Internal & External Causes of Business Cycle

Mon, 07/30/2012 - 00:19 -- Umar Farooq

Business Cycle occurs due to numbers of factors and causes, these causes are classified into:

1. External Causes of Business Cycle

2. Internal Causes of Business Cycle

External Factors of Business Cycle

1. Wars. In war days all the available resources are utilized for the production of weapons which greatly affect the product of both capital and consumer goods. This fall in production decreases income, profits which further create unemployment. These create contraction in the economic activity.

2. Postwar Period. In the post war period the level of consumption and investment goes upward. Both the government and individuals involve the construction (houses, roads, bridges etc). All these activities increases the effective due to which the economic variables, output, income and employment goes upward.

3. Scientific Development. Another cause of business cycle is scientific development. Every day new products come to the markets like mobile phone, laptops etc. These products require huge amount of investment through which new technology of production is adopted. All this increases income, employment and profit etc. and plays an important part in the revival of economy.

4. Gold Discoveries. The discoveries of gold and mines stimulate the volume of international trade and help in adjusting trade deficit, loans etc. the rising income lead to expansion in economic activity.

5. Surplus, Exports and Foreign Aid. Surplus, exports and foreign aid raises the level of consumption and investment spending which helps in increasing output, income and employment level.

6. Weather. Weather is one of the causes of business cycle. It is an important factor which can cause economic activities. If in any year, weather is good the output of agricultural sector will goes upward. 

7. Population Growth Rate. Population growth rate is one the factors of business cycle. If the population growth rate is higher than the economic growth rate, income level and consumption expenditure and savings will be low.

Internal Factors of Business Cycle

Internal causes of business cycle are those, which are built in within economic system. These are the internal factors of business cycle:

Psychological Factors. According to Pigou business cycle appears because of the optimistic and pessimistic mood of the entrepreneur. When entrepreneurs are in optimistic about future market conditions they take up investment. Here the expanses phase of business cycle starts which ultimately ends in a boom.

On the contrary, the pessimism reduces investment, production, employment and shifts to downward trend in business activity.

Money Supply. Hawtrey and Friendman relate trade cycle to fluctuation in money and credit supply. If there is expansion in money and credit supply, there will be raise in economic activity. If there is contraction there will be down fall in economic activity.

Over Investment. Hayek relates business cycle to variation in capital goods industries. Excessive investment in capital goods industries brings upswing and downswing when there is a fall in investment.

Marginal Efficiency of Capital (MEC). According to Keynes changes in the rate of marginal efficiency of capital are responsible for business cycle. When the rate of marginal efficiency of capital gets higher the expansion phase of trade cycle commences. There is a contraction phase when the rate of marginal efficiency of capital is lower.