THEORIES OF BUSINESS CYCLES NON-MONETARY THORIES OF BUSINESS CYCLE MONETARY THORIES OF BUSINESS CYCLE

I. SUNSPOT THEORY This 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 THEORY This 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 expectorations The theory does not explain full cause.

Iii. Overproduction THEORY This 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 THEORY It 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 THEORY The 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: The introduction of a new product The introduction of a new method of production The opening of a new market New source of a raw material

Criticism: Innovator not necessary for innovation Innovations not the only cause of cycle Full employment assumption unrealistic Bank credit not the only source of funds

vi. cobweb Theorem The 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 price The commodity can be stored only for one year Both demand and supply

Criticism: Not realistic Output not determined by price Not a theory Continuous 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: Credit not the cause of cycle Traders do not depend only on bank credit Traders do not react to changes in interest rates Do not explain period of cycle

Ii. Dr. Hayek‘s THEORY F.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: Narrow assumption of full employment Unrealistic assumption of equilibrium Interest rate not the only determinant Incomplete theory

iii. Keynesian THEORY Keynes 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: Investment in the new assets The supply price of the new assets These two factors are based upon the psychology of investors.

Criticism: Half of explanation Psychological theory No explanation of the trend of growth with business cycles Neglects the theory of capital