phases of economy is defined along with the theories of business cycle

1. Phases of Economy
Presented By:
Harvinder Kaur
Kajal Sharma
Vivek Singhal

2. Business Cycle
•The business cycle is the fluctuation in economic activity that an
economy experiences over a period of time. The business
cycle or economic cycle is the downward and upward movement
of gross domestic product (GDP) around its long-term growth
trend.
•Business cycles are usually measured by considering the growth
rate of real gross domestic product. Despite the often-applied
term cycles, these fluctuations in economic activity do not exhibit
uniform or predictable periodicity.
•The common or popular usage boom-and-bust cycle refers to
fluctuations in which the expansion is rapid and the contraction
severe.

3. Phases of Business Cycle

4. Expansion
• The line of cycle that moves above the steady
growth line represents the expansion phase of
a business cycle.
• There is an increase in various economic
factors, such as production, employment,
output, wages, profits, demand and supply of
products, and sales.
• The prices of factor of production and output
increases simultaneously.

5. Peak
• It refers to the phase in which the increase in growth
rate of business cycle achieves its maximum limit.
• The economic factors, such as production, profit, sales,
and employment, are higher, but do not increase
further
• There is a gradual decrease in the demand of various
products due to increase in the prices of input.
• The increase in the prices of input leads to an increase
in the prices of final products, while the income of
individuals remains constant.

6. Recession
• There is a gradual decrease in the demand of
various products due to increase in the prices
of input.
• All the economic factors, such as production,
prices, saving and investment, starts
decreasing.
• The supply of products exceeds the demand.

7. Trough
• The economic activities of a country decline
below the normal level.
• The growth rate of an economy becomes
negative.
• There is a rapid decline in national income and
expenditure.
• The level of economic output of a country
becomes low and unemployment becomes
high.

8. Recovery
• An economy reaches to the lowest level of
shrinking.
• Once the economy touches the lowest level, it
happens to be the end of negativism and
beginning of positivism.
• During recession the rate at which the price of
factor of production falls is greater than the rate
of reduction in the prices of final products.
• Some of the depreciated capital goods are
replaced by producers and some are maintained
by them.

9. Theories of Business Cycle
• Pure Monetary Theory
• Monetary Over-investment Theory
• Schumpeter’s Innovation Theory
• Multiplier-Accelerator Interaction Theory
• Hicksian Theory of Trade Cycle

10. Pure Monetary Theory
• According to Hawtrey, the changes in the money
flows in the economy cause the fluctuations in
the level of economic activities.
• With an increased supply of money, the prices
rise, profit increases, total output increases and
thus overall growth takes place or vice versa.
• The principle factor behind the supply of money
is the credit created by the banking system.

11. (Contd…)
• Credit expansion helps in accelerating the
economy and at the same time helps in the
price rise. The economy observes the upswing
and enters into the expansion phase.
• After a point of time, the banks might restrain
the credit expansion at the prevailing rate.
• The expansion slows down and marks the
beginning of the downswing.

12. Criticism
• The business cycles are not purely a business
phenomenon.
• Describes only expansion and recession
phases and fails to explain the intermediary
phases of business cycles.
• Assumes that businessmen are more sensitive
to the interest rates that is not true rather
they are more concerned about the future
opportunities.

13. Monetary Over Investment Theory
• Imbalance between the actual and desired
investments, i.e. actual investments exceeding the
desired investments.
• In order to maintain economy’s equilibrium the pattern
of investments should correspond to the consumption
pattern.
• Total investments should be distributed among various
industries in such a way that each industry produces
only as much as the consumer demands.
• The economic equilibrium and stability get disturbed
by the changes in the money supply and saving-
investment relations.

14. Criticism
• The business cycles have occurred even when the
resources are not completely employed.
• Theory lays emphasis on the change in the
interest rate as the major determinant of
investment and ignores other important factors,
such cost of capital equipment, businessman’s
own expectations, etc.
• An undue emphasis is laid on the imbalance
between the investments in the capital goods and
consumer goods as in the modern economy.

15. Schumpeter’s Theory of Innovation
• Innovation in business is the major reason for
increased investments and business fluctuations.
First Approximation: If the firm decides to
undertake a new technique of production, then the
same needs to be financed through bank credit.
Second Approximation: The speculation is the main
element of second approximation. As the primary
wave of expansion begins, the investor, particularly
in capital goods industries, expects this upswing to
remain permanent and hence borrows heavily.

16. Criticism
• Its arguments are more based on the
sociological factors rather than the economic
factors.
• Schumpeter’s theory is not basically different
from the over-investment theory.

17. Multiplier-Accelerator Interaction
Theory
Assumptions:
• There is no excess production capacity.
• At least one-year lag in the consumption.
• At least one-year lag in the increase in
demand for consumption and investment.
• No government intervention, and no foreign
trade.

18. Multiplier-Accelerator Interaction
Theory
• Samuelson’s model is regarded as the first
step in the direction of integrating theory of
multiplier with the principle of acceleration.
• Autonomous investment is the investment
undertaken due to the external factors.
• Derived Investment is the investment,
particularly in capital equipment, is
undertaken to meet the increase in consumer
demand necessitating new investment.

19. (Contd…)
• With an increase in the autonomous
investment, the income of people rises and
the process of multiplier begins.
• An increase in consumption creates a demand
for investment, and this is called as Derived
Investment.

20. Criticism
• The model has been developed on highly
simplifying assumptions.
• It has also ignored the other important factors
that play a crucial role in a cyclical process.
• It is assumed that the capital/output ratio
remains constant while there are chances of
change in this ratio during expansion and
depression.

21. Hicksian Theory
Assumptions:
• An equilibrium rate of growth in the economy.
Gr=Gn
• Samuelson-type consumption function,
Ct = aYt-1
• Autonomous investment is the function of current
output.
• ‘Ceiling and Bottom’ for the expansion (upswing) and
depression (downswing).

22. Criticism
• Does not provide the reasons for the constant
multiplier and the linear consumption
function.
• The Hicksian theory like some other theories is
considered as highly abstract and incapable of
explaining the fluctuations in the real life
situations.

23. Conclusion
According to the theories stated by different
economists which are known as the causes for
the fluctuations in the business cycle we should
find the solutions and control the fluctuations in
the business cycle.