Concept of Trade Cycle

The trade cycles or business cycles are an important feature of the capitalist economies. Trade cycle refers to the regular fluctuations in economic activity in the economy as a whole. The expansions, recessions; contractions and revivals of aggregate economic activity occur and recur in an unchanged sequence. In brief, the fluctuations in economic activity are called trade cycle. The presence of trade cycle is reflected by the fluctuations in production, income, prices and employment. The situation of inflation existing at present in the world clearly indicates the danger of economic instability and crisis.

In the decade of 1930, ‘Great Depression’ was seen in the world economy. This great depression created new revolution in the economy. Depression proves the widely accepted concept of the classical economists that ‘supply creates its own demand,’ that prevailed in the economy for a long period, to be wrong.

Different economists have presented their own views in relation to the trade cycle.

According to J.M. Keynes- “A business cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages alternating with periods of bad trade characterized by falling prices and high unemployment percentages”.

According to D. Dillard, “Business cycle is nothing more than a rhythmic fluctuation in the overall level of employment, income and output.”

According to Benham, “Trade cycle refers to a period of prosperity followed by a period of depression”.

From the definitions of a business cycle given above we can say that a trade cycle invariably starts in the industrial sector and then spreads itself over the other sectors quickly because in modern economy, the different sectors are interrelated. In general, trade cycle created in one sector fully affects the whole economy.


Phases (Or stages) and Effects of Trade cycle

Trade cycle means the occurrence of boom and slump or fluctuations in economic activities like sea waves, such as one phase follows the other as economic ups and downs. According to American economists Arthur F. Burns and Wesley C. Mitchell, in any trade cycle there will be two states of minimum ‘trough’ and maximum ‘peak’. But, there are other phases within these two phases. According to these facts, the phases of trade cycle can be divided in to four categories:

(1) Depression or contraction:

It is very tough to point out the starting point of the ride cycle. However, depression follows the state of prosperity and the state of prosperity is again reached after the state of depression. Therefore, depression may be called the first phase of trade cycle. Most of the economists also have taken the state of depression as the starting phase of trade cycle.

Depression is the critical and fearful stage of a trade cycle. In this phase, the economic activities in the economy are far below normal or below the normal rate of growth. In the state of depression, there will be unfavorable situations everywhere in the economy. The level of price, wage, credit, profit, production, employment, etc., all are at low level. Since price of the goods is in a decreasing state, the investors are discouraged to invest. Due to less investment, output and employment will decrease. So in this phase, the business will be in very weak condition. The wage of the labors will decrease as a result of decrease in investment. The purchasing power of money will increase. The profits of investors will decrease and move towards zero or even a negative state. Despite the increase in purchasing power of money, the purchasing power of people will be very low due to high rate of unemployment in the depression state.  Depression or contraction leads to redistribution of the national income. Profits and wages fall faster relatively to rent and other fixed incomes. Incomes of shareholders go down fast. This reduces the deposits with banks and other financial institution. There is a great decline in construction and construction industries. The fall in the prices of agricultural commodities and raw materials push the farmers to a very unfavorable position. There is pessimism and anxiety all-round. It is said that the long depression had occurred in U.S.A. during 1873-79 and 1929-33. Depression expanding widely in the economy will reach the minimum point, that is, trough.

There are following effects of depression phase of trade cycle in the economy:

(i)      Decrease in output and business.

(ii)     High rate of unemployment and very low level of income.

(iii)    Decrease in demand and fall in the price level.

(iv)     Excessive decrease in the price of raw materials and agricultural products than the price of produced goods.

(v)      Reduction in the flow of loan of bank and finance companies.

(vi)     Decrease in the rate of interest.

(vii)    Decrease in expansion of construction and manufacturing industries.

(viii)   Failure in economic activities.


(2)     Recovery or Revival:

It is the second phase of the trade cycle. In this phase, the trade cycle slowly rises and moves towards the state of prosperity from the minimum point ‘trough’. It means that recovery process starts after the economy reaches the trough and is in a very weak condition. Recovery shows the upturn of the output and employment of the economy from the sate of depression. Recovery is most probably the result of the fresh demand for plant and equipment arising from the consumer goods industries which had been postponing this investment during depression. The capital goods have a limited life. They wear out completely after some time and need replacement. This replacement demand starts the recovery process. The investors will be ready to bear risks in investing. In such a period, factor of production will be available at lower prices. Due to low cost of product, the profit will start increasing. This will encourage the investors towards investment. Many new industries will be established in the economy which increases employment rate. Due to increase in employment, income of the people also increases. Due to increase in profit, the investment in capital goods industries begin to increase. The businessmen begin to take credit from the banks and there is an expansion of bank credit. This has favorable effect even in agriculture. In this way, during the period of recovery, the whole economy begins to rise upward. The pessimism of depression phase disappears. There is all round growth of new hope in the economy.

