(BUSINESS CYCLES)

Peak Peak Peak Peak

Peak Peak

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io
sion
Cont

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Level of GNP

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n

io
ns

io
sio

ans
Contrac

Cont

Cont

Cont
ans

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Cont
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Expa

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Exp
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tion

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Throug Throug Throug Throug Throug

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Through
h
Depression
h h h Depression h

TIME
 Phases of Business Cycles
Business Cycles has different phases.

1. Expansion (Boom, Upswing or Prosperity)

2. Peak ( upper turning point)

3. Contraction (Downswing, Recession or

Depression)

4. Trough (lower turning point)

 Anti Cyclical Policies

MONETARY

FISCAL

EXIM POLICY-DEVALUATION/APPRECIATION
 Inflation and Unemployment
• Models of the short term determination of GDP explain why actual GDP deviates from
potential GDP.
• Actual GDP above potential can be associated with inflation, while actual GDP below
potential is associated with unemployment and lost output.
What determines aggregate spending?
• Desired aggregate spending includes desired consumption, and desired government
spending, plus desired net exports. It is the amount that economic agents want to spend on
purchasing the national product.
• A change in personal disposable income leads to a change in private consumption and
saving. The responsiveness of these changes is measured by the MPC and MPS, which are
both positive and sums one.
• A change in wealth tends to cause a change in the allocation of disposable income
between consumption and saving. The change is consumption is positively related to the
change in wealth, while the change in saving is negatively related to this change.
• Investment depends, among other things, on real interest rates and business confidence.
• The part of consumption that responds to changes in income is called induced spending.
 Price Stability
Types of price rise-
1. Creeping-2 percent annually
2. Walking-5 percent annually
3. Running-10 percent annually
4. Galloping or Hyper Inflation-more than 10 percent
annually
On the basis of time-
1. Peace time
2. War time
3. Post war time
Main causes
1. Demand Pull
2. Cost-push-wage push, profit push, material push
 Demand Pull Inflation
The Monetarist Theory Keynesian Theory

S
s

P3

P2
P2
d4
Price Level

P1 P1
D2
s d3
D1
P d2
d d1
D

M m m1 m3 m4 Output
Output
 Cost Push Inflation
S

E1
P1
E
Price Level

S1

D
S

M1 M Output
 INFLATIONARY GAP

According to Keynes, inflationary gap exists when, at full

employment income level, aggregate demand exceeds
supply. This means that due to increase in investment and
government expenditure, the money income increases,
but production does not increase because of the
limitations of productive capacity. As a result, an
inflationary gap comes to exist, causing the prices to rise.
The prices continue to rise so long as the inflationary gap
exists.
 Inflationary and Deflationary Gaps AS or
Inflationary Y=C+I+G
Inflationary gap occurs when AD gap

EXPENDITURE
exceeds AS at full employment
level of output. In this case, money AD or

(C+I+G)
rises to a higher equilibrium, but E C+I+G
real income being at full employment A
output level remains unchanged. As a
result there is an upward rise in prices
because the consumers compete for B
limited supply of output and bid prices Income (Y)
up. O Yf YO
AS or
Deflationary Y=C+I+G
EXPENDITURE gap B
Deflationary gap prevails when AD is
(C+I+G)

less than AS at full employment level

E AD or
of output. Income equilibrium occurs A C+I+G
while resources are unemployed.

Income (Y)
O
YO Yf
 Equilibrium GDP
Equilibrium GDP:
• At the Equilibrium level of GDP, purchasers wish to buy exactly the
amount of national output that is being produced. At GDP above
equilibrium, desired spending falls short of national output, and output will
sooner or later be curtailed. At GDP below equilibrium, desired spending
exceeds national output, and output will sooner or later be increased.
• In a closed economy with no government, desired saving equals desired
investment at equilibrium GDP.
Changes in GDP:
• With constant price level, equilibrium GDP is increased by a rise in the
desired consumption or investment spending that is associated with each
level of NI. Equilibrium GDP is decreased by a fall in desired spending.
• Changes in equilibrium is also because of Multiplier effect.