Four Phases of Business Cycle

Business Cycle (or Trade Cycle) is divided into the following four phases;

1. Prosperity Phase: Expansion or Boom or Upswing of economy.
2. Recession Phase: from prosperity to recession.
3. Depression Phase: Contraction or Downswing of economy.
4. Recovery Phase: from depression to prosperity.

Inflationary Gap

In his pamphlet,’ how to pay for the war ‘published in 1940, Keynes explained the concept of ‘inflationary gap’. It differs from his views on inflation given in the general theory. In the general theory, he started with underemployment equilibrium, but in how to pay for the war, he began with a situation of full employment in the economy. He defined an inflationary gap as an excess of planned expenditure over the available output at pre-inflation or base prices. According to Lipsey,’ the inflationary gap is the amount by which aggregate expenditure would exceed aggregate output at the full employment level of income’. The classical economists explained inflation as mainly due to increase in the quantity of money, given the level of full employment. Keynes, on the other hand, ascribed it to the excess of expenditure over income at the full employment level. The larger the aggregate expenditure, the larger the gap and the more rapid the inflation will increase. Given a constant average propensity to save, rising money incomes at full employment level would lead to an excess of demand over supply and to a consequent inflationary gap. Thus Keynes used the concept of the inflationary gap to show the main determinants that cause an inflationary rise in prices.

Inflation

The term ’inflation’ is used in many senses and it is difficult to give a generally accepted, precise and scientific definition of the term. Popularly inflation refers to a rise in price-level or fall in the value of money. Kemmerer states that,” inflation is too much currency in relation to the physical volume of business being done”.

Types of Inflation

There are several types of inflation observable in an economy. These can be classified as under: 

1. Creeping, Walking, Running, and Galloping Inflation: 

This classification is made on the basis of the” speed” with which the prices increase in the economy. 

Effects of Inflation

A period of prolonged, persistent and continuous inflation results in the economic, political, social and moral disruption of society. The effects of inflation can be discussed under two sub-heads;

1. Effects on production 
2. Effects on distribution 

Effects on Production: 

The phenomenon of inflation produces a very deep impact on the production of wealth in the economy. Inflation may not always be detrimental to production. Mild inflation may actually be good for the economy, particularly, when there are unemployed productive resources in the country. An expansion of money supply in an underdeveloped economy will result in a slow and gradual rise in the prices. The production costs in such an economy do not increase in the same proportion as the prices with the result that the profit margins of the businessmen continue to increase, creating optimistic conditions in the economy. Thus, an expansion of money supply up to the point of full employment may not be harmful for the economy. But, any expansion of money supply after the point of full employment may not be harmful for the economy. But any expansion of money supply after the point of full employment will degenerate into runaway or hyper-inflation and, hyper-inflation is very harmful for the economy. It creates business uncertainty which is not good for production. 

Control of Inflation

The measures to control inflation can be divided into: 

I. Monetary Measures: 

These measures are adopted by the central bank of the country and include such steps as an increase in re-discounted rates, sale of government securities in the open market, an increase in reserve ratios and adjustments in selective controls to arrest an inflationary credit boom. Each of these steps has its own limitations though it can be said that monetary measures are more effective in checking inflation than curbing a depression. 

a) Increased Re-discount Rates: 

To curb inflation, the central bank generally increases the re-discount rates. An increase in re-discount rates increases the cost of borrowing funds for business and consumer spending and, thus, discourages excessive activity based on borrowed funds. 

Causes of Inflation

Following are the factors which cause an increase in the size of demand: 

1. Increase in Public Expenditure: 

An increase in public expenditure, consequent upon the outbreak of war or development planning, invariably, causes an increase in the demand for goods and services in the economy. Infact, this is an important cause giving rise to the emergence of excess demand in the country. 

2. Increase in Private Expenditure: 

An increase in private expenditure, both consumption and expenditure as well as investment expenditure is an important cause of the emergence of excess demand in the economy. When business conditions are good, private entrepreneurs start investing more and more funds in new business enterprises, giving rise to an increase in the demand for the services of factors of production. This results in an increase in factor-prices. When factor incomes increases there is more and more expenditure on consumption goods. The ultimate effect of an increase in private expenditure is to push up the demand for commodities as well as factors of production.

Effects of Deflation

Deflation affects the entire economic life of the country. The different sections of society are affected in the following manner. 