The following are the effects of trade cycle in the recovery phase:

(i)    Increase in output and employment.

(ii)   Increase in income and demand.

(iii) Increase in price.

(iv)   Increase in wage and interest.

(v)    The feeling of pessimism will gradually decrease.

(vi)   There will be optimism every where in the economy.

(vii) Increase in credit demand for investment.


(3)     Prosperity or Boom:

After the phase of recovery, the phase of prosperity emerges in the trade cycle. The period in which there is the rapid increase in economic activity is known as prosperity or boom. In this phase of trade cycle, there is a feeling of optimism among the businessmen and the industrialists. In the state of prosperity, real income and output will increase as well as employment level also increases. As a result, business parties and entrepreneurs will earn maximum profits. More labors will be required for the higher level of production. This will bring about the state of full employment. Keynes has said that in such a situation, voluntary unemployment exists but the number will be very small.

According to Haberler,- “Prosperity is a sate of affairs in which the real income consumed, real income produced and level of employment are high or rising, and there are no idle resources or unemployed workers or very few of either.” This means that the ideals of full employment of the labour force and full utilisation productive capacity are realized in the prosperity phase. Industrial and commercial activity, both speculative and non-speculative, shows remarkable expansion. Construction activity gets a big boost. Share markets give handsome gains to investors which encourages accumulation of inventories of durable capital goods. Financial institutions tend to expand credit as the interest rates and discount rates go up. Thus, everyone seems to be happy during the state of prosperity which ultimately, of course, proves to be short-lived.

The following are the effects of prosperity phase of trade cycle in the economy:

(i)    Optimum utilization of all factors of production.

(ii)   Good indicators and full of hopefulness everywhere in the economy.

(iii)  Excessive increase in the output and employment.

(iv)   Increase in demand and price.

(v)    Excessive increase in stock and inventories.

(vi)   Comprehensive expansion in industrialization


(4) Recession:

After the phase of prosperity, the phase of recession starts in the trade cycle. The end of prosperity phase comes because of certain tendencies in the private-enterprise economy prevalent during the boom conditions.

Firstly, as prices rise, wages tend to lag behind. Secondly, expansion of production is hampered by shortages of some inputs and bottlenecks in production. Thirdly, excessive demand for labour and materials pushes up both the factor and the product prices and fourthly, the non-availability of credit beyond a particular rate of expansion might also act as a serious break on prosperity. In this way the wave of pessimism gets transmitted to other sectors of the economy. The whole economic system thereby runs into a crisis. Thus the next stage of prosperity phase of the trade cycle, called recession.

When sure signs of recession appear on the stock and financial markets, over-pessimism, nervousness and fear born out of uncertainty overtake the businessmen. In this state, the entrepreneurs and businessmen will start suffering loss in their productive activities. As a result, industries will start closing down. This will stop the new investments also. At this atmosphere, even the projects in-hand may be abandoned, some firms go sick. Others simply go bankrupt. The fall in the purchasing power of the general public reduces the demand for consumer goods. In this way, as M.W. Lee has remarked, “a recession once started, tends to build upon itself much as forest fire.” The recession was experienced by USA in 1873 and 1907. Flowing are the effects of recession:

(i)    Cost of production is higher than the price of goods.

(ii)   Decrease in profit.

(iii)  Decrease in investment and industrial improvement.

(iv)  Diminishing in employment level and the level of income.

(v)   Adverse effect on money and credit market

(vi)  Feeling of pessimism in the economy.

These different phases of trade cycles has been illustrated in figure below:


In above figure, different phases of the trade cycle are shown. Time period is measured along the OX-axis and economic activity is measured along on the OY-axis. The line PQ represents economic trends. Above this line, we have two phases of trade cycle, they are: prosperity in the upswing and recession in the downswing. Below this line also two phases, i.e., recovery in the upswing and depression in the downswing. The trade cycle as shown in above diagram passes through four stages. It starts with depression to be followed by recovery, prosperity, recession and ultimately ends up again with depression.

It should be notified that each phases of trade cycle need not pass all the phases. The recession can occur after recovery without passing prosperity. such a situation had occurred in USA at 1937. Likewise, the duration or length of the different phases of trade cycle cannot be accurately ascertained.

One thought on “Concept of Trade Cycle”

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