What are the Causes of Trade Cycle & How to Control it

Causes of Trade Cycle & How to Control it



By Prof. Haberler:


“Business cycle in the general sense may be defined as an alternation of period of prosperity and depression of good and bad Trade.”


By Hansen:


“Business cycle is the luctuation in the employment:

output and prices.”

By M.Keynes:


“A trade cycle is composed of period of good trade characterized by rising prices and low unemployment percentage alternating with period of bad trade characterized by falling prices and high unemployment percentage

Causes of Trade cycle

Internal causes


  1. Under consumption

There is too much saving during boom which reduces the level of consumption. The price goes on increasing but wages lag behind. The profit of rich increase at higher rates but income of the poor does not increase as compared to price level. The result is that demand for consumption gods decrease.

  1. Unsold stock

Trade cycle occurs due to unsold stock. There is excess supply of goods and services but people are unable to buy goods of their own choice. The unsold to buy in depression.

  1. Imports


The imports increase the supply of goods in the economy. If the total stock of goods is more than its demand there is depression.


  1. Money supply

The change is money and credit supply has a major effect upon the level of economic activity. An expansion money and credit supply. Stimulates economic activity and its contraction brings down economic variables over period of time.

  1. Over investment

Excessive investment in capital goods industries brings upswing and a fall in investment brings downswing in economic activity.

  1. Marginal efficiency of capital

Keynes claims that fluctuations in marginal efficiency of capital are the main cause of trade cycles. The expansionary phase of the trade cycle commence when the marginal efficiency of capital is higher than the rate of interest an vice versa brings the co traction phase.

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  1. Aggregate market

The business cycle can also be caused by changes in aggregate demand and change in aggregate supply. The contraction phase of the business cycle is caused by decline in aggregate demand and expansion phase by increase in aggregate demand.



External causes


  1. Wars

During war the resources are used for the production of armaments. As such the output of capital and consumer goods greatly falls. The fall in output, income, profit etc, causes contraction in economic activity.

  1. Population

The population increases aggregate demand. The investment, employment and income go up. There is tendency towards boom. High rate of inflation will make the bankers nerves. They will take back loan due to which investment level will shrink.


  1. Science and technology


The discovery of new material, machines, and methods helps to produce more at low cost. The invention leads to high level of competition in the economy. There is big investment in the economy. There is tendency towards boom.

  1. Government polices


Govt. polices at home an abroad bring changes in total spending and hence in the level of economic activity.

  1. Surplus exports and forging Aid



Surplus exports and foreign aid raise the level of consumption and investment spending. The output income and employment are boosted.


  1. Weather


The good and bad weather affect the production in agriculture sector. When weather conditions are bad threes low production in agriculture, as well as low production in industrial sector. The demand is the same but output is low so price level goes up.

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Remedies to control the Trade cycle Monetary policy

  1. Bank rate



The central bank can increase bank rate when there is prosperity. The bank rate can be reduced in case of depression the borrowing and lending is make according depression the borrowing and lending is made according to bank rate. The commercial banks help the central bank to control trade cycle.



  1. Market operation


The central bank can buy and sell bills and government securities. When money supply is less as compared to its demand the central bank buy the securities and vice versa. For the purpose of regulate supply.

  1. Reserve ratio


The central bank can increase or decrease the reserve ratio. The ratio of reserve is decreased during depression and increase in expansion.

  1. Selective control


The central bank can provide credit to one sector at low rates and at high rate for another sector. The central bank can check the loans granted by commercial banks, to control trade cycle.




Fiscal policy


  1. Public work


The government can start public words program during depression and stop construction of various proje ts during good trade period. Public works program help to control trade cycle.

  1. Taxes


The state can increase or decrease ates of taxes. The government can raise more taxes or Contraction of money supply. The tax rates may be lowered to provide excess money supply.

  1. Budget


The government can prepare surplus budget during boom period. There is need of deficit budget during deflation. The government can use budgetary measure along with other methods to control trade cycle.

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  1. Public debt


The government must take loans during depression to meet various needs. In case of boom the debt should be repaid. The government can overcome the difficulties of low business activity through public debt.

  1. Imports


The government can allow import of goods, which are needed by public. During depression there is no need to import the items, but when there is boom period the supply of goods can be maintained through imports.



International measures


  1. Production


The production control measure can be made at international level. The goods produced in excess of demand create from such stock. In case of excess production they hold sups stock. Control over supply means control over trade cycle.


  1. Buffer stock


Buffer stock can be kept in warehouses. When production is low the suppliers can meet the demand from such stock. Encase of excess demand production they hold surplus stock. Control over supply means control over trade cycle.

  1. Investment control


The government may allow investment in an area where there is low investment. Excess investment in any sector may lead towards depression. There is need for balanced investment in all economic sectors.


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