Theories of trade cycle


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Theories of trade cycle

  1. 1. Business CycleByManickarajRamkumar
  2. 2. DEFINITION• The business cycle or economic cycle refers to the fluctuations of economic activity about its long term growth trend.• The cycle involves shifts over time between periods of relatively rapid growth of output (recovery and prosperity), and periods of relative stagnation or decline (contraction or recession).• These fluctuations are often measured using the real gross domestic product• Perodic up’s and down’s movement in economic activity
  4. 4. STAGES OF BUSINESS CYCLE• Boom : - Results from too much spending. - Economy experiences rapid inflation - Factors of production become expensive• Recession : - Results from too little spending. - GDP is falling - Demand in the economy will fall leading to closure of firms and unemployment
  5. 5. Slump : - High level of unemployment. - Business will rapidly close down creating serious consequences for the economy• Growth/Recovery : - GDP is rising - Unemployment is falling - Business are experiencing rising profits - ‘Feel good’ factor among the people as their incomes are rising
  6. 6. FEATURES OF BUSINESS CYCLE• PERIODICITY:  Occurs in 6 to 12 years  The gap between two cycles is not certain• SYNCHRONIZATION: Interdependence of sectors leads to slowdown in one sector affects the other sector• SELF ENFORCING: Most critical features of business cycle Cyclical movements in one sector spreads to other sector
  7. 7. TYPES OF BUSINESS CYCLE• The Short Kitchin Cycle : It is also known as the minor cycle, which is of approximately 40 months duration on the basis of on the basis of his research that a major cycle is composed of two or three minor cycles of 40 months research that a major cycle is composed of two or three minor cycles in 1923• The Long Jugler Cycle : This cycle is also known as the major cycle. It is defined “as the fluctuation of business activity between successive crises.” This cycle is also known as the major cycle. It is defined “as the fluctuation of business activity between successive crises.”
  8. 8. • The Very Long Kondratieff Cycle : In 1925, N.D. Kondratieff, the Russian economist, came to the conclusion that there are longer waves of cycles of more than 50 years duration, made of six Jugler cycles A very long cycle has come to be known as the Kondratieff waveKuznets Cycle : This cycle occurs in the intervel of 7 to 11 years
  9. 9. Post-World War II Recessions
  10. 10. Another Look at Expansions andRecessions
  11. 11. Changing nature of the Indianbusiness cycle from 1950 - 2010• Our focus is to compare Indias business cycle in the pre 1991 economy, with the post 1991 Indian economy, after the large scale liberalization reforms of 1991
  13. 13. 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• Time gap between two trough ( or peaks) will vary between 6 to 12 years
  16. 16. TERMS TO REMEMBER• Accelerator : Changes in demand for consumer goods bring about wider changes in the production of appropriate capital goods
  17. 17. Theories of trade cycle/businesscycle Climatic or Sunspot theory Keynes’ theory Hick’s Theory Hawtrey’s monetary theory Innovation theory Over-investment theory Over-production theory
  18. 18. 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
  20. 20. 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
  21. 21. Keynes’ theory• Deals with fluctuations in income, employment and money• concept of Marginal Efficiency of Capital(MEC) MEC:- where price of capital=yield from capitalExample: buying of a machinery- how much return will we get in the coming years
  22. 22. FACTORS• Rate of investment depends upon Rate of interest Marginal efficiency of capital• Entrepreneurial expectations Pessimistic Optimistic
  23. 23. Rate of investment Marginal Rate of efficiency of interest capital Supply price Prospective of capital yield goodsEntrepreneurial expectations
  24. 24. Keynes’ theory• Govt expenditure helps the economy to recover• Growth path cannot continue indefinitely. Excess inventory of capital goods brings pessimistic feelings in entrepreneurs who fear recession, which discourages further investment• Example : $100 million dam Project; 10,000 people employed (increases demand for consumer goods) 30,000 people in different sectors gets benefit whose combined income is say 250 million Vice versa also happens
  25. 25. Hick’s Theory• Occurs due to interaction of multiplier and accelerator• Super multiplier• Upswing is the outcome of multiplier and accelerator• downswing is the outcome of multiplier alone, since accelerator remains inactive• Upper turning point is affected by elements like population, technology, capital stock• At lower turning point there is increase in net investment, turning cycle upwards
  26. 26. Hick’s Theory• Warranted rate of growth : is the one that will sustain itself in congruity with equilibrium of saving and investment• Autonomous investment : Direct response to invention Long range investment• Induced investment : Level of income• Multiplier and Accelerator : Time Lag Consumption of current year is a function of income oflast year ( ex: buying a car) . With a lag of 1 year Investment is function of output of same year
  27. 27. 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.