(1) Producers and Traders: 

Deflation adversely affects both the producers as well as the traders. The producers are adversely affected on three counts 

1. The production costs at a time of deflation do not fall as rapidly as the prices of the finished product. 
2. Whenever a producer buys raw-materials etc, for the purpose of production, he has to pay a higher price for it when the finished product reaches the market, the prices of raw-materials will have fallen still further and the producer will be compelled to sell his product at a reduced price.
3. The demand for commodities also goes down at a time of deflation. 

Deflation

Deflation is the opposite of inflation. In the words of Prof. Crowther,”deflation is the state of the economy where the value of money is rising or the prices are falling”. 

This definition is not free from defects. From this definition, it appears that every fall in the price-level is deflation but actually this may not be so. Sometimes the price-level starts falling down without any contraction in the supply of money. Now such a fall in the price-level cannot be called deflation. 

According to Prof. Pigou, “Deflation is that state of falling prices which occurs at that time when the output of goods and services increases more rapidly than the volume of money income in the economy”. 

Thus, according to Pigou every fall in the price-level is not deflation. Deflation occurs at that time when the output of goods and services increases at a faster rate than the money income. A fall in prices in the following situations may be termed deflationary according to Pigou.

1. If the money income diminishes but the output remains constant.
2. If the money income and the output both diminish but the money income diminishes much more rapidly than the output.
3. If the volume of output increases but the money income remains constant.
4. If the volume of output increases but the volume of money income diminishes. In each of the cases, the fall in prices will be deflationary. 

Effects of Deflation

Notes provided by Prof. Sujatha Devi B (St. Philomina's College)

Monetary Policy

Monetary policy refers to the credit control measures adopted by the central bank of a country. Johnson defines monetary policy ,” as a policy employing central bank’s control of the supply of money as an instrument for achieving the objectives of general economic policy”. G.K Shaw defines it as, “ any conscious action undertaken by the monetary authority to change the quantity , availability or cost of money”. 

Objectives: 

The broad objectives of monetary policy are to establish at full employment level of output, to ensure price stability and to promote economic development of the economy. Monetary policy is concerned with changing the supply of money stock and the rate of interest for the purpose of stabilizing the economy at full employment or potential output level by influencing the level of aggregate demand. More specifically at times of recession monetary policy involves the adoption of some monetary tools which tend to increase the supply of money and lower interest rate so as to stimulate aggregate demand in the economy. On the other hand at times of inflation, monetary policy seeks to contract the aggregate spending by tightening the money supply or rising the rate of interest. It may however be noted that in a developing country like India, in addition to achieving equilibrium at full employment or potential output level, monetary supply also promotes and encourages economic growth both in the industrial and agricultural sectors of the economy. Thus in the context of the developing countries the following three goals are or objectives that are important. They are:

1.  To ensure economic stability at full employment level or potential level of output. 
2. To achieve price stability by controlling inflation and deflation. 
3. To promote and encourage economic growth. 

The role of monetary policy is to achieve economic stability at higher level of output and employment. 

Instruments of the Monetary Policy: 

The instruments of monetary policy are of two types: 

1. Quantitative, general or in-direct methods: 
2. Qualitative, selective or direct methods 

1. Quantitative, general or in-direct methods: 

The following are the three quantitative methods of credit control 

• Bank rate policy 

• Open market operations 

• Change in the reserve ratios 

a) Bank Rate Policy: 

The bank rate is the minimum lending rate of the central bank at which it re-discounts first class bills of exchange and government securities held by commercial banks. When the central bank finds that inflationary pressure have started emerging within the economy it rises the bank rate. Borrowing from the central bank becomes costly and commercial banks borrow less from the central bank. The commercial banks, in turn rise their lending rates to the business community and borrowers borrow less from the commercial bank. There is contraction of credit and prices are checked from rising further. On the contrary, when prices are depressed the central bank lowers the bank rate. It is cheap to borrow from the central bank on the part of commercial banks. The later will also lower their lending rates. Business men are encouraged to borrow more. Investment is encouraged. Output , employment, income and demand start rising and the downward movement of the prices is checked. 

b) Open Market Operations: 

Open market operations refer to the sale and purchase of securities in the money market by the central bank. When prices are rising and there is need to control them, the central bank will sell securities. The reserves of the commercial banks are reduced and they are not in a position to lend more to the business community. Further investment is discouraged and the rise in prices is checked. On the other hand, when recessionary forces start in the economy, the central bank buys securities. The reserves of the commercial banks are raised. They lend more , investment, output, employment, income and demand rise, and fall in price is checked. 

c) Change in the reserve ratios: 

This method of credit control was suggested by Keynes in his “treatise of money” and USA was the first to adopt it as a monetary devise. Every bank is required by law to keep a certain percentage of its total deposits in the form of a reserve fund and also a certain percentage with the central bank. When the prices are rising, the central bank rises the reserve ratio. Banks are required to keep more with the central bank. There reserves are reduced and they lend less. The volume of investment, output and employment are adversely affected. In the opposite case, when the reserve ratio is lowered, the reserves of the commercial banks are raised. They lend more and the economic activity is favorably affected. 

