Trend Projection (2) Leading Indices, and (3) Econometric Models.

Trend projection

A graph showing the actual movement of a series is constructed and the apparent trend of the data on future is projected(extrapolated).This is based on the assumption that those forces which contributed past will continue to have the same effect.

Leading Indices

The‟ Leading Indices‟ refer to certain sensitive series which tend to turn upward or downward in anticipation of other series. If one knows a series which would reliably lead say ,commodities, price indices etc. It would not be difficult to purchase raw materials in advance if prices are expected to rise .
Certain important Leading Indices are(1)New orders for durable goods;(2)Building contracts;(3)Number of new incorporations;(4)Whole sale prices of basic commodities , New order placed with manufactures, building contractors etc have early reflection of the coming demand for products, raw materials, labour loans ,and capital.

Econometric Models

Econometrics combines Economics and mathematics. It is the science of economic measurement. Econometrics explains past economic activity by deriving mathematical equations that will express the most probable inter-relationship between asset of economic variable .By combining the relevant variable the econometricians proceed to predict the future course of one or more of these variables on the basis of established relationship.

Techniques of Economic Forecasting

There are several methods or techniques of economic and business forecasting, Important methods may be briefly discussed as follows:

  1. Naive Method: This is one Of the oldest and crudest methods of forecasting business situation. This method is not based on any scientific approach. Projection are made purely by guesswork and sometimes by mechanical interpretation of historical data. This method includes such techniques as tossing the coin, simple correlation and even some other simple mathematical techniques.

Advantages of Naïve Method

a)      It is simple method.

b)      It is less costly

c)      It is suitable small firms

Disadvantage of Naïve Method

a)      It is not a scientific method .

b)      It is not always reliable

2. Survey Techniques:- One of the simplest forecasting device is to survey business firms or individuals and to determine what they believe will occur is survey techniques. Under survey techniques ,interviews and mailed questionnaires are used for forecasting tools. These are helpful in making short-term forecasts. These techniques may be used for forecasting the overall level of economic activity or some special portion of it or they may be used within the firm for forecasting future sales.

Advantages
a)      This method is simple and less costly.

b)      These techniques provide substantial amount of qualitative information that may be useful in economic and business forecasting

c)      These techniques are usually used to supplement other quantitative forecasting methods

Disadvantages

a) When the opinions differ it will create problem b)Not useful for long term forecasts
3. Expert opinion method

It is a qualitative technique. Under this method an expert or informed individual uses personal or organizational experience as a basis for developing future expectations.

4.Trend Projection method

Under this method historical data is used to predict future business activity. Here actual data are presented on a graph paper and forecasts for the future are prepared on the basis of analysis of trend of this data.

Advantages
a)  Very simple and less expensive
b)  More reliable

Disadvantages

When sudden fluctuations in data occur, this method will not be suitable.Similiarly it requires considerable technical skill and experience.

Smoothing techniques(Exponential smoothing)

Under this method smoothed average of several past observations are considered say, moving average, exponential smoothing average etc.This method is very cheap and inexpensive. But it cannot provide accurate forecasts.

Barometric Techniques

In this method present events or developments are used for predicting the future .Further , here we apply certain selected economic and statistical indicators in time series to predict variables. They are leading, lagging and coincident indicators. If changes in one series of data consistently occur prior to changes in another series-leading indicators can be shown, If changes in one series of data consistently occur after changes in another series- there is lagging indicators, If two series of data frequently increase or decrease at the same time and one series may be regarded as a coincident indicator of the other-there is coincidental indicators. This method is the most complex and scientific one.

Econometric Methods.

Econometrics is the combination of “econo” and “metrics” which means measurement of economic variables. This method combines the economic theory, statistical tools and mathematical model building to analyse economic relations. It predicts the future activity on past economic activity by using mathematical and statistical techniques

a)        These methods are more reliable.

b)            It is possible to compare forecasts with actual results. The model can modified to improve future forecasts.

c)  These methods indicate both direction and magnitude of change in the variables.
d)These methods have the ability to explain economic phenomena.

Input Output Table Method:

This is another approach of economic forecasting . This method enables the forecaster to trace the effects of increases in demand for one product to other industries. An increase in the demand for automobiles will first lead to an increase in the output of the auto industry. This, in turn, will lead to an increase in the demand for steel, glass, plastics, rubber and upholstery fabric. In addition, secondary impact will occur as the increase in the demand for upholstery fabric.