[Commerce Class Notes] on Causes of Business Cycles Pdf for Exam

A business cycle is the fluctuations of Gross Domestic Products (GDP). It is a series of cycles of economic expansions and contractions, therefore, it is also called an economic cycle or a trade cycle. In this article, students will learn about the causes and the effects of the business cycle.

Internal Causes

The factors that are built within the economic system and influence the business cycle are called the internal causes of the business cycle. The major causes that affect the business cycle are as follows:

• Change in Demand: A change in the demand of a good or service will lead to changes in production and supply of the concerned goods and services, thus, affecting output in an economy. This kind of change can also cause inflation in an economy if there is excessive demand. A decrease in demand will lead to lower output, lower employment affecting the income of the public eventually leading to a trough in the economy. If the situation is not resolved, it will lead to depression in the economy.

• Investment Fluctuations: Changes in investments made will lead to differences in output in an economy much like what happens in changes in demand. So it naturally follows that an increase in investments will lead to expansion of the economy while a decrease will lead to trough or depression. There are a few factors affecting the investment decisions: expectation of profits, entrepreneurial and current rate of interests, and income generation.

• Macroeconomic Policies: The monetary and other related policies set up by a government are the macroeconomic policies that immensely affect the business cycle. If the policies benefit businesses and investors, the economy will see an expansion or boom leading to economic growth, whereas, policies that will not benefit such businesses but discourage investment instead such as an increase in tax rates or removing subsidies will create recession in the economy.

• Supply of Money: It is obvious that more supply of money will make people spend more which will, in turn, lead to growth or expansion in the economy and vice-versa. But excessive money in the economy will lead to inflation that will hurt the spending habits of the citizens whose income did not increase at the same rate as inflation.

External Causes

The factors or changes that arise outside of an economy but still affect it are called external causes of the business cycle. These are exogenous causes that affect economies in other countries as well.

• Wars: During wars, economic resources and available capital are used for manufacturing weapons and providing for the army which increases the need for basic amenities among the general citizens as the focus shifts to the battlefield and other places of the economy are ignored. This slows down the economy and is one of the main causes of the Great Depression of the 1930s.

• Natural Causes: Natural disasters like drought, famine or flooding greatly affect several factors of input in the economy such as transportation, employment, agriculture which results in an increase in existing prices of related products. Such natural calamities may cause depression.

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