  28. 28. HAWTREY’S MONETARY THEORY GROWTH PHASE• The expanded phase of the trade cycle starts when banks increase credit facilities.• They are provided by the reducing the lending rate of interest and by purchasing securities• These encourage borrowings on the part of merchants and producers. This is because they are very sensitive to changes in the rate of interest. So when credit becomes cheap, they borrow from banks in order to increase their stocks or inventories.• For this, they place larger orders with producer who, in turn, employs more factors of production to meet the increasing demand. Consequently, money incomes of the owners of factors of production increase thereby increasing expenditure on goods. The merchants find their stocks being exhausted.
  29. 29. HAWTREY’S MONETARY THEORY• BOOM PHASE• They place more orders with producers. This leads further increase in productive activity, in income, outlay, demand and a further depletion of stocks of merchants• According to Hawtrey, “Increased activity means increased demand, and increased demand means increased activity. A vicious circle is set up, a cumulative expansion of productive activity.”• As the cumulative process of expansion continues, producers quote higher and higher prices. Higher prices induce traders to borrow more in order to hold still larger stocks goods so as to earn more profits.• Thus optimism encourages borrowing, borrowing increases sales, and sales raise optimism.
  30. 30. HAWTREY’S MONETARY THEORY RECESSION PHASE• According to Hawtrey, prosperity cannot continue limitlessly. It comes to an end when banks stop credit expansion.• Banks refuse to lend further because their cash funds are depleted and the money in circulation is absorbed in the form of cash holdings by consumers.• Another factor is the export of gold to other countries when imports exceed exports as a result of high prices of domestic goods.• These factors force the banks to raise interest rates and refuse to lend.• Rather, they ask the business community to repay their loans. This starts the recessionary phase. In order to repay bank loans, businessmen start selling their stocks. This sets the process of falling prices. They also cancel orders with producers.
  31. 31. HAWTREY’S MONETARY THEORY SLUMP PHASE• This, in turn, leads to reduction in the demand for factors of production. There is unemployment. Incomes fall.• Falling demand, prices and incomes are the signals for depression. Unable to repay bank loans, some firms go into liquidation thus forcing banks to contract credit further. Thus the entire process becomes cumulative and the economy is forced in to depression.• According to Hawtrey, the process of recovery is very slow and halting. As depression continues, traders repay bank loans by selling their stocks at whatever prices they can.• As a result, money flows into the reserves of banks and funds increase with banks
  32. 32. Disadvantage• Trade cycle is not purely monetary phenomenon• It is world wide phenomenon
  33. 33. Real business cycle• Business cycle are driven entirely by technology shocks rather than by monetary or changes in expectations• If there is an invention, productivity will increase and business people invest more on that. It leads to boom• If there is lack of invention, the productivity will decrease
  34. 34. Innovation theory• Innovation can be of various types1-new product2-new market3-niche market4-new technology5-new source of raw material
  35. 35. Innovation theory• Innovation leads to more production• Ultimately increase in aggregate demand• Further increase in income of business
  36. 36. 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.
  37. 37. 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
  38. 38. Cont’d Thereafter as a result firms starts withdrawing resulting in Less demand Less income Less production Less labour
  39. 39. THANK YOU