2. Selective Credit Control: 

Selective credit controls are used to influence specific types of credit for particular purposes 

a) Changing Margin Requirements: 

They usually take the form of changing margin requirements to control speculative activities within the economy. When there is brisk speculative activity in the economy or in particular sector in certain commodities and prices start rising, the central bank rises the margin requirements on them. The result is that the borrowers are given less money in loans against specified securities. For instance, rising this margin requirements to 60% means that the pledger of securities of the value of Rs. 10000 will be give 40% of their value, that is, rupees 4000 as loan. In case of recession in a particular sector the central bank encourages borrowing by lowering margin requirements. 

b) Regulation of Consumer Credit: 

Originally used in USA since the beginning of world war II regulation of consumer credit is now being used extensively in many countries. During world war II, an acute scarcity of goods were felt and position was worsened in USA by the system of bank credit to consumers to enable them to buy durable and semi-durable consumer goods through installment buying. This was responsible not only for intensifying inflationary pressure in the country but also in disturbing the production of goods for defence purposes. The federal reserve banks of USA were authorized to regulate the terms and conditions under which consumer credit was extended by the commercial banks. The restraints under these regulations were two fold: 

1. They limited the amount of credit for the purpose of any consumer goods listed in the regulation.
2. They limited the time for repaying the debt. 

c) Control Through Directives: 

In the post war period, most central banks have been vested with the direct power of controlling bank advances. This power has been granted to the central banks either by statute or by mutual consent between the central bank and the commercial bank. For instance, the banking regulation act of India, 1949, specifically empowers the reserve bank of India to give directions commercial banks in respect of their lending policies, the purpose for which advances may or may not be made and the margins to be maintained in respect of secured loans. The RBI can also prohibit any particular bank or banking system as whole against entering into any particular transactions or class of transactions. 

d) Moral Suasion: 

Moral suasion implies persuasion and request made by the central bank to the commercial bank to follow the general monetary policy of the former. In a period of depression the commercial banks may be persuaded to expand their loans and advances to accept inferior types of securities which they may not normally accept fix lower margin and in general, provide favourable conditions to stimulate bank credit and investment. In a period of inflationary pressure the central bank may persuade the commercial banks not to apply for further accommodation already obtained for financing speculative or non-essential activities lest inflationary pressure should further worsened. 

e) Rationing of Credit: 

This is another method in the armoury of the central bank. Rationing of credit as an instrument of credit control was first used by bank of England. The term rationing of credit implies two things. 

1. It means that the central bank fixes a limit upon its rediscounting facilities for any particular bank, 
2. It means the central bank fixes the quota of every affiliated bank for financial accommodation from the central bank. 

f) Publicity: 

Several central banks have adopted publicity as an instrument of credit control. They use this instrument not only for influencing the credit policies of commercial banks but also to educate and influence public opinion in the country.

Notes provided by Prof. Sujatha Devi B (St. Philomina's College)

Fiscal Policy

Meaning of Fiscal Policy: 

Fiscal Policy may be defined as that part of governmental economic policy which deals with taxation, expenditure, borrowing and the management of public debt in an economy. It is an indispensable instrument of modern public finance. The importance of fiscal policy has greatly increased in modern times, both in the developed as well as the underdeveloped countries of the world. In developed countries, fiscal policy is being increasing used as an instrument to achieve full employment and economic stability. In underdeveloped countries, on the contrary, fiscal policy is more and more being used as a means to step up the rate of economic growth. Fiscal policy primarily concerns itself with the flow of funds in the economy. Taxation diverts the funds from the private sector to the governmental sector. Public expenditure on the contrary, diverts funds from the governmental sector back to the economy. Public borrowing, like taxation also diverts funds from the private sector to the governmental sector, but the two diversions influence the private sector in different ways. Management of public debt includes functions, such as, floating of governmental loans, payment of interest thereon and retirement of matured debts. Fiscal policy, thus, exerts a very powerful influence on the working of the national economy. It directly affects the volume of output, income and employment in the economy. The greater the percentage of national income and expenditure represented by the governmental budget, the greater would be the influence of fiscal policy on aggregate economic activity. 

