Business cycle

Nature of business cycle

The periodic rise and decline of

economic activity.
Business does not move evenly.
The forces of demand and supply
do not always move together.

Industrial revolution

During Spanish times periods of

food shortage and scarcity as well as
periods of abundance and prosperity.

1929 1933: most severe

depressions; New York stock market
crash and spread through out the
world.

Rhythm in the economic

activity

Downward swing of business cycle

is always followed by an upward
swing.

Length of business cycle

No two business cycles are of the same

duration; they vary in length and severity.
In US have an average of 4years.
England from 1793-1920 was 5 years
and 9 mos.
France from 1838-1920 was 5 years.
Germany from 1847-1940 was 5 years
Cycles are generally longer in less
develop countries.

Amplitude of Business
cycle

Past may be a good measure for

coming cycle.
Highest boom 10% above normal
The upswings of business activity
reaches 25% above normal and
about 20% to 25% on downward
swing.

Secular trend, seasonal

variations and accidental
variations

Secular trend

Long-time trend of business activity; it is a

smooth upward or downward movement of
business over a long period of years.
Movement of businesses that can be
determined not during a single business
cycle but after many cycles have been
completed
An upward movement may take place within
50 years or more before any downward trend
is observed.

Seasonal variations

Occur more or less regularly within

a year because of changes in
weather and existence of the usual
national or religious holidays.
Planting and harvesting seasons
are brisk seasons in the Philippines.
Christmas and Easter.

Accidental Variations

Unforeseen events: wars, strikes,

flood, drought, fire, and
earthquakes.
Affects business activity.
Undue business movements that
results from fortuitous events
should be considered abnormal.

Phases of the Business

cycle

Prosperity Phase

High prices and great business activity.

Everything is booming
High prices are yielding large profits
With industries at top speed: large demand for
labor and very little unemployment.
Wages are high in common with high prices for
all kinds of commodities.
Increased volume of sales and forward buying
of commodities.
Optimism pervades -> volume of trade
increases -> increase in prices and spreads
buoyancy.

A large demand for credit during

the period of prosperity
Banks have very low reserves
because of large loans and
discounts
Demand for credit -> Interest rates
increases

Crisis phase

Prosperity slows down

Factories are in full blast in order to meets orders
suddenly find that they can no longer dispose of the
same volume of goods.
Prices increase as before
Demand for goods decreases relative to the supply
Margin of profits shrinks
Trade slows down
Industrial activity curtailed
Large quantity of unsold goods
Factory reduces their output > reduces their labor force
> unemployment
Reduction of wages -> curtailing purchasing power.

To finance their activities, they use

Credit
Liquidation forced sale to meet
their obligations which involves a
loss; it may result to crisis.
Panic when the financial
institutions of the country are in
unsound position and they can not
meet their obligations

Depression phase

Business had to go readjustment

Pessimism declining prices and tight credit
Volume of sales reduced because of falling prices.
Prices are falling -> sellers become more anxious to sell ->
prices drop to lower level
Closing factories swelling of unemployment, curtaining
purchasing power, decreasing the demand for goods
Banks plenty of money in their vaults -> Business men
are afraid to borrow
- plenty of idle funds awaiting borrowers -> banks reduces
the rate of interest; money and credit stringency is
loosened.
-cost of production are low as unemployed men are willing
to get a job; cost of raw materials is low; credit at low rate
of interest- because of the abundance of idle funds.

Recovery Phase

Factors of recovery: low prices of raw

materials, low wages, and interest rates
Replacement of machines and other
equipments
Factories have to be repaired
Increase in demand for goods and labor.
Consumers have to replace their clothing and
other needs.
Stocks => retailers must replenish and have
to place their orders to wholesalers.
Manufacturers have to increase their demand
for raw materials and labor.

Demand for labor increase ->

unemployment will decrease ->
purchasing power increase.
Idle funds will be loaned as interest
rates are low
Rise in the price of securities
stimulates business activity.

Theories of business cycle

Sun-spot theory

W. Stanly Jevons business cycles

are caused by solar radiation.
Spots on sun affects the sun of the
weather, thus affecting the
development of crops.

psychological

Fluctuation of business activity to the fluctuation

optimism and pessimism among business men.
Slack season caused by lack of confidence
among the leaders of business
Business men become optimistic (business man
will hire more business, expansion) about the
future and are apt to expand their business unduly.
Spreading optimism all around -> increasing
output beyond the capacity of the people to
consume.
When production outruns consumption; market is
glutted with unsold articles, wave of pessimism
follow.

Overproduction

Stagnation in business When the

amount produced exceeds the
amount that can be consumed
Effects of overproduction: surplus
= decrease in profit -> decrease in
price.
Goods cannot be sold at a profit.

maladjustment

Closely related to the theory of

overproduction.
The purchasing power of the
consumers may be adequate, but
enterprisers often misjudge what
the public wants

over saving

Persons possess large purchasing power

who would not spend it on consumption
goods.
Saved income invested in the industries
in form of new equipment and
producers goods to produce more
goods intended for final consumer, thus
increasing in amount of consumption of
goods that cannot find a buyer.

Bank credit theory

Banks influence business activity

through the expansion or
contraction of credit.
Increase in interest rates ->
decrease in investments ->
decrease in demand and income.

Self generating

By Prof. Wesley C. Mitchell,

business cycles are self generating
Prosperity generates the
circumstances that leads to crisis
that breeds depression and in time
brings revival of activity.
Demand > supply

Other

3 groups:
Physical theories that are concerned
with changes in the physical environment
like sun-spot theory of Jevons
Emotional theories which associate
business fluctuations with cycles of
optimism and pessimism of business men
institutional attribute business cycles
to business practices like maladjustment
theory.

Control of business cycle

Stabilization of business
cycle

The productive forces must be

organized in such a way as to
secure a steady production of
goods.

Control of credit

Bank credit is the most important

factor to be considered in the
changes in the price level.

Control of public works

By the government
Adopting a plan to construct public
buildings, roads, bridges, and other
public works during the period of
slack business rather than during
the period of prosperity.