theories of business cycle/trade cycle
TRANSCRIPT
Theories of trade cycle/business cycle
1) Climatic or Sunspot theory
2) The psychological theory
3) Innovation theory
4) Monetary theory
5) Over-investment theory
6) Over-production theory
7) Keynes’ theory
Sunspot theory
Offered by Mr . Jevan.
Trade cycles are caused by sun spots.
Sunspots appear on the face of the sun.
Almost at regular intervals of 10.4 years.
SPOT APPEARS
SUN EMITS LESS HEAT
CROP YIELD WILL BE LOW
INCOME OF FARMER FALLS
LESS PURCHASING POWER
Drawback
• Based on only agro based theory
• Good or bad crop can only be one factor of
depression or expansion but they cannot
account for all the features
• The trade cycle occur at regular intervals of
10.4 years, while length of the trade cycle is 7
to 8 years
The psychological theory
Given by professor PIGOU
Trade cycles are caused by the optimistic and
pessimistic attitude of the businessman
OPTIMISTIC
Brisk businessman earn high profits and expands
the investment and production
Overestimate the future demand of goods and
increase the production
Psychological theory (cont’d)
PESSIMISTIC
businessman puts less investment and less
production
Rate of employment and rate of profit
decreases
Supply exceeds the demand so price falls.
Monetary theory
• Takes money supply into consideration
• Deals with money expansion and contraction
• Money contraction - demand falls, rate of
interest increases- decreased borrowings
• Money expansion – demand rises, rate of
interest decreases- increased borrowings
Innovation theory
• Innovation can be of various types
1-new product
2-new market
3-niche market
4-new technology
5-new source of raw material
Innovation theory
• Innovation leads to more production
• Ultimately increase in aggregate demand
• Further increase in income of business
Drawback of innovation theory
The full employment assumption is unrealistic.
Bank is not the only source of finance for every innovation in business.
Many times the profits are ploughed back to finance innovations.
Innovation cannot be the sole cause of business cycle.
Over investment theory
• Natural rate of interest is determined at a
point where savings(voluntary)= investment
• if market ROI < natural ROI
then, businessman demands more investment,
capital, more prod., more income, more
labour, more demand
Cont’d
• If market ROI> natural ROI
then reduction in capital demanded , less prod.
, less labour , less income , less demand
Over prod. theory
• If economic system is capitalism, all the
entrepreneurs wants to produce goods which
are profit making
• Leads to high competition because of entry of
new firms
• Profit making possibility : high
• Due to over production activity, initially
everything increases
Cont’d
Thereafter as a result firms starts
withdrawing resulting in
Less demand
Less income
Less production
Less labour
Keynes theory
1)concept of marginal efficiency of capital(mec)
MEC:-
rate where price of capital=yield from capital
Example: buying of a machinery- how much
return will we get in the coming years
2)Says that depression & unemployment is there
because there is decrease in the aggregative
demand.
• Now aggregative demand can be increased:
1.investment 2.consumption
and we know in short run consumption cant
be increased….but so can investment
So, by controlling the investment, depression &
unemployment can be reduced in the short
run.
3) Yield depends on the expectations
(psychology):: yield is the only factor
affecting MEC and yield is affected by the
psychology of the entrepreneur….