Cont’d• Prosperity or boom• Peak• Downturn or recession• Recovery
Reasons for expansionRise 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 cycle1) Climatic or Sunspot theory2) The psychological theory3) Innovation theory4) Monetary theory5) Over-investment theory6) Over-production theory7) Keynes’ theory
Sunspot theoryOffered 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 APPEARSSUN EMITS LESS HEATCROP YIELD WILL BE LOWINCOME OF FARMER FALLSLESS 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)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 theoryThe full employment assumption is unrealistic.Bank is not the only source of finance for everyinnovation in business.Many times the profits are ploughed back tofinance innovations.Innovation cannot be the sole cause of businesscycle.
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 inLess demandLess incomeLess productionLess labour
Keynes theory1)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….