Trade cycle

here giving a brief and point wise description of theories of trade cycle

1. Theories of trade cycle Nasiya V K

2. Trade cycle Trade cycles are recurrent fluctuations in economic activity .

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

13. Keynesian theory Good trade Bad trade Fluctuations in MEC Expected rate of profit on new investment

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.

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