Objectives of Fiscal Policy in a Developed Capitalist Economy: 

There are two broad objectives of fiscal policy in a developed capitalist economy, namely, 1. To achieve and maintain full employment in the economy, and 2. To achieve economic stability in the economy through avoidance both of inflation as well as deflation. In short, the basic goal of fiscal policy in a developed economy is one of full employment and economic stability. 

Objectives of Fiscal Policy in Underdeveloped Economy: 

The nature of fiscal policy in an underdeveloped economy is bound to be different from that of a developed economy. In a developed economy, the problem is not so much that of development as that of achieving economic stability on account of business fluctuations caused by the operation of the trade cycles. But the problem of an underdeveloped economy is not so much that of economic stability as that of promoting rapid economic growth in the country. 

The major objectives of fiscal policy in an underdeveloped country are: 

• The first objective of fiscal policy in an underdeveloped country should be to maximize the level of aggregate saving by applying a cut to the actual and potential consumption of the public at large. The fiscal policy should especially curb conspicuous consumption of the rich and force them to save more for capital formation. 

• The second objective should be to maximize the rate of capital formation to break economic stagnation and to lead the country on to the path of rapid economic progress and growth. 

• The third objective of fiscal policy in an underdeveloped economy should be to divert capital resources from less productive to more productive and from socially less desirable to socially more desirable uses.
• The fourth objective of fiscal policy should be to protect the economy of an underdeveloped country from inflation. Inflation can ruin an underdeveloped country. As such, the fiscal policy of an underdeveloped country should be designed in such a manner so as to curb inflationary forces arising during the process of growth. 

• The fifth objective of fiscal policy should be to eliminate as far as possible, sectoral imbalances arising in the economy from time to time. 

• The sixth objective of fiscal policy should be to provide incentives for encouraging those industries which have a high employment potential in the economy. 

• The seventh objective of fiscal policy in an underdeveloped country should be eliminate as far as possible, the glaring economic inequalities in the economy and bring about an equitable redistribution of income and wealth in society. 

Fiscal Policy and Economic Growth: 

Fiscal policy is also a potent weapon for the achievement of accelerated economic growth in a backward, underdeveloped economy. Without an appropriate fiscal policy, the process of economic growth in a country is bound to suffer. In achieving a fast economic growth, the government may have to deploy all the instruments of fiscal policy at its disposal, namely, taxation, public expenditure, public debt and deficit financing. The problem in a backward underdeveloped economy is not one of lack of real resources, but that of shortage of financial resources. So the instruments of fiscal policy may have to be used to raise adequate finance for economic growth. 

1. Taxation: 

It is an indispensable instrument for raising finance for economic development. For this purpose, the government may resort to direct as well indirect taxation. Direct taxes, such as, income tax, wealth tax, gift tax, capital gains tax etc may have to be levied to net adequate revenues for development purposes. The incidence of these taxes mostly falls on the richer classes. As such, they are quite justified from the point of equity. The government may impose steep excise duties and import taxes on luxury goods which are consumed exclusively by the rich. To raise enough revenue for developmental purposes, it may also be necessary to levy excise taxes on articles of mass consumption, though the burden of such taxes is mostly borne by the poor and middle-class. 

2. Public Debt: 

Taxation taken alone may not yield adequate revenue for mobilizing the real resources of the country. The government may therefore resort to public borrowings, short-term as well as long-term, to add to its fund of investible resources. There may be opposition to heavy taxation, but no one opposes public borrowings because the government pays interest on public loans. While borrowing from the public, the government should ensure that the burden of interest charges does not turn to be unbearable for it. For this purpose, the government may adopt a cheap money policy to keep interest-rates at a comparatively low level. Since the amount raised through internal borrowings may not be adequate there is no harm if the government if the government resorts to the international money market for raising the necessary funds for developmental purposes. The government may even take loans from foreign countries or international lending agencies on suitable conditions and terms of repayment. While raising external loans, the government has to be alert enough to see that such loans do not compromise its economic and political sovereignty in any way. 

