Theories of Trade cycle/business cycle

Presented by:Pahul mahajan

Pearl aroraRubbaljeet kaur

Sagar pruthiSakshi goomer

Shivani bedi

Introduction of trade cycle

• It is a cyclic process• It refers to ups and downs in the level of

economic activity• It is a period during which trade expands then

slow down and then expands again

Phases of business cycle

Cont’d

• Prosperity or boom• Peak• Downturn or recession• Recovery

Reasons for expansion

Rise in national outputRise in consumer & capital expenditureRise In the price of raw materials and finished

goodsRise in the level of employment

Reasons for recession

• Due to Discrepancy between demand and supply • Which Leads to decline in investment• Decline in income• Decline in consumption and production• Employment rate falls• Demand for consumer and capital goods decreases • Borrowings decreases • Unemployment increases

Reasons for depression

INTRO- It marks the end of pessimism and beginning of optimism and the process begins in the labour market, phase of trough is reached

Fall in the stock prices comes to end Optimism takes the way in the stock market Investment increases Employment gradually increases Recovery in production and wage income Consumption of consumer and capital goods increases

Reasons for recovery

• Employment is generated in construction sector

• Wage income further increases • Consumption expenditure increases• Factors of production are being fully employed• Consumption of durable goods and variety

items goes up

Theories of trade cycle/business cycle

1) Climatic or Sunspot theory2) The psychological theory3) Innovation theory4) Monetary theory5) Over-investment theory6) Over-production theory7) 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 PIGOUTrade cycles are caused by the optimistic and

pessimistic attitude of the businessman OPTIMISTICBrisk businessman earn high profits and expands

the investment and productionOverestimate the future demand of goods and

increase the production

Psychological theory (cont’d)

PESSIMISTICbusinessman puts less investment and less

productionRate of employment and rate of profit

decreasesSupply exceeds the demand so price falls.

Drawbacks

• Considers only psychological views of businessman

• Ignore other factors

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

Criticism

• Trade cycle is not purely monetary phenomenon

• It is world wide phenomenon

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 demandLess incomeLess productionLess labour

Keynes theory

1)concept of marginal efficiency of capital(mec) MEC:- rate where price of capital=yield from capitalExample: buying of a machinery- how much

return will we get in the coming years2)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….

Possible causes of trade cycle

• MEC & efficiency cant be the only reasons………

• therefore al the theories have an equal impact on the trade cycle….