Question

what do you think causes the business cycle? how can we diminish the boom and bust?

Answer 1

It is most common that the economic activity is experience by alternating upswing and downswing. Such fluctuations are generally termed as business cycle or trade cycle. The business cycle has four phases namely Expansion (Boom), Peak (End of the Boom) Contraction (bust) Trough (end of the bust. When the economy passes through these phases there will be wide fluctuations in aggregate employment, income, and output and price level.

Causes of business cycle.

1. Increase in demand.

One of the reasons of business cycle is the increased consumer demand. The increase in demand increases the business investment rising national employment, income and output. This will cause boom in the economy.

On the other side, when the demand decreases, the business investment decreases which further reduce the national employment income and output. This leads to a contraction or bust which continue for a long period and the economy may turn into depression.

2. Changes in investment.

The investment in an economy may fluctuate due to the changes in rate of interest and expectations of profit. A fall in rate of interest and an expectation of higher profit in future induces more investment in the economy. The increased investment will lead to expansion and the decrease in investment cause contraction or bust.

3. Changes in supply of money.

An increase in money supply causes expansion while decrease in money supply initiate recession in the economy. According to R.G Hawtrey, trade cycle is purely a monetary phenomenon. Changes in the flow money are the sole and sufficient cause of business cycle. If the quantity of money and credit are expanded, demand exceeds which brings rise in prices, production and employment. A reduction in money supply cause decrease in demand and reduced price level, decreased production and employment.

4. Government policies.

The fiscal and monetary policies of the government also cause business cycle. An expansionary fiscal and monetary policies cause a boom and contractionary policies cause a bust.

5. Technological changes.

Introduction of new technology boost up the economy.

6. Natural factors.

Natural calamities like flood, drought, hurricanes etc damages to the crops and cause a shortage of agricultural production. This will reduce demand both in agricultural sector and industrial sector resulting in a bust.

7. Population growth.

If the population growth outstrips the economic growth, total saving in the economy decrease. The investment will decrease which will slow down the economy.

Measures to control business cycles.

1. Monetary policy.

Monetary instruments can be used to stimulate the flow of credit as well as to suppress it. During times of boom, flow of credit to be restricted. Thus the central bank can choose a dear money policy instruments like Open market operation, rising bank rate and reserve ratio. On the other hand during bust the monetary authority can use a cheap money policy.

2. Fiscal policy.

During boom the government increases the tax rate and reduces its expenditure. But during the period of bust the government decreases the tax rate and increases the public expenditure. In short the monetary and fiscal measures can be used to control business cycle.

3. Direct controls.

The business cycle can be more or less control by fixation of prices of essential commodities. Price control like price ceiling and price floor helps to prevent the fall in price and a bust and increase in price and a boom.

The government can use wage control measures to prevent the boom and bust.