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Thursday, 26 May 2011

Modern Theory of Trade Cycle


The modern economists are of the view that it is the interaction of multiplier and accelerator which cause movement in the national income. According to multiplier when investment increases it increases the income. But income increases more than the investment according the size of multiplier. For example is MPC (Marginal Propensity to Consume ) is 3/4 an investment of one lakh will increase national income by 4 lakh.If MPC is 7/8 on investment of one lakh will cause income to Rs. 8 lakh. If investment falls by me Rs. one lakh and the MPC is 2/3 the national income will fall by 3 lakh.
Multiplier is also reciprocal of Marginal propensity to save (MPC). If MPC is 1/3, net investment spending of Rs. 5 lakh will causes. Income to increase to 15 lakh. We conclude that :

Charge in income = 1/1-MPC x Change in investment

Change in income = 1/MPC x Change in investment

The increase in income further leads to greater investment through the accelerator effect. The stock of capital depends upon the level income. If the income level is higher the capital assets will be also higher. When the demand for consumer goods increases, it will effect the demand for capital assets. So we find that investment first affects income which and then income effects income which and then income effects capital assets when net investment increases. The income rises in a greater proportion depending upon the size of multiplier. The expansion phase of the trade cycle starts when the investment increases.
The recession phase starts when the investment falls which ultimately reduces income, output and employment in the country.

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