1. Business/Trade cycles
Chapter 8
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2. Business cycle
 For this chapter, you should also read the
note of chapter 1.
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3. Meaning
 A business cycle is a swing in total national
output, income, and employment, usually
lasting for a period of 2 to 10 years, marked
by widespread expansion or contraction in
most sectors of the economy.
 The pattern of cycles is irregular. No two
business cycles are the same.
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4. Meaning
 A business cycle is a swing in total national output,
income, and employment, usually lasting for a
period of 2 to 10 years, marked by widespread
expansion or contraction in most sectors of the
economy.
 The pattern of cycles is irregular. No two business
cycles are the same. No exact formula applies to
predict the duration and timing of business cycle.
 But in their irregularities, business cycles more
closely resemble the fluctuations of the weather.
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5. Meaning
 Economists say cycles are like mountain
ranges, with different levels of hills and
valleys. Some valleys are very deep and
broad as in the Great Depression of 1930s,
others are shallow and narrow as in the
American recession of 1991.
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6. Types of cycles
Business cycles are of the following types:
 The short run Kitchin cycle: It is also known as
the minor cycle which is of approximately 40 months
duration. It is famous after the name of the British
economist Joseph Kitchin, who made a distinction
between a major and a minor cycle is 1923. He
came to the conclusion, on the basis of his
research, that a major cycle is composed of two or
three more cycles of 40 months.
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7. Types of cycles
 The Long Jugler Cycle: This cycle is also known
as the major cycle. It is defined as the fluctuation of
business activity between successive crises. In
1862 Clement Jugler, a French economist, showed
that periods of prosperity, crisis and liquidation
followed each other always in the same order. Later
economists have come to the conclusion that a
Jugler cycles duration is, on average of nine and a
half years.
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8. Types of cycles
 The Very Long Knodratieff Cycle: In 1925,
N.D. Kondratieff, the Russian economist,
came to conclusion that there are longer
waves of cycles of more than 50 years
duration made of six Juggler cycles. A very
long cycle has come to be known as the
Kondratieff wave.
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9. Types of cycles
 Building Cycles: Another type of cycle
relates to the construction of buildings which
is of fairly regular duration. Its duration is
twice that of the major cycles and is on an
average of 8 year's duration. Such cycles are
associated with the name of Warren and
Pearson, two American economists, who
came to this conclusion in World Prices and
the Building Industry(1937).
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10. Types of cycles
 Kuzents Cycle: Professor Simon Kuzents,
the famous American economist, propounded
a new type of cycle the secular swing of 16-
22 years' which is so pronounced that it
dwarfs that 7 to 11 years cycle into relative
insignificance. This has come to be known as
the Kuzents cycle.
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11. Phases of business cycles
The business cycle have four phases, which
are explained in the following paragraphs.
 Prosperity
 Recession
 Depression
 Recovery
(Remember these were discussed in chapter 1)
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12. Theories of business cycles
 The monetarist approach: Monetarists believe
that expansion and contraction in economy are
attributed to money and credit. This is what Milton
Friedman argued. The rough correlation between
changes in the money supply and changes in the
level of economic activity is accepted by many
economists. Milton Friedman and Anna Schwartz
argued that the severity of great depression was
due to the contractionary monetary policy. Another
example is of the severity of 1981-82 recession in
the US and in many parts of the world when the
Fed raised nominal interest rates to 18 percent to
fight inflation.
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13. Theories of business cycles
 The Keynesian approach: Keynes and his
followers believe that both monetary and
non-monetary forces are important in
explaining business fluctuations. They
argue that fluctuation in GDP are often
caused by fluctuations in autonomous
expenditures. And they believe that
fluctuations in GDP cause fluctuations in
money supply, contrary to the view of
monetarists.
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14. Theories of business cycles
 The New classical approach: This approach
assumes that private agents have expectations of
what policy makers are going to do and this
influences private behavior. This is also called
rational expectations. The idea is that any shift in
aggregate demand that is expected at the time
wages are set, such as an announced
(anticipated) increase in the money supply will
cause the SRAS to shift up immediately. Because
of this, economy will experience price rise
immediately without any increase in GDP. Only an
unexpected increase in AD will lead to an increase
in GDP in the short run.
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15. Theories of business cycles
 The New classical approach: Robert Lucas
assumed that this shock to AD would be an
unexpected increase in the money supply.
According to this approach, only unanticipated
policy changes lead to changes in real national
income. Systemic policy changes will be
predictable and will have no real effects. Thus the
claim of this theory is that misperceptions about
price and wage movements lead people to supply
too much or too little labor, which leads to cycles of
output and employment.
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16. Theories of business cycles
 External shock theories: External shocks are
economic disturbances that originate outside the
economy such as oil price hike, weather, and war.
The example is of the oil prices of 1990s that
severely weakened the oil importing economies.
Internal strife and war at the global level both
affect the output and infrastructure as well as
capital investment. Similarly, in many economies
that are agriculture dependent, weather plays a
major role in output and income.
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17. Theories of business cycles
 Long wave theory/real business cycle
theories: In 1911, Joseph A. Schumpeter
proposed a long wave theory of business
cycles in which development is fueled when
entrepreneurs initiate innovations such as:
discoveries of raw materials, new goods or
new quality in familiar products,
technological advances, opening of new
markets, and major reorganization of
industries.
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18. Theories of business cycles
 Long wave theory/real business cycle
theories: Real business cycle proponents
hold that innovations or productivity shocks
in one sector can spread to the rest of the
economy and cause fluctuations. In this
classical approach, cycles are primarily
caused by shocks to aggregate supply, and
aggregate demand is unimportant for
business cycles.
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19. Theories of business cycles
 The political business cycle theory: This theory
attributes fluctuations to politicians who manipulate
fiscal or monetary policies in order to be reelected.
In pre-election periods, politicians would rise
spending and cut taxes. The resulting
expansionary demand shock would create high
employment and good business conditions. But
the resulting inflationary gap would lead to a higher
price level. And the government, after the election,
will depress the demand to slack the inflationary
gap.
 The theory argues that vote maximizing
government manipulates employment and output
solely for the electoral purposes. Ronald Regan’s
example is very often quoted in this regard.
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20. Business Cycle and Business
Decision Making
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