UNIT-4

Business Cycle- Features, Phases and Causes

The "trade cycle" refers to the naturally occurring cyclical variations in economic
activity that occur in economies. The cycle is described by phases of expansion, peak,
contraction, and trough, each of which represents a different stage of the cycle.
A rise in economic activity during the expansionary phase leads to growth. The peak,
or the highest point of expansion, is followed by the contraction phase, which is marked by a
decline in output and growth. After that, the cycle continues as the economy enters an
expansionary stage. The recession's lowest point is indicated by the trough. In this blog, we
will look into what is trade cycle, trade cycle meaning, features of the trade cycle, and more.
Trade Cycle Definition
Business or trade cycles are the terms used to describe the cyclical expansion and
contraction of economic activity. Period of Expansion, Upswing, or Prosperity" refers to the
era of high income, high output, and high employment. The era of contraction, recession,
downswing, or depression is a time of low income, poor production, and low employment.

Features of Trade Cycle

The trade cycle's key features are as follows:
 Economic Activity Movement: A trade cycle is a wave-like movement of the
economy that exhibits both an upward and a negative tendency
 Periodic: Trade cycles do not exhibit the same regularity but recur periodically
 Different Phases: Trade cycles go through several phases, including prosperity,
recession, depression, and recovery.
 Two distinct types of trade cycles exist: small and large. Primary trade cycles last
4–8 years or more, whereas minor trade cycles last 3–4 years. Although the time of
trade cycles varies, they all follow a similar pattern of successive stages.
 Duration: Trade cycles can last between two years and a maximum of twelve years.
 Dynamic: All economic sectors change as a result of business cycles. Other factors,
including employment, investment, consumption, interest rate, and price level, also
experience fluctuations along with output and income.
 Phases are Cumulative: In a trade cycle, expansion and contraction are, in fact,
cumulative, rising or reducing over time.
 Economic Uncertainty: Business people face economic uncertainty which is because
earnings vary more than any other source of income.
 International Character: Trade Cycles have a global nature. Consider the 1930s
Great Depression.

Phases of Business Cycles

The business cycle can be classified into 4 phases
1. Expansion
The first step of a new business cycle is expansion. An increase in income, employment,
production, and sales characterises an expansion phase. Money is flowing more freely into
the economy, and investments are booming. People take on debt and pay it off in a timely
manner.
2. Peak
The ‘Peak’ stage occurs when all economic indices have reached their highest levels of
growth. The economy is regarded to have reached its apex at this point. The economy stops
rising after prices reach their highest point. As the economy reaches its pinnacle and the
growth trend reverses, people and businesses restructure their businesses.

3. Recession
A recession is a period in which the economy contracts. Production is slowing, and sales and
income are growing slowly at this point. Sales may drop or grow negatively, resulting in job
losses.
4. Depression:
As unemployment rises, the economy continues to contract. Industrial production is on the
decline, and businesses and consumers cannot obtain finance. Bankruptcies can also result
from a drop in business. Low corporate and consumer confidence also characterise this
period.
5. Trough
The trough marks the conclusion of the depression stage and the start of the healing process.
6. Recovery
Recovery is the stage of the economy’s turnaround. Because of the earlier stage of the
depression, the prices are low. Low prices often generate demand for commodities, resulting
in increased output and rebirth of industrial production. As a result, credit is on the rise. As a
result, employment and wages are on the rise.

Causes of Business Cycles

The cyclic pattern of changes that occurs in the economy is caused by many factors in
combination. There are internal factors within the economy that may be causing these
changes. And there are also external factors which may lead to a boom or bust of an
economy. Let us take a look at all the causes of business cycles.
Internal Causes of Business Cycles
These endogenous factors can cause changes in the phases of the firm and the economy in
general. Let us take a look at the internal causes of business cycles.

