Business Cycle

 

Business Cycle

Fluctuations in the aggregate economic activities of a nation. It includes expansion, recession, depression and recovery. 

It shows increase and decrease in a nation's GDP over time. 

The sequence of change is recurrent and Aperiodic. 

But for better understanding, let's have a look on recurrent and periodic business cycle. 

Expension- Increase in GDP(decrease in unemployment) 

Peak- Turning Point of business cycle after which GDP start decreasing

Technical Recession- When there is decrease in GDP for 2 consecutive quarter

Recession- Decrease in GDP for more than 2 consecutive quarter

Depression- Extreme recession, severe and prolonged downturn of economic activities(recession for more than 2 years) 

Trough- Turning Point of business cycle, end of recession and start of recovery

Recovery- Increase in GDP after a decline period. 

Potential Output(Full Employment Output) 

Level of GDP that would be produced with efficient/optimum utilization of all resources. 

Output Gap- difference between actual output and potential output. 

Positive Output Gap-  Actual output> Potential output

Economy producing more than full employment output. 

Negative Output Gap-  Actual output< Potential output

Economy producing less than full employment output(High unemployment rate). 

Economic Theories

There are numerous economic theories to explain the interdependence of economic activities(GDP fluctuations, inflation, etc), but two theories are major one. 

1. Classical Economics- It supports Laissez-faire(free economy, no government interference) 

As per classical economics, it is the aggregate supply that keeps an economy strong. 

2. Keynesian Economics- It was introduced by John Maynard Keynes after Great depression 1930s.

As per this theory, it is the aggregate demand(money spent) that keeps an economy strong. 

And to increase the demand(spent money) in an economy, it talks about government measures to increase government expenditure and reducing the tax on people.(government interference can boost the economy) 

It relates total spending with inflation and output in an economy. 

Keynesian Multiplier- Rise in demand for each unit of currency spent by government. 

The main drawback of Keynesian economics-

The theory doesn't talk about saving more and more, it only focused on spending. 

Monetary Economics- It was introduced by Milton Friedman in 1970s and based on Keynesian economics. This theory talks about increasing demand by monetary policy(by Central Bank) instead of government. 

Demand Raising Method(by Government) 

1. Trickle-up Economics(demand side)- Policies that directly benefits the lower income group like increasing tax slabs. 

If the lower income group will get more money, they will spent more(rise in demand). Thus the income of whole society will rise including lower income group and higher income group. 

2. Trickle-down Economics(supply side)- Policies that directly benefits the higher income group. 

If the higher income group will get more money, they will invest it in new ventures and increase the supply and job in the market. Thus the income of whole society will rise including lower income group and higher income group. 

Business Cycle and Fiscal Policy(Government measures) 

Countercyclical Fiscal Policy

Strategy by the government to counter boom or recession through fiscal measures that works against the ongoing boom or recession trend. It tries to stabilize the economy. As

Exploding Boom- increase inflation and government debt burden. Government increase taxes and reduce its public expenditure to counter the adverse effects of exploding boom. 

Deep recession- loss in economic growth. Government reduce taxes and increase its public expenditure to counter the adverse effects of exploding boom. 

Procyclical Fiscal Policy

Strategy by the government to boost the current mood of the business cycle.