LEAD College of Management,

Palakkad

Presentation by: Nelson Kuriakose

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.

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 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….

Email: nelson@lead.ac.in

LEAD College of Management,

Palakkad