THEORIES OF BUSINESS CYCLES

I. NON-MONETARY THORIES OF BUSINESS CYCLE

II. MONETARY THORIES OF BUSINESS CYCLE

I. SUNSPOT THEORYThis is the oldest theory of business cycle. It is

associated with the name of W. Stanley Javons, that variations in the atmosphere of the sun. This affected the agricultural crops which in their turn influenced the level of business activity in the economy.

- Agricultural crops- Production- Rainfall- industries

Ii. Psychological THEORYThis is associated with the name of prof. A.C. Pigou, who

developed it in his well known work industrial fluctuations. According to this theory ,business fluctuations are the result of the waves of optimist and pessimist among businessmen and industrialists. In this way, the entire business community becomes optimistic-minded.

CRITICISM:This is not a theory of business cycles in the true sense

because it fails to explain the different phase of a business cycle.

It is fail to explain the period of a business cycle.It neglects the role of various monetary factors which

influence business expectorationsThe theory does not explain full cause.

Iii. Overproduction THEORYThis theory is also known as the competition theory of business cycles. It has been put forward by socialistic-minded economists. This means there will be overproduction and the market will be flooded with large stocks of the commodity. The price of the commodity will fall in such a situation of overproduction. The same thing happens in the case of other commodity.

Iv. Over saving THEORYIt is known as the underconsumption theory of

business cycle. It was propounded by socialistic-minded economists like major Douglas and J.A. Hobson. According to this theory, is the inequality of income that prevails in a capitalistic society. Thus, too much saving and too little consumption is the cause of business depression according to this theory.

Criticism:It cannot just be explained in terms of a single cause

– oversaving and underconsumption.The saving of the rich automatically find their way

into investment in industrial equipments

v. Innovation THEORYThe innovation theory is mainly the work of

Joseph Schumpeter, a brilliant economist of the USA. By innovation theory he means the introduction of something new that changes the existing method of production. An innovation may consist of:

1. The introduction of a new product2. The introduction of a new method of

production3. The opening of a new market4. New source of a raw material

Criticism:1. Innovator not necessary for innovation2. Innovations not the only cause of cycle3. Full employment assumption unrealistic4. Bank credit not the only source of funds

vi. cobweb TheoremThe cobweb theory of business cycles was

propounded in 1930 independently by prof. H. Schultz of America. The cobweb theory is used to explain the demand , supply and price over long period of time.

Assumption:Current demand Current priceThe commodity can be stored only for one

yearBoth demand and supply

Criticism:

Not realisticOutput not determined by priceNot a theoryContinuous impractical

Ii.Monetary business

cycles

I. hawtreys’ THEORY

According to Hawtrey the business cycle is a “purely monetary phenomenon”, according to this theory , is the basic cause of the operation of this business cycle.

Criticism:1. Credit not the cause of cycle2. Traders do not depend only on bank credit3. Traders do not react to changes in interest

rates4. Do not explain period of cycle

Ii. Dr. Hayek‘s THEORYF.A.Hayeks formulated his monetary over-

investment theory of trade cycle. According to Hayek when the prices of factors are rising continuously, the rise in production costs bring fall in profits of producers.

Criticism:1. Narrow assumption of full employment2. Unrealistic assumption of equilibrium3. Interest rate not the only determinant4. Incomplete theory

iii. Keynesian THEORYKeynes maintained that trade cycles are

essentially caused by variations in the rate of investment due to the

fluctuations in the efficiency of capital.

The keynesian effeciecny of capital depended mainly upon two factors:

1. Investment in the new assets2. The supply price of the new assets

These two factors are based upon the psychology of investors.

Criticism:Half of explanationPsychological theoryNo explanation of the trend of growth with

business cyclesNeglects the theory of capital