1] Changes in Demand
Keynes economists believe that a change in demand causes a change in the economic
activities. When the demand in an economy increases the firms start producing more goods to
meet the demand.
There is more output, more employment, more income, and higher profits. This will lead to a
boom in the economy. But excessive demand may also cause inflation.
On the other hand, if the demand falls, so does the economic activity. This may lead to a bust,
which if it continues for a longer period of time may even lead to depression in the economy.
2] Fluctuations in Investments
Just as fluctuations in demand, fluctuations in investment is one of the main causes of
business cycles. The investments will fluctuate on the basis of a lot of factors such as the rate
of interest in the economy, entrepreneurial interest, profit expectation, etc.
An increase in investment will lead to an increase in economic activities and cause
expansion. A decrease in investment will have the opposite effect and may cause a trough or
even depression
3] Macroeconomic Policies
The monetary policies and the economic policies of a nation will also result in
changes in the phases of a business cycle. So, if the monetary policies are looking to expand
economic activities by promoting investment, then the economy booms. On the other hand, if
there is an increase in taxes or interest rates we will see a slowdown or a recession in the
economy.
4] Supply of Money
There is another belief that says that business cycles are purely monetary phenomena.
So, changes in the money supply will bring about the trade cycles. An increase of money in
the market will cause growth and expansion.
But too much money supply may also cause inflation which is adverse. And the decrease in
the supply of money will initiate a recession in the economy.
External Causes of Business Cycles
1] Wars
During times of wars and unrest, the economic resources are put to use to make
special goods like weapons, arms, and other such war goods. The focus shifts from consumer
products and capital goods. This will lead to a fall in income, employment, and economic
activity. So the economy will face a downturn during war times.
And later post-war the focus will be on rebuilding. Infrastructure needs to be reconstructed
(houses, roads, bridges, etc). This will help the economy pick up again as progress is being
made. Economic activity will increase as effective demand will increase.
2] Technology Shocks
Some exciting and new technology is always a boost to the economy. New technology
will mean new investment, increased employment, and subsequently higher incomes and
profits. For example, the invention of the modern mobile phone was the reason for a huge
boost in the telecom industry.
3] Natural Factors
Natural disasters like floods, droughts, hurricanes, etc can cause damage to the crops
and huge losses to the agricultural sector. Shortage of food will cause a surge in prices and
high inflation. Capital goods may see a reduction in demand as well.
4] Population Expansion
If the population growth is out of control that might be a problem for the economy.
Basically, of the population growth is higher than the economic growth the total savings of an
economy will start dwindling. Then the investments will reduce as well and the economy will
face depression or a slowdown.
Concept of Inflation, Deflation

Inflation and deflation are two commonly used terms in

Macroeconomics. These two phenomena are experienced by almost every
country in the world. It can be said that inflation and deflation are two
sides of the same coin.
Inflation is referred to as the situation when the price level of goods
and services rise, which leads to decrease in the purchasing power in the
economy or in other words decreases the buying power of the money.
Inflation is characterised by two conditions, (1) there is always a
steady or sustained rise in the prices of goods and services, which is not
seasonal and has a tendency of continuing for a long time (2) the impact
is felt across most of the sectors of the economy.
Deflation is the exact opposite of inflation. In this condition, the
price level of goods and services decrease exponentially which results in
an increase of the buying power of the money. In other words, in case of
deflation, the people in an economy are able to purchase more quantities
of products with limited amounts of money.

National Income- Concepts and Measurements

1. Gross Domestic Product at Market Price or GDPMP: It is the gross market value of all final
goods and services that is produced within the domestic territory of a nation within an
accounting year. It is shown as:
GDPMP = Net domestic product at FC (NDPFC) + Depreciation + Net Indirect tax
2. Gross domestic product at Factor Cost or GDPFC: It refers to the total money value of
goods and services excluding net indirect taxes that are produced within the domestic
territory of a nation within one accounting year. It can be shown as:
GDPFC = GDPMP – Net Indirect tax
3. Net Domestic Product at Market Price or NDPMP: It is the net market value of all the final
goods and services produced within the domestic territory of the nation within a year
excluding depreciation. It can be shown as:
NDPMP = GDPMP – Depreciation
4. Net Domestic Product at Factor Cost or NDPFC: It refers to the net money value of all the
final goods and services that are produced within the domestic territory of a nation excluding
the net indirect taxes and depreciation. It is shown as:
NDPFC = GDPMP – Net Indirect tax – Depreciation
5. Net National Product at Factor Cost or NNPFC: It is the net value of all the final goods and
services that are produced by the residents of a nation within a period of one year. It can be
shown as
NNPFC = GNPMP – Net Indirect Taxes – Depreciation
Or NNPFC can be defined as the sum total of all the factor incomes which includes rent, profit,
interest, employee compensation during an accounting year.
It can be represented as:
NNPFC = NDPFC + Factor income earned by normal residents from abroad – factor payments
made to abroad
NNPFC is also known as the National Income.
6. Gross National Product at Factor Cost or GNPFC: It is referred to as the gross money value
of all the final goods and services that are produced by the residents living within the
boundaries of a nation during one accounting year excluding the net indirect taxes. It is
shown as:
GNPFC = GNPMP – Net Indirect Taxes
Or it can be defined as the sum total of all factor incomes that are earned by the residents of a
nation living within the boundaries of the nation along with depreciation.
GNPFC = NNPFC + Depreciation or
GNPFC = GDPFC + NFIA
Where NFIA is the Net Factor Income from Abroad which is factor income received by
residents from abroad minus the factor income paid to non-residents domestically.
7. Net National Product at Market Price or NNPMP: It is the net market value of all the final
goods and services produced by the residents living within boundaries of the nation during
one accounting year.
It is shown as
NNPMP = GNPMP – Depreciation
Or, it can be defined as the sum total of all the factor incomes earned by the residents living
within the boundaries of the nation during an accounting year inclusive of net indirect taxes
NNPMP = NNPFC + Net Indirect Taxes
8. Gross National Product at Market Price or GNPMP: This is the gross market value of all
final goods and services that are produced by the residents living within the boundaries of a
nation.
It can be said as the sum total of all the factor incomes by the residents of a country during a
year and is inclusive of depreciation and net indirect taxes.
GNPMP = NNPFC + Net Indirect Taxes + Depreciation

