For practical purposes, it would be useful to know the typical shape of a cycle and how to recognize its peak and trough. This happens because in the contraction process imports fall drastically due to decrease in income and consumption of households, whereas exports do not fall much. Firstly, the improved technology increases the supply of goods and services. The so-called Juglar cycle has often been regarded as the true, or major, economic cycle, but several smaller cycles have also been identified. Changes in agricultural output through its demand and input-output relations affect industry. Further, they assume that the rich have a large propensity to save, that is, they save a relatively large proportion of their income and therefore, consume a relatively smaller proportion of their income.
According to classical economists, if there is high unemployment condition in an economy, then economic forces, such as demand and supply, would act in a manner to bring back full employment condition. Thus, the cycle is complete. As a result employers will either reduce investment, or start to lay off workers, and a downswing will begin. This gives consumers more money to spend, and their purchases of houses and cars, at low interest rates, fuels the expansion of the economy. This makes further investment unprofitable. Autonomous investment leads to multiplier effect that result in derived investment.
Current rate of interest is higher that encourages people to save rather than invest. In business-cycle theory, we are interested in real variables and not nominal variables, so the price level is unimportant. During peak times business investment and consumer spending are at very high levels. The Debate over Real-Business-Cycle Theory: Economists disagree about the validity of real-business-cycle theory. Let W 1 be his real wage in the first summer, and W 2 the real wage he expects in the second summer. Government activities fiscal policy and monetary policy 1.
As a result, economic activities, such as employment, investment, savings, consumption, and prices of goods and services, start declining. The two key relationships under flexible prices can be shown in Fig 17. When consumer spending decreases the opposite occurs: production is reduced, workers are laid off and the economy enters the period of recession 2. This consumption spending must represent floor below which the level of income cannot be expected to fall. Offers only a systematic framework for business cycles, not the whole concept.
These and other leading indicators are widely used in. Those who believe that wages and prices are sticky often believe that fiscal and monetary policy should be used to try to stabilise the economy. Random disturbances are shown in Fig. Fiscal Policy: An increase in government purchases is shown in the real-business-cycle model. Random shocks, or what economists call exogenous factors, the third type of phenomena affecting business cycles. Another assumption made by him is that there would be a gap of one year between the increase in consumption and increase in the demand of investment. Thus, the theory fails to offer adequate explanation of business cycles.
A great amount of has been done in what may be called the morphology of cycles. Researchers using these methods have identified a number of series, each of which reaches its turning point 2 to 10 months before the turns in general business activity, as well as another group of series, each of which follows the turns in business by 2 to 7 months. For example, the construction was found to have cycles of 17 to 18 years in the United States and 20 to 22 years in England. Inflation redistributes income in favour of the richer actions and also when inflation rate is high, it impedes economic growth. New classical economists argue that macroeconomic analysis should be based on the same assumption. These are propensity to save, propensity to consume, and propensity of marginal efficiency of capital.
This situation results in the contraction or recession in economy. After a certain point of time, the autonomous investment brings the multiplier process at work, which further increases output and employment. Contraction Downswing, Recession or Depression 4. This is in the recovery phase. In addition, he propounded that innovations are responsible for the occurrence of business cycles. Thus, lower demand for bank credit in times of recession pushes down the money rate of interest below the natural rate.
Contraction and Depression: As stated above, expansion or prosperity is followed by contraction or depression. The technological knowledge may slow down, but it is hard to imagine that it would go into reverse. In this kind of model, real output is volatile, reaching occasionally the ceiling or floor, with each successive random disturbance pushing real income downwards or upwards and with underlying stabilizing influences of the multiplier and accelerator. Haberler in his important work on business cycles has named the four phases of business cycles as: 1 Upswing, 2 Upper turning point, 3 Downswing, and 4 Lower turning point. Historical fluctuations in economic activity cannot be explained entirely in terms of combinations of cycles and subcycles; there is always some factor left over, some element that does not fit the pattern of other fluctuations. According to him, changes in an economy take place due to changes in the flow of money. A common method to obtain this trend is the.
As a result, the demand for consumer and capital goods decreases. Is the stickiness of wages and prices a key to our understanding of economic fluctuations? Further, since supply or production of goods increases relatively more as compared to the consumption demand for them, the prices fall. Apart from monetary factors, several non-monetary factors, such as new investment demands, cost structure, and expectations of businessmen, can also produce changes in economic activities. Although money may be available for firms to borrow and interest rates may be low, investment will not increase because of pessimistic expectations. This leads to depression in the economy. A turning point may be reached if income increases at a decreasing rate; investment will start to fall and as soon as the fall in investment exceeds the rise in consumption, income will start to fall as well. While we see continuous growth of output, it is not a steady increase.
But this is not the case. Monetary policy appears to have a strong influence on the real economy. Features of Business Cycles : Though different business cycles differ in duration and intensity they have some common features which we explain below: 1. The other decision is the labor-leisure tradeoff. The more theories must in addition explain why, during downturns, 1 employment falls and unemployment increases and 2 investment declines by a much greater percent than output. We call relatively large negative deviations those below the 0 axis troughs.