THEORIES OF TRADE CYCLE

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

PESSIMISTIC

businessman puts less investment and less production

Rate of employment and rate of profit decreases

Supply exceeds the demand so price falls.

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

• If market ROI> natural ROI then reduction in capital demanded, less prod. , less labour , less

income , less demand

UNDER CONSUMPTION THEORIES

• In an expanding economy, production tends to grow more rapidly than consumption. The disparity

results from the unequal distribution of income: the rich do not consume all their income, while the

poor do not have sufficient income to meet their consumption needs. This imbalance between output

and sales has led to theories that the business cycle is caused by overproduction or under consumption.

But the basic, underlying cause is society’s inadequate provision for an even flow of savings out of the

excess of production over consumption. In other words, saving is out of step with the requirements of

the economy; it is improperly distributed over time.

HAWTREY’S MONETARY THEORY

• This trade cycle is a purely monetary phenomenon

• It is changes in the flow of monetary demand on the part of businessmen that lead to prosperity

and depression in the economy

He opines that non-monetary factors like strikes, floods, earthquakes, droughts, wars, etc. may at best

cause a partial depression, but not a general depression

SUNSPOT THEORY

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