NON-MONETARY THORIES OF BUSINESS
CYCLE
II. MONETARY THORIES OF BUSINESS CYCLE
I.
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
2. The introduction of a new method of production
3. The opening of a new market
4. New source of a raw material
1.
Criticism:
Innovator not necessary for innovation
2. Innovations not the only cause of cycle
3. Full employment assumption unrealistic
4. Bank credit not the only source of funds
1.
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:
1. Credit not the cause of cycle
2. Traders do not depend only on bank credit
3. Traders do not react to changes in interest rates
4. 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:
1. Narrow assumption of full employment
2. Unrealistic assumption of equilibrium
3. Interest rate not the only determinant
4. 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:
1. Investment in the new assets
2. 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