3. Public Expenditure: 

The government of an underdeveloped country should devote quite a substantial portion of its expenditure to the building up of the necessary infrastructural facilities for economic growth, such as, roads. Railways, communications, irrigation works, power stations, coal-mining, general and technical education. These facilities will induce the rapid growth of the economy. Along with that, a part of the purpose expenditure may also be allocated for the growth and development of basic industries which will provide the foundation of industrial growth in future. Agriculture which is generally the most important segment of an underdeveloped economy should receive special attention of the government. Expenditure incurred by the government on the promotion of labour and social welfare also aids the rapid growth of the economy by improving the productivity of the labour force. 

4. Deficit Financing: 

It is still another important instrument of fiscal policy. It has proved to be a dispensable means of financing the economic growth of underdeveloped economy. Several developing countries have in recent years, employed the technique of deficit financing as a means of financing economic development. 

Limitations of Fiscal Policy: 

Fiscal policy as an instrument of economy stability and economic growth suffers from certain limitations which may be as follows; 

1. Firstly, the difficulty of accurately forecasting the onset of depression robs fiscal policy of much of its utility and effectiveness as an anti-cyclical device. More often than not, a country finds itself already knee-deep in depression before it moves about to take corrective action. 
2. Secondly, the corrective action taken by the government does not produce immediate results, because, there is often a prolonged time interval between the enforcement of fiscal measures and their final impact on the functioning of the economy. 
3. Thirdly, fiscal steps taken by the government to curb unemployment may fail to yield results if the unemployment is due to causes other than the deficiency of aggregate demand. Fiscal measures for example will fail to create any dent on unemployment, if it is due to seasonal, frictional, structural or technological causes. 
4. Fourthly, fiscal measures may prove inadequate or ineffective in dealing even with cyclical unemployment caused by the deficiency of aggregate demand for several reasons. For example: increased public expenditure intended to create more employment opportunities may be accompanied by a decline in private expenditure due to an increase in factoral prices. Increased public expenditure may also have adverse effect on employment-generation in the private sector through a general increase in wage-levels. 
5. Fifthly a strong and powerful fiscal policy adopted to deal with more mass unemployment may unduly inflate the size of the public debt which will impose an unbearable burden on the future generations. 
6. Sixthly, while dealing with hyper-inflation and boom, the government may carry its fiscal measures to the other extreme, namely, far too high taxation and cut-back in public investment, which will pave the way for the forth coming depression. 
7. Lastly, fiscal measures taken to finance economic growth in an underdeveloped economy may not suffice unless and until recourse is taken to monetary devices such as deficit financing etc.

Notes provided by Prof. Sujatha Devi B (St. Philomina's College)

Business Cycles

An important feature of the working of a capitalist economy is the existence of alternating periods of prosperity and depression generally referred to as a ‘business cycle’ or ‘trade cycle’. In a business cycles there are wave like fluctuations in aggregate employment income, output and price-level. The term business cycle has been defined in various ways by different economists. 

• Prof Haberler’s definition is very simple, he says,” The business cycle in the general sense maybe defined as an alternation of periods of prosperity and depression of good and bad trade.” 

• Keynes’s definition in his treatise of money is more explicit: “A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentage alternating with periods of bad trade characterized by falling prices and high unemployment percentages.” 

• Prof. Gordon’s definition is precise,” business cycles consist of recurring alternation in aggregate economic activity, the alternating movements in each direction being self-reinforcing and pervading virtually, all parts of the economy”. 

• The most acceptable definition is that given by Prof. Mitchell in these words,” Business cycles are a type of fluctuations found in the aggregate economic activity of nations that organize their work mainly in business enterprise”. 

Thus business cycle, in short, is an alternate expansion and contraction in overall business activity, as evident by fluctuations in measures of aggregate economic activity, such as, the gross product the index of industrial production, employment and income. Generally speaking, the cyclical fluctuations have a tendency towards simultaneous appearance in a;; the branches of the national economy. But sometimes they may be defined only to individual sectors of the economy. Cyclical fluctuations in such cases are referred to as specific cycles.

Characteristics of Business Cycles:

The main characteristics or features of business cycles are as follows: 

1. A business cycle is a wave like movement. 
2. Business cycles operate periodically at fairly regular intervals of 10 to 12 years. 
3. Business cycle is of an all embracing nature, that is, it prevails in all industries, all occupations including agriculture and all areas in a country. 
4. Expansion and contraction in a business cycle are cumulative in effect. 
5. Business cycles are all-pervading in their impact. 
6. A business cycle is characterized by downwards and upward movements. 
7. In business cycles, cyclical fluctuations are recurrent in nature.

