A Business Cycle Fluctuations - Causes and Effects - Assignment Example

Ans. 1 a) A business cycle generally follows from the fluctuation experienced by an economy over the time frame. These fluctuations result from the changes in economic growth. A typical business cycle may be illustrated through the following diagram: In the above diagram, the horizontal axis stands for the time and the vertical axis depicts the real GDP growth rate. If the curve plotted in the graph represents a business cycle then we can easily see that starting from a point a business starts to move towards the peak and the region in between the starting point and the peak (crest) may be termed as the zone of expansion. After reaching the peak it stays there for sometime and then starts falling to reach trough (the minimum most point of the curve). At the trough the business experiences recession. The region between the peak and trough may be termed as the zone of downturn. After reaching the nadir, i.e., the trough, the economy starts to improve again (it passes through the zone of expansion again to reach the peak). In this manner the process continues time and again. The most interesting point of discussion in a typical business cycle is that while an economy experiences growth and reaching the peak does not stay there for long and sooner or later must experience recession to fall along the down ladder. (Francisco and Luis, 1985, pp. 367 – 385), The reason is that the economy’s growth is usually accompanied by rising inflation rates and this inflation tempts the onrush of further flourish and limits the growth rate. In order to track the movements of GDP, inflation and interest rates during a typical business cycle, it would be necessary to decompose the above economic variables into their constituting blocks and judge their individual experiences during a typical business cycle. Movement of GDP: The consumption expenditure holds the lion’s share of GDP whereas the investment is much smaller as a component of the same, but decline of GDP during recessions is generally initiated by decline in investment is much smaller component of the same, but decline in GDP during recessions is generally initiated by decline in investment rather than consumer expenditure. Among the consumption expenditures, purchase of durable goods is most sensitive to the changes in economy. It has been found that during recession the purchase of durable goods is at their minimum. (Branson, 1979, pp. 3-12) The government expenditure during a recession does not decline. This follows from the inertia in government budgeting and spending process instead of financial activism on behalf of the government. Net exports are that export- import generally increases during the recession. That is because domestic firms failing to experience sufficient demand in the indigenous market opt for selling the product abroad. If successful, it brings a shy of relief to the economy. So, if Y represents the GDP, then Y = C+I+G+NX, where C stands for consumption expenditure, I for investment expenditure and G for government expenditures respectively. Then it has been analyzed till now that during a typical business cycle, which is a continuation of expansion and recession leading to crest and trough respectively. Consumption rises during expansion and reaches a peak before declining towards the trough. Investment follows the similar route and NX behaves oppositely to C and I. Since C and I are the main building blocks of GDP, the GDP as a whole expands during expansion reaches the peak and then experiences the recession to reach the trough. It is interesting to note that even if consumption expenditures experiences positive growth during recession, due to the assured decline in investment during recession, GDP always declines. Phase wise, a business cycle consists of boom and slump. During boom, GDP rises and during slump it falls. Movement of inflation: During the boom period, due to high demands, the price will rise and rate of inflation is at a high. In contrast, during the slump period due to fall in aggregate demand, the rate of growth in price level and hence rate of interest is at a low. Movement of interest rates: Movement of market rate of interest is at a tune with movement of rate of inflation. Facing a higher rate of inflation, the government raises the market rate of interest so that people may opt for interest bearing asset, bond rather than non-interest bearing asset, money. When people purchase bonds using the excess supply, they have in their hand; excess liquid cash in the economy gets dried up. So in course of time, it becomes a major helping factor in facing inflation. As a whole, during the boom period, market rate of interest rises and during the boom period market rate of interest falls. b) If the Japanese economy faces a stagnation leading to a decline in Australian export of goods and services and on the other hand, Australian import of Japanese products remain the same, then the aggregate expenditure line will shift downwards. To see why it is so, let us assume that initially the aggregate expenditure is AE1 and AE1 = C+I+G+(X1-M), where, C, I, G and M are exogenously given and X1 is the initial level of export. Now, X1 is reduced to X2 (that is, X2I, then we have NX>0 that is, a trade surplus. On the other hand if S Read More