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Thursday, 26 May 2011

Various or Different Theories of Trade Cycle

Various theories have been offered to explain the causes of trade cycle. Now we will discuss them one by one.


Keynes has not offered a pure theory of trade cycle. But he explains those factors which brings changes in income, output and employment. Yet it is an incomplete explanation of the trade cycle.
According to Keynes, the cyclical fluctuations are caused by changes in the marginal efficiency of capital. According to Keynes if the rate of return of capital is greater than the rate of interest then businessman expands the business and increases the investment. On the other hand if ratio of interest is higher than rate of return the business will be contracted. While the marginal efficiency of capital depends upon two factors.
1 ). Expected return from capital assets.
2 ). Replacement cost of the assets.
Marginal efficiency of capital is raised by new investment and by expectation of rising prices. It is lowered by falling prices and fall in investment.
When the rate of capital return is higher then the rate of interest, it leads to investment. The volume of employment and income increases. The demand for consumer goods and capital goods increases. It is called the expansion phase of the trade cycle.
When marginal efficiency of capital relatively falls than the current rate of interest. It is the phase of Contraction. Because further scope of investment declines. People save more money due to higher rate of interest. More savings reduce the demand of consumer goods.
Due to the excess of savings the income and employment declines. We are in the phase of recession which finally results depression.
Keynes has also introduced very important terms which brings change in the economic activities. There are :
( 1 ). Propensity to Consumer.
( 2 ). Propensity to Save.
( 3 ). Marginal efficiency of Capital.
He says that down swing of the trade is caused by the fall in the propensity to consume. Because when the income increases or decreases, consumption also changes but not according to that ratio as the income changes. There is always less change then the change in income. Whenever saving begins to exceed then the investment a depression is developed.

Criticism on Keynes Theory of Trade Cycle:-

1. This theory fails to explain the repetition of booms and depression at almost regular intervals.
2. Multiplier concept of Keynes does not offer the satisfactory explanation of the business cycle.
3. Hicks says that cyclical fluctuations are caused by the interaction of multiplier and acceleration.


Mr. Jevan has offered this theory. He says that trade cycle are caused by sun spots which appears on the face of the sun at almost regular intervals of 10.4 years. He says that when these spots appear the sun emits less heat and leads to the failure of crops when the crops yield will be low, the income of the farmer will fall. So the demand or purchasing power of the farmers will decreases. In this way demand of consumption goods will fall. The industrialist income will be also affected. The industrialist will reduce the demand of raw material. He may also reduce the employees in his factory. So the down war swing starts.
On the other hand when the sun is clear it emits normal heat and there is a bomber crops. The purchasing power of the farmers will increase. They buy more commodities and it will be a period of expansion.

Criticism on Sun Spot Weather Theory of Trade Cycle :-

1. They trade cycle do not occur at regular intervals of 10.4 year while length of the trade cycle is 7 to 8 years.
2. Good or bad crop can be only one factor of depression or expansion but they cannot account for all the features.


This theory is associated with professor Pigou. According to him trade cycles are caused by the optimistic and pessimistic attitude of the businessman. When the trade is brisk businessman earns high profit and expands the investment and production. They over-estimate the futures demand of the goods and increases the production. An optimistic wave cover all the quarter of the business and over all production increases. In this stage a period of prosperity is in full swing. The aggregate supply increases then the aggregate demand.The market becomes over flooded with consumption goods when supply will exceed then the demand, and prices will fall. Rate of profit will decrease. Producer will reduce the investment. So rate of employment will also fall and economy will be caught by the rises.
Now businessman will under estimate the future prospects of business. A offer the true explanation of the trade cycle.
No doubt here is some truth in this story but it does not offer the true explanation of the trade cycle.


Sir Ralph Howtery offered this theory. He says that main cause of trade cycle is the contraction and expansion of bank credit. He says that most of the business are carried on with loans. When the trade is good, the bank expand credit by lowering the rate of interest. The merchants are attracted by the low rate of interest and they expand the business. The producer expand production keeping in view the demand. Employment output and money income increases. The expansion of credit brings up swing in the business cycle. A stage comes when the commercial banks realize that they have advance more than their limits. Some of the banks will feel that their cash reservation has reached to the danger point. They will increase the rate of interest and recall the advances. When the rate of interest will be high the rate of profit will fall and business will not borrow and he will reduce the production. Employment, profit and income decreases. According to Prof. Howtery the merchants are very sensitive to the change in the rate of interest. So changes in the rate of interest first affect merchants and then manufacturers when the rate of interest is low the merchants will increase their stock and they will place more orders with the manufacturers. When the rate of interest is high than there will be reserve situation.

Criticism on Monetary Theory of Trade Cycle :-

1. Critics says that trade cycle is not purely monetary phenomena.
2. Secondly trade cycle is a world wide phenomena. It can not only occur in one or two countries.


Prof. J.A Hobson had developed the theory. He says that due to over savings depression takes place. He says that modern capitalistic world has divided the people into two classes rich and poor. Rich class is in small number, but possesses a large portion of the total wealthy. The wealthy community is so well-off that they can not consume all their income. So they use their savings in investment. They total production or supply of goods increases. But on the other side the poor class is in large number. They are so poor that they even cannot get basic needs of life. So the demand remain low the supply. Demand and supply balance is disturbed. The market becomes over flooded with unsold goods. The businessman will stop the production and it will lead to depression.
Hobson says that if there is an equality of income there would be no crises or depression in the economy.

Criticism on Under Consumption Theory of Trade Cycle :-

1. The first objection on this theory is that it only explains the depression not the trade cycle.
2. This theory also fails to explain the period of trade cycle.


Anonymous,  18 August 2013 at 19:14  

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