What is Trade Cycle? Definition, Types, Theories, Features, & More
Do you know about the great depression that happened in the 1930s? The trade cycle had a major part to play in it. It is the periodic fluctuations in economic activity over some time. It encompasses changes in production, employment, investment, and prices. Trade cycle also represents the alternating periods of growth and contraction in an economy.
The trade cycle is typically measured by analyzing economic indicators, such as gross domestic product (GDP), unemployment rates, consumer price index (CPI), industrial production figures, etc. It also includes fluctuation in currency exchange rates.
What is Trade Cycle?
Trade cycles occur when the rate of economic growth in a country fluctuates. This can be caused by various factors, including changes in consumer demand, shifts in capital flows, and government policies. These fluctuations cause businesses to adjust their production schedules and investments. They can also have an impact on employment levels, prices of goods and services, interest rates, and exchange rates.
The effects are wide-ranging. During periods of expansion, increased investment leads to improved productivity. It helps drive economic growth while also reducing unemployment levels. On the other hand, during times of contraction, business activity slows down as investment dries up, leading to less output and higher unemployment levels. Inflationary pressures may also increase as companies pass on rising costs due to input price increases or shortages to consumers through higher prices for their products or services.
According to the economist Joseph Schumpeter’s trade cycle definition, these patterns of contraction and expansion in economic activities are inherent features of capitalist economies. Overall governments need to manage these cycles effectively for sustained long-term economic growth. They can achieve this through various fiscal measures, such as reducing taxes or increasing spending during recessions to stimulate aggregate demand.
Central banks may also intervene through monetary policy, such as setting interest rates, which again helps regulate macroeconomic variables, like GDP growth and inflation over time.
3 Types of Trade Cycle
Some of the different types of business cycles are as follows:
1. The Economic Cycle
It is the overall pattern of growth and contraction in an economy over time. It includes changes in GDP, unemployment, inflation, and other key economic indicators. This cycle usually lasts between 5-10 years and is driven by a combination of factors, such as consumer spending, investment activity, government policy, and global influences.
During periods of expansion, increased production levels lead to higher wages for workers, which can spur further consumption. This leads to more investment into new businesses or technologies, fueling further growth until eventually, market saturation forces a period of recession.
2. The Business Cycle
It refers to the fluctuations in business activity that occur during different phases of the economic cycle. It typically consists of four stages – recovery (where businesses start investing again), prosperity (when profits are rising), recession (when investments slow down), and depression (when profits fall). The length, depth, and severity can vary depending on the underlying cause.
3. The Financial Cycle
It reflects shifts in financial markets, such as stock prices, bond yields, or foreign exchange rates over an extended period. It usually lasts several years. These cycles are often linked to broader macroeconomic trends but may also be influenced by external factors, like geopolitical events or changes in regulations affecting certain parts of the financial sector.
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Phases of Trade Cycle
The following are the phases of a business cycle.
1. The Peak Phase
It is the period when economic activity reaches its highest level, and growth slows down. During this stage, businesses are producing at full capacity, investment levels are high, and consumer spending is strong. This leads to an increase in prices as demand outstrips supply – a phenomenon known as inflation.
As the economy approaches the peak of a cycle, there may be signs that it’s beginning to slow down, such as rising unemployment or decreasing consumer confidence.
2. The Contraction Phase
It marks the start of a recession where the economic output begins to decline due to reduced business investment and lower consumer spending. Inflation usually falls during this period as companies reduce production in response to falling demand for goods and services. Unemployment also rises significantly during this phase due to firms cutting back on staff costs to remain profitable.
3. The Trough Phase
It follows after contraction when economic activity has reached its lowest point before any recovery takes place. During this stage, GDP growth may remain stagnant or even fall further depending on external factors, such as global events or political instability. However, most economies tend towards some kind of recovery eventually regardless of how deep their downturn was previously.
4. The Expansion Phase
It occurs once GDP starts increasing again following a recessionary period and investments begin flowing back into markets. Employment figures improve, and inflation becomes more manageable than seen during previous peaks.
Businesses take advantage by expanding operations and investing capital into new projects. It drives further economic growth over time until another cycle begins.
5. The Recovery Phase
This phase occurs when all indicators return close enough to pre-recession levels so that economists can consider it an endpoint for that particular cycle. It is not necessarily indicative of long-term stability since future recessions could still occur.
Theories of Trade Cycle
Given below are several theories related to the business cycle.
1. The Keynesian Theory
It is based on the idea that governments should intervene in their economies during recessions by increasing spending and cutting taxes to stimulate demand.
In this theory, it is argued that a government’s intervention can help alleviate the severity of economic downturns by providing an influx of money into the economy. It helps spur consumption and investment. This increased activity helps create jobs and provides income for households, leading to further economic growth.
2. The Austrian Theory
This theory suggests that such cycles are caused primarily by the misallocation of capital resources due to artificially created low-interest rates by central banks. It argues that when central banks lower interest rates too quickly or dramatically, investors become overly optimistic about future returns. This results in them taking on greater levels of risk. Eventually, these investments lead to losses for those who invested.
3. The Monetarist Theory
This theory says that inflationary pressures lead to boom-bust cycles. It happens due to increases in aggregate demand, causing a company’s costs of production inputs, like labor, materials, etc., to increase faster than their output prices. This means they make less profit per unit sold, reducing overall business confidence and investment levels. It also results in slower GDP growth over time until eventually, an economic contraction occurs.
Features of Trade Cycle
Some features of the trade cycle are:
- Occurs Periodically: They occur from time to time, but each cycle does not have the same regularity and intensity. The duration can also vary.
- Is Synchronous: It is not related to a single industry or sector and can affect any industry. If there is any problem in one industry, it will affect industries in other sectors too.
- Global Impact: They have a global impact. If any major country is affected by a recession, it is bound to have an effect globally.
- Duration: The business cycle can last anywhere from 2 years to a maximum of 12 years.
Conclusion
The importance of trade cycles should not be underestimated. They significantly affect businesses and the economy, both in terms of short-term fluctuations and longer-term structural changes. During periods of growth, companies help drive economic activity; conversely, during recessions, it leads to reduced output and job losses.
FAQs
Though there is no specific individual who invented the trade cycle, the first one to mention it is Clement Juglar, a French economist. In 1862, he published a book where he talked about the periodic nature of economic crises and fluctuations.
A trade cycle usually ranges between 5 to 10 years. Since trade cycles are influenced by a number of factors, such as economic policies, consumer behavior, technology, etc., their duration varies for each cycle.
In 12th economics, the trade cycle refers to the business cycle or economics cycle. It means fluctuations in trade, production, and other economic activities in an economy over a period of time. It has four phases: Expansion, Peak, Contraction, and Trough.
In India, the trade cycle is the schedule followed by exchanges for buying and selling securities. It generally involves a pre-open session, regular trading session, and post-closing session.
The trade cycle is important for understanding economic fluctuations and predicting economic performance. It impacts policy formation, investment decisions, and consumer behavior and assists policymakers and financial institutions in achieving economic stability and managing risks.
Trade cycles occur due to a number of factors, such as changes in economic policies, technological advancement, geopolitical events, economic crises, fluctuations in demand and supply, investment decisions by businesses, etc.
The two types of trade cycles are the recessionary trade cycle and the expansionary trade cycle. The former is about economic contraction and slowdown while the latter deals with economic growth and expansion.
Some of the other names for a trade cycle are the business cycle, economic cycle, boom and bust cycle, and contradiction-expansion cycle.