Phases of Business Cycles:

A typical or standard business cycle is characterized by; 

1. Recovery
2. Prosperity
3. Recession
4. Depression 

Related Article: Four Phases of Business Cycle

Notes provided by Prof. Sujatha Devi B (St. Philomina's College)

Phases of the Business Cycle

1. Recovery: 

We start from a situation when depression has lasted for some time and revival phase or the lower-turning points starts. The ‘originating force’ or ‘starters’ may be exogenous or endogenous forces. Suppose the semi-durable goods wear out which necessitates their replacement in the economy, it leads to increased demand investment and employment increase. Industry begins to revive. Revival also starts in related capital goods industries. Once begum, the process of revival becomes cumulative. As a result, the levels of employment, income and output rise steadily in the economy. In the early stages of the revival phase, there is considerable excess or idle capacity in the economy so that output increases without a proportionate increase in total costs. But as time goes on, output becomes less elastic, bottlenecks appear with rising costs, deliveries are more difficult and plants may have to be expanded. Under these conditions prices rise. Profit increases, business expectations improve, optimism prevails. Investment is encouraged which tends to raise the demand for bank loans. It leads to credit expansion. Thus the cumulative process of increase investment, employment, output, income and prices will feed upon itself and becomes self-reinforcing. Ultimately revival enters the prosperity phase. 

2. Prosperity: 

In the prosperity phase, demand, output, employment, and income are at a high level. They tend to raise prices. But wages, salaries, interest-rates, rentals and taxes do not rise in the same proportion to the rise in prices. The gap between prices and costs increases the margin of profit. The increase of profit and the prospect of its continuance commonly cause a rapid rise in stock market values.” All securities including bonds rise under the influence of improving expectations. The outstanding change is in stocks that, reflecting the capitalized values of prospective earnings, register in an exaggerated form the rising profits of enterprise”.  The economy is engulfed in waves of optimism. Larger profit expectations further increase investments which is helped by liberal bank credit. Such investments are mostly in fixed capital, plant, equipment and machinery.  They lead to considerable expansion in economic activity by increasing the demand for consumer goods and further raising the price-level. This encourages retailers, wholesalers and manufacturers to add to inventories. In this way, the expansionary process becomes cumulative and self-reinforcing until the economy reaches a very high level of production, known as the peak or boom. 

The peak or prosperity may lead the economy to over-full employment and to inflationary rise in prices. It is a symptom of the end of the prosperity phase and the beginning of the recession. The seeds of recession are contained in the boom in the form of strains in the economic structure which act as brakes to the expansionary path. They are: 

1. Scarcities of labour, raw-materials etc leading to rise in costs relative to prices. 
2. Rise in the rate of interest due to scarcity of capital and 
3. Failures of consumption to rise due to rising prices and stable propensity to consume, when incomes increase.  

The first factor brings a decline in profit margins. The second makes investment costly and along with the first lowers business expectations. The third factor leads to the piling of inventories indicating that sales or consumption lags behind production. These forces become cumulative and self-reinforcing. Entrepreneurs, businessmen and traders become over cautious and over optimism give way to pessimism. 

3. Recession: 

Recession starts when there is a downward descend from the ‘peak’ which is of a short duration.” It marks the turning point during which the forces that make for contraction finally win over the forces of expansion. Its outward signs are liquidation of bank loans, and the beginning of the decline of prices.” As a result, profit-margins decline further because costs start overtaking prices. Some firms close down. Others reduce production and try to sell out the accumulated stocks. Investment, employment, incomes and demand decline. This process becomes cumulative. 

4. Depression: 

Recession merges into depression when there is a general decline in economic activity. There is considerable reduction in the production of goods and services, employment, income, demand and prices. The general decline in economic activity leads to a fall in bank deposits. Credit expansion stops because the business community is not willing to borrow. Bank rate falls considerably. According to prof. Esley; “This fall in active purchasing power is the fundamental background of the fall in prices. That, despite the general reduction of output, characterizes the depression”. Thus depression is characterized by mass unemployment, general fall in prices, profits, wages, interest rate, consumption expenditure, investment, bank deposits and loans. Factories close down and construction of all types of capital goods, buildings etc. comes to a standstill. These forces are cumulative and self reinforcing. 

Depression may be short lived or it may continue at the lowest point for considerable time. But sooner or later limiting forces are set in motion which ultimately tends to bring the contraction phase to end and pave the way for the revival. A cycle is thus complete.

Related Article: Four Phases of Business Cycle

Notes provided by Prof. Sujatha Devi B (St. Philomina's College)