III. Business Cycle

1

BOOM

PEAK

RECESSION

DEPRESSION

TROUGHS

RE

VIV

AL

POTENTIAL GDP

RE

AL

GD

P

O

TIME

X

Y

III. Business Cycle - Recession• Industrial production— Decline• Commodity Prices— Decline• Cost of production— Gradual Decline• Profits— Gradual Decline• Investment— Falls slowly• Employment— Starts Falling• Wage rate— Starts Falling• Bank credit— Starts Falling• Bank Reserves— Suffers a Set back• Discount rates— Gradual Decline• Speculation activity— Minimum Possible• Inventory stocks— Gradual increase• Business failures— Fall in numbers• Business expectations— Pessimistic

2

III. Business Cycle - Depression• Industrial production— Rapid Decline• Commodity Prices— Rapid Decline• Cost of production— Rapid increase but slower than prices• Profits— Negligible• Investment— Falls rapidly• Employment— Falls rapidly• Wage rate— Falls rapidly than the commodity prices.• Bank credit— Falls rapidly• Bank Reserves— Falls rapidly• Discount rates— Falls rapidly• Speculation activity— Hardly any• Inventory stocks— High Level• Business failures— Large in numbers• Business expectations— Highly Pessimistic

3

III. Business Cycle - Recovery• Industrial production— Gradual Increase• Commodity Prices— Gradual Increase• Cost of production— Gradual Increase• Profits— Satisfactory• Investment— Replacing of existing capital• Employment— Gradual Increase• Wage rate— Improvement• Bank credit— Liberal Loans• Bank Reserves— Improvement• Discount rates— A little improvement• Speculation activity— Gradual Increase• Inventory stocks— Gradual decline• Business failures— Smaller in numbers• Business expectations— Optimistic with cautious decision-making

4

III. Business Cycle - Boom• Industrial production— Rapid Increase• Commodity Prices— Rapid Increase• Cost of production— Rapid Increase but slower than price• Profits— High• Investment— High• Employment— Rapid Increase• Wage rate— Rapid Increase but less than price of goods and services• Bank credit— Liberal Loans but high demand for advances• Bank Reserves— Rapid Increase• Discount rates— Rapid Increase• Speculation activity— At a high level• Inventory stocks— Very Little• Business failures— Hardly any• Business expectations— Highly Optimistic

5

Inflation• Inflation is commonly defined as a persistent and appreciable rise in

general price level of prices.• Positive effect of inflation is- increase in output and employment.

Fresh opportunities for business growth. Aggregate demand increases.

• Negative effect of inflation is – as the prices do not grow at a uniform rate, there is misallocation of resources and in turn decline in output and income. Which adversely affect business. High inflation rate leads to unequal distribution of income and therefore aggregate demand reduces.

• Thus, inflation from the business point of view does not provide a congenial economic environment. Therefore, government should attempt to stabilise prices.

6

Demand – Pull Inflation

• Increase in the Public Expenditure • Increase in Private Expenditure • Increase in Foreign Demand • Reduction in Taxation • Repayment of Internal Debts • Changes in Expectations

7

8

Demand – Pull Inflation

AD1

AD2

AD3

AD4

Y*X

o

Y

P1

P2

P3

P4

Output

Pri

ce

Lev

el

AS

a

b

c

d

Cost – Push Inflation :

• Scarcity of the Factors of Production • Bottlenecks • Natural Calamities • Hoarding by Merchants • Rise in Costs.

9

10

Cost- PushInflation

Output

Pri

ce L

evel

Y

Xo

ADAS1

AS2

AS3

AS

a

b

c

P1

P2

P3

Y*

11

Gross National Product (GNP)

…is the total measure of the flow of goods and services at market value resulting from current production during a year in a country, including Net Factor Income from Abroad (NFIA).

It is money value of all goods and services produced in a country at current prices.

Market price of only final products should be taken into account, to avoid double counting.

12

Following are not included in GNP…….

• Goods and services rendered free of charge. • Sale and purchase of old goods, shares, bonds and assets of

existing companies.• Social Security like unemployment insurance allowance, old

age pension and interest on public loans.• Profits earned or losses incurred on account of changes in

capital assets as a result of fluctuations in market prices.• Income earned through illegal activities.

13

National IncomeNet Factor Income from Abroad (NFIA)=

Export - Imports (X-M)

Market Price is when the value of goods and services are calculated according to the prevailing price.

Factor Cost is when the value of goods and services is calculated as per the income received by the factors of production

14

Private Income

• Private income = National Income at factor cost (NNPfc) + Transfer Payments + Interest on Public Debt – Social Security – Profits and Surpluses of Public Undertakings

15

Personal Income

• Personal Income = National Income – Undistributed Corporate Profits – Profit Taxes – Social Security Contributions + Transfer Payments + Interest on Public Debt

16

Personal Disposal Income (PDI)

• PDI = National Income – Business Savings – Indirect Taxes + Subsidies – Direct Taxes on Persons – Direct Taxes on Business – Social Security Payments + Transfer Payments + Net Income from Abroad.

17

Real Income

• When National income is expressed in terms of a general level of prices of a particular year taken as base.

18

Per Capita Income

• Per Capita Income = National Income_______________

Total Population

Real Per Capita Income = Real NI _______________

Total Population

19

Three Approaches or Methods to calculate GNP

Income MethodExpenditure MethodValue-Added Method

20

Income Method

• GNP = Wages and Salaries + Rent + Interest + Dividends

+ Undistributed Corporate Profits + Mixed Income of Self employed + Direct Taxes

+ Indirect Taxes + Depreciation + Net Income From Abroad

21

Expenditure Method

• GNP = Private Consumption Expenditure (C) +Gross Domestic Private Investment (I) + Government Expenditure on Goods and Services (G) + Net Foreign Investment (X - M)

• I.e., C + I + G + X - M

22

Value- Added Method

• In calculated GNP the money value of final goods and services produced at current prices during a year is taken into account.

• This is one of the way to avoid double counting.• But it is difficult to distinguish between final and

intermediate goods.• For example, fuel, raw materials, semi-finished

goods etc are intermediate goods.

23

Value Added MethodSectors Total

OutputIntermediate

purchaseValue –

Added

Agriculture 30 10 20

Manufacturing 70 45 25

Others 55 25 30

Total 155 80 7524