TOPIC 7: TRADE CYCLE ~ ECONOMICS FORM 5
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TRADE CYCLE
Trade cycles can well be called Business cycles.
It means the rise and fall in the level of economic activities in an economy over time.
Trade cycle means ups and downs (fluctuations) in the level of economic activities in an economy.
A trade cycle simply means the whole course of trade or business activity which passes through all phases of prosperity and adversity
The level of economic activities in any economy does not remain constant but do change as factors upon which they are based also change.
Features of Trade cycles
Trade cycles are wave like structure i.e. Their occurrence is like the shape of waves.
Expansion and contraction in trade cycles is cumulative in effects.
Trade cycles differ in timing and level of fluctuations.
Trade cycles have common patterns of phases which are sequential in nature.
A downward movement of trade cycle is more sudden and violet than change from downwards to upwards
Trade cycles occur in aggregate variables such as output, income, prices.etc.TYPES OF TRADE CYCLE
A damped Cycle
The fluctuation become smaller and smaller over time.
The fluctuations become larger and larger overtime
Trade cycles has four (4) phases which are arranged in order as below;-
1. Depression (trough/ slump)
2. Recovery (revival/ expansion)
3. Boom (peak/prosperity)
4. Recession (downturn/ contraction)
Characteristics of phases of trade cycles
This is a period when economic activities are at the most lowest level. Therefore it is the period where there is maximum decline in the level of economic activities.
Characteristics of Depression
Lowest level of investments
Highest level of unemployment
Lowest level of income
Lowest level of consumption
Price are very low
People lose confidence in their government
Lowest standard of living
Banks and businesses are bankrupt.etc
This is a period when the economy starts to improve from a depression.
Characteristics of Recovery
Investment starts to increase
Unemployment starts to reduce
Standard of living starts to improve
Incomes and prices start to increase
Banks starts providing credit and people start saving
Consumption starts to increase
People start to gain confidence in their economy
Boom
This is a period the economy is at most highest level and therefore economic activities are at the most desirable level.
Characteristics of Boom
Highest level of investment
Lowest level of unemployment
Highest standard of living
Social Economic and political stability
High incomes
High effective demand
Recession
This is a phase where there is a decline in the level of economic activities.
Characteristics of a recession
Decline in investment
Increase in unemployment
Decrease in incomes
Decline in effective demand
Decrease in the standard of living
Tax revenue falls.etc
Causes of Trade cycles
Changes in climatic conditions
When climate is favorable, agricultural activities and other related ones such as ago based industries are stimulated which results into expansion in output,employment opportunities,incomes.etc and hence an expansion in economic activities. However with unfavorable climate such activities contract and hence decline in employment, income, output etc
Change in the age of capital
When machines are new they tend to be more efficient and hence more output, income, employment opportunities and hence expansion in the levels of economic activities but it is time which gives on machine become older through depreciation, which reduces efficiency and hence fall in output, incomes, employment opportunities and finally a contraction in economic activities.
Technological innovation
When a new technology is discovered, it will result in to better methods of production and hence output, incomes, employment opportunities.etc and hence expansion in the level of economic activities but when the innovations do not take place regularly and hence fluctuation in the level of economic activities.
Changes in government policy.
The government policy is as well responsible for fluctuations in the level of economic activities. If the government opts for an expansionary fiscal policy and monetary policies such as decrease in taxes increase in government expenditure .etc, it will result into expansion of economic activities.
However if the government opts for contraction momentary policy such as increase in taxes, decrease in government expenditures, it will result into contraction in economic activities.
Changes in marginal efficiency of capital
The level of investment is an important factor as regard to the level of economic activities but however this depends primary on marginal efficiency of capital.
When marginal efficiency of capital increase investment expands output increases, employment and incomes also increases and hence expansion.
On the other hand when MAPC decline, it will result into decline on investments, output, employment etc and hence a decline in the level of economic activities.
Changes in political climate
When there is political stability, investment expands and hence increase in output, employment opportunities, incomes and hence expansion in the level of economic activities. On the other hand with political instability the economic activities decline.
Unpredictable changes in business investment depending on business optimism and pessimism (Psychological factor)when entrepreneurs are optimistic they will have confidence and hope for better business and profit then they will motivate more increased investment and hence expansion in the level economic activities.
Theory of Trade cycles
Climatic theory (harvest Theory) / Sunspot theory
According to the theory trade cycles is said to occur due to changes in climatic conditions .When climate condition is favorable, it leads to economic expansion conversely,unfavorable climate causes a decline in outputs in agriculture and in ago based industries and therefore leading to economic decline.