Financial markets and financial instruments

What is a Financial Instrument?

Financial instruments are contracts for monetary assets that can be purchased, traded,
created, modified, or settled for. In terms of contracts, there is a contractual obligation
between involved parties during a financial instrument transaction.

For example, if a company were to pay cash for a bond, another party is obligated to
deliver a financial instrument for the transaction to be fully completed. One company is
obligated to provide cash, while the other is obligated to provide the bond.
Basic examples of financial instruments are cheques, bonds, securities.
There are typically three types of financial instruments: cash instruments, derivative
instruments, and foreign exchange instruments.
Types of Financial Instruments
1. Cash Instruments
Cash instruments are financial instruments with values directly influenced by the condition of
the markets. Within cash instruments, there are two types; securities and deposits, and loans.
Securities: A security is a financial instrument that has monetary value and is traded on the
stock market. When purchased or traded, a security represents ownership of a part of a
publicly-traded company on the stock exchange.
Deposits and Loans: Both deposits and loans are considered cash instruments because they
represent monetary assets that have some sort of contractual agreement between parties.
2. Derivative Instruments
Derivative instruments are financial instruments that have values determined from underlying
assets, such as resources, currency, bonds, stocks, and stock indexes.
The five most common examples of derivatives instruments are synthetic agreements,
forwards, futures, options, and swaps. This is discussed in more detail below.
Synthetic Agreement for Foreign Exchange (SAFE): A SAFE occurs in the over-the-counter
(OTC) market and is an agreement that guarantees a specified exchange rate during an agreed
period of time.
Forward: A forward is a contract between two parties that involves customizable derivatives
in which the exchange occurs at the end of the contract at a specific price.
Future: A future is a derivative transaction that provides the exchange of derivatives on a
determined future date at a predetermined exchange rate.
Options: An option is an agreement between two parties in which the seller grants the buyer
the right to purchase or sell a certain number of derivatives at a predetermined price for a
specific period of time.
Interest Rate Swap: An interest rate swap is a derivative agreement between two parties that
involves the swapping of interest rates where each party agrees to pay other interest rates on
their loans in different currencies.
3. Foreign Exchange Instruments
Foreign exchange instruments are financial instruments that are represented on the foreign
market and primarily consist of currency agreements and derivatives.
In terms of currency agreements, they can be broken into three categories.
Spot: A currency agreement in which the actual exchange of currency is no later than the
second working day after the original date of the agreement. It is termed “spot” because the
currency exchange is done “on the spot” (limited timeframe).
Outright Forwards: A currency agreement in which the actual exchange of currency is done
“forwardly” and before the actual date of the agreed requirement. It is beneficial in cases of
fluctuating exchange rates that change often.
Currency Swap: A currency swap refers to the act of simultaneously buying and selling
currencies with different specified value dates.
Asset Classes of Financial Instruments
Beyond the types of financial instruments listed above, financial instruments can also be
categorized into two asset classes. The two asset classes of financial instruments are debt-
based financial instruments and equity-based financial instruments.
1. Debt-Based Financial Instruments
Debt-based financial instruments are categorized as mechanisms that an entity can use to
increase the amount of capital in a business. Examples include bonds, debentures,
mortgages, U.S. treasuries, credit cards, and line of credits (LOC).
They are a critical part of the business environment because they enable corporations to
increase profitability through growth in capital.
2. Equity-Based Financial Instruments
Equity-based financial instruments are categorized as mechanisms that serve as legal
ownership of an entity. Examples include common stock, convertible debentures, preferred
stock, and transferable subscription rights.
They help businesses grow capital over a longer period of time compared to debt-based but
benefit in the fact that the owner is not responsible for paying back any sort of debt.
A business that owns an equity-based financial instrument can choose to either invest further
in the instrument or sell it whenever they deem necessary.