Causes of Business Cycles
The cyclic pattern of changes that occurs in the economy is caused by many factors
in combination. There are internal factors within the economy that may be causing
these changes. And there are also external factors which may lead to a boom or bust
of an economy. Let us take a look at all the causes of business cycles.
Internal Causes of Business Cycles
These endogenous factors can cause changes in the phases of the firm and the
economy in general. Let us take a look at the internal causes of business cycles.
1] Changes in Demand
Keynes economists believe that a change in demand causes a change in the economic
activities. When the demand in an economy increases the firms start producing more
goods to meet the demand.
There is more output, more employment, more income, and higher profits. This will
lead to a boom in the economy. But excessive demand may also cause inflation.
On the other hand, if the demand falls, so does the economic activity. This may lead
to a bust, which if it continues for a longer period of time may even lead to
depression in the economy.
Browse more Topics under Business Cycles
Phases of Business Cycles
Features of Business Cycles
Importance of Business Cycles
2] Fluctuations in Investments
Just as fluctuations in demand, fluctuations in investment is one of the main causes of
business cycles. The investments will fluctuate on the basis of a lot of factors such as
the rate of interest in the economy, entrepreneurial interest, profit expectation, etc.
An increase in investment will lead to an increase in economic activities and cause
expansion. A decrease in investment will have the opposite effect and may cause a
trough or even depression
3] Macroeconomic Policies
The monetary policies and the economic policies of a nation will also result in
changes in the phases of a business cycle. So if the monetary policies are looking to
expand economic activities by promoting investment, then the economy booms. On
the other hand, if there is an increase in taxes or interest rates we will see a slowdown
or a recession in the economy.
4] Supply of Money
There is another belief that says that business cycles are purely monetary phenomena.
So changes in the money supply will bring about the trade cycles. An increase of
money in the market will cause growth and expansion.
But too much money supply may also cause inflation which is adverse. And the
decrease in the supply of money will initiate a recession in the economy.
External Causes of Business Cycles
1] Wars
During times of wars and unrest, the economic resources are put to use to make
special goods like weapons, arms, and other such war goods. The focus shifts from
consumer products and capital goods. This will lead to a fall in income, employment,
and economic activity. So the economy will face a downturn during war times.
And later post-war the focus will be on rebuilding. Infrastructure needs to be
reconstructed (houses, roads, bridges, etc). This will help the economy pick up again
as progress is being made. Economic activity will increase as effective demand will
increase.
2] Technology Shocks
Some exciting and new technology is always a boost to the economy. New
technology will mean new investment, increased employment, and subsequently
higher incomes and profits. For example, the invention of the modern mobile phone
was the reason for a huge boost in the telecom industry.
3] Natural Factors
Natural disasters like floods, droughts, hurricanes, etc can cause damage to the crops
and huge losses to the agricultural sector. Shortage of food will cause a surge in
prices and high inflation. Capital goods may see a reduction in demand as well.
4] Population Expansion
If the population growth is out of control that might be a problem for the economy.
Basically of the population growth is higher than the economic growth the total
savings of an economy will start dwindling. Then the investments will reduce as well
and the economy will face depression or a slow down.