Jevons sunspot theory, According to Stanley Jevons, spots appear on the face of the sun at regular intervals. These spots affect the emission of heat from the sun, which in turn condition the degree of rainfall. The rain affects agriculture which it affects trade and industry.
Monetary theory
According to this theory trade occurs due to changes in money supply and money demand.
Change in money supply.
Increase in money supply: When money supply increases through increase in provision for credits, investment are encouraged and thus employment, incomes, effective demand increases as well as the standard of living. This is a period of boom or economic recovery.
Decrease in money supply: When money supply decreases it discourages investment as a result employment, income and effective demand fall, hence an economic recession occurs
Changes in money demand
Increase in money demand: An increase in money demand for transaction motive situation insertion and production thus cause an economic expansion.
Decrease in demand: A decrease in money demand for transaction motive discourages effective demand and production; therefore it results in a recession or depression.
3. Over –investment theory
According to this theory, trade cycle occur due to over investment, over investment occur due to the following reason;-
-Fall in the rate of interest; When rate of interest is low investors are encouraged to borrow money for investment hence more investments are created leading to economic growth.
-Technological innovations; Invention of new technology causes an increase in production and economic expansion.
-Increase in effective demand: When effective demand increase production, therefore the economy undergoes economic growth.
4. Psychological Theory
Attempts are made by some economists to explain trade cycles interms of psychology. There are moods of optimism alternating with moods of pessimism. At some stage people just think trade is good and that it is going to remain good.
Business activity is intensified and become flourish.Then all of a sudden, people start thinking that the period of prosperity has lasted long enough and adversity is round the corner. Thus although no valid reason for depression to come about, but it is brought about b the people themselves. It is all psychological.
The psychological theory lacks any sound basis. There is conjectural element in it. There is no doubt that, individual fluctuations are affected by the waves of optimism and pessimism and are intensified by them. But they do not explain the cause of the trade cycles or their periodic aspect.
5. Under-consumption theory.
According to under consumption theory, there is too much saving during a boom and further additions to saving reduce the level of consumption. A reduction in the level of consumption in the case of increasing productive capacity, must sooner or later lead to the collapse of the boom.
The under consumption or over saving theory contains an element of truth. But it cannot be the adequate explanation.Eg;if the under consumption theory were exclusively relied on, we expect the consumption goods industries to fluctuate more than investment goods industries. But exactly reverse is the case in real life during a trade cycle.
6. Keynes Theory.
According to Keynes, trade cycle is caused by changes in the rate of investment, the rate of investment is caused by the marginal efficiency of investments, ie profitability of investments, if the rate of profit declines, investors are discouraged to increase investments, the economy falls into a recession and the rate of profit increases. Investors are encouraged to increase investments and therefore the economy will experience recovery.
7. Political Theory
According to this theory, fluctuations in economic activities are caused by;
– Actions of politicians who apply expansionary monetary and fiscal policy for their political interest. I.e. to gain popularity this policy led to economic prosperity in the short run, but after winning elections politicians apply contraction monetary and fiscal policies which lead to economic contraction.
– Political stability and instability; When there is political stability, investors are encouraged to increase investments causing economic growth. In contrast when there is political instability investors are discouraged to invest and thus an economy falls into recession.
8. Modern Theory
According to this theory trade cycle occur due to multiplier and accelerator processes. An increase in investments leads to an increase in income which stimulates further increase in investments through the accelerator process and increase in investments stimulates further increase in income.
Therefore economic recovery or a boom is caused by the effectiveness of the multiplier and accelerator processes while economic recession is caused by ineffectiveness of the multiplier and accelerator processes.
MEASURES TO CONTROL BUSINESS CYCLES
Expansionary monetary policy
This involves the central bank through commercial banks increasing money in circulation in order to deal with a depression and recession. Under this the central bank will reduce the bank rates, reduce legal reserve requirements and so on, which will encourage banks to lend more to customers and businessmen. This will result into more investments, increase in aggregate demand which will finally result into expansion of economic activities.
Expansionary fiscal policy.
Under this the government should opt for the following in order to deal with a depression and recession.
– Increase in government expenditure especially in productive areas such as construction of roads which will result into increase in money supply and stimulation of business activities.
-The government should as well lower direct and indirect taxes which will as well stimulate aggregate demand of goods and services, hence stimulation of economic activities.
The government can as well as employ direct controls in order to ensure proper allocation of resources in order to bring about price stability and economic stability, such controls will take different forms such as;-
Exchange rate policy: Under this the government evaluate its currency in order to encourage exports which helps to boost up domestic production.
Price and wage control: Under this the government fixes minimum prices in order to encourage production. It can as well increase wages in order to increase aggregate demand.
Monopoly control: Under this the government can monitor the operation of monopoly firms so that they do not limit output which helps to stimulate production.
