3. Phases of trade cycle
Prosperity
Recession
Depression
Recovery
4. Theories of trade cycle
Hawtreys monetary theory
Hayek’soverinvestment theory
Keynesian theory of trade cycle
5. Hawtreys theory
Purely monetary phenomenon
Changes in the flow of bank credit
Expansion and contraction of bank credit
Rate of interest
6. Expansion phase
Reduced rate of interes
Increasing investment activities
More factors of production are employed
Increasing income leads to increased demand for goods
Charge higher prices
Traders to induce borrow more
Prosperity period ending when banks stops credit expansion
7. Reserves reduced due to credit expansion
Banks starts to increase interest rate
Ask the business man to repay the loan
Starts recessionary process
8. Contractionary phase
Increasing rate of interest
To repay loans business man starts selling their stocks
Price falls
Declining investment activities
Unemployment
Falling demand for goods
Depression
9. Hawtreys recovery process is very slow
It will happen in the economy by cheap money policy of central bank
10. Hayek’s theory
Over investment theory
Difference between natural rate of interest and the market rate of interest.
Natural rate of interest- demand for loan capital equals the supply of saving
Market rate of interest- interest rate prevails in the market
Equilibrium in the economy- Natural rate of interest= market rate of interest
11. If market rate of interest is < natural rate of interest
The demand for funds for investment will exceed the available supply of saving
Increasing bank credit leads to increase in money supply
Reduction in rare if interest
Firms borrow more
Increase employment then rise the price level
Overinvestment
12. If the market rate of interest > natural rate of interest
The demand for funds for investment will be less than the available supply of savings.
Contraction in bank credit
Decrease in money supply
Increase in rate of interest
Decreasing economic activity
Decrease employment
Fall the price level
14. Expansion phase- Boom- rise in investment- high MEC
Employment is rising
Multiplier effect
High MEC – increase in cost of production- increase in output from recently produced
capital assets
Increase output lowered the profitability of new capital assets.
15. Cost of production continue to rise
The MEC remains high only as long as the optimism prevails
Optimism gives way to pessimism
MEC collapsed
Investment declined
Unemployment
16. Contraction starts with a rise interest rate and reverse multiplier effect in the economy
Liquidity preference rise
A further decline in investment
17. The revival of MEC – recovery phase
Length of contraction is depends on the stocks of goods left over from the
boom
When consumption > total production the rate of interest falls
Gradual recovery of business confidence
Expansion starts in the economy again.