8 Theories of Trade Cycle By Economists

Different economists have presented different concepts and Theories of Trade Cycle. The detail of some important theories is as under:The trade cycle is a fluctuation in employment, output and prices.

8 Theories of Trade Cycle You Must Study.

Theories of Trade Cycle

Climatic Change Theory

Psychological Theory

Over Saving Theory

Over Investment Theory

Monetary Theory

Keynes’ Theory

Innovation Theory

Modem Theory


This theory has been presented by W.S. Jevons and H.L. more. They think that trade cycles appear because of the changes in climate and weather. According to the them the trade cycles are evident that there is emergence of solar stains after a decade which decrease its heat. Due to this decrease in solar heat, the rains fall less which results in to a decrease in agricultural production affects the industrial production which starts depression in the economy.

When these solar stains come to an end, its * heat increases, therefore, agricultural production does increase. This increment in agricultural production also increase the industrial production and the economy steps into the thresh


This theory has been presented by Prof. Pigou. In his view, trade i yclc is formed due to psychological trends and behaviours of businessmen. The businessmen increase capital investment to have more I no fit in the time to come which increases the production. It increases the opportunities of employment and raises the level of incomes. As a result, 11 ic phase of boom takes place. On the other hand, when businessmen have pessimistic expectations about the future of their business, they reduce the investment that results in the decrease of output and employment and the economy enters the phase of depression.


  • According to this theory, the cause of trade cycle is the change in the psychological condition of the businessmen. This theory does not explain how people fall a prey to optimism or pessimism.
  • Some economists think that the psychological factor may play a secondary role in the occurrence of trade cycles.


Many economists favour this theory but the name of Hobson, f oster, Catchings and Dughlas are worth mentioning.

Prof. Hobson divided the society into two classes       the rich and

i he poor. The rich have more purchasing power than that of the poor but (heir consumption level is lower than that of the poor. They save more money for investment and investment results in more production. On the contrary, poor class is not able to buy produced quantity of goods. Thus aggregate supply increases more than aggregate demand. The country faces the problem of over production which results in decreasing prices. With the decreasing prices, the profits of the entrepreneurs also go down and they reduce the quantity of production. In this way phase of depression starts.

According to Foster and Catchings, the entrepreneurs provide incomes to factors of production with their investment. If the savings and investment remain equal, then equilibrium of production and consumption is maintained. Conversely, if the savings increase, the production of goods will increase due to increase in investment. But the situation of under consumption may create a trend of fall in prices. It will decrease the profits and discourage the investment and the phase of depression starts in the economy.

Critical Analysis:

  1. This theory only explains the phase of depression and does not explain the phase of boom.
  2. The theory does not take into account the international trade activities.


This theory has been presented by Hayek, Mises and Cassel belonging to Austrian school of thought.

According to this theory, the business cycles occur in capitalistic countries owing to over investment. According to Hayek, Mises and Cassel, when commercial banks and other financial institutions offer loans at low interest rate then investment increases, due to which production activities increase and phase of boom takes place.

In the phase of boom when demand for loans rises, the banks increase the rate of interest. As a result, investment contracts and demand for capital goods also decreases. Due to this, unemployment is created in capital goods industries and the whole economy becomes prey to depression.

Critical Analysis:

In this theory, over investment is considered the basic cause of fluctuations in economic activities. But this theory does not explain the causes of expansion and contraction in investment.


Prof. Hawtrey and Friedman have presented this theory. According to them trade cycles occur because of expansion and contraction in legal money and credit money.

In the phase of prosperity, the entrepreneurs demand loans from the commercial banks to expand their business and the banks provide them loans by the creation of credit. As a result of that, capital goods industry and consumer goods industry also expand. Due to this opportunities of employment increase, the incomes of the people increase and the demand for goods and services also increases. With these positive business prospects, economic activities reach at their peak (Boom). To overcome this problem, banks increase the rate of interest and they demand the entrepreneurs to return their loans. The entrepreneurs have to leave their projects incomplete and they are also bound to sell their stocks of goods at low price. In this way prices of goods decrease and profits of entrepreneurs go down to the lowest level. This situation leads economy to depression.

Critical Analysis:

  1. This theory emphasizes that the change in loans is the basic cause of trade cycles whereas trade cycles, infact, do not occur only because of change in loans.
  2. di) Hawtrey gives excessive importance to money ignoring the importance of capital goods that cause fluctuations in economic activities.


According to Keynes, the major causes of trade cycle are the ।lumges in investment, that appear because of the change in the marginal efficiency of capital. He thinks that rate of interest and marginal productivity of capital both determine the level of investment. As rate of interest does not change usually, so marginal efficiency of capital influences investment mainly.

The incomes of the people increase if the rate of profit will be high. Employment opportunities will increase and the demand for goods will also go up. This increase in demand for goods will encourage further investment and it will result in economic boom in the country. After some nine a limit comes when there is no chance of further investment. The iciison is that prices of capital goods increase due to the increase in their demand. Prices of raw material and wages increase. While the prices of <onsumer goods decrease due to increase in their supply. It means costs of production increase and the revenues go down. So marginal efficiency of capital falls which results in decrease in investment. Due to decrease in investment, level of employment starts falling. Incomes of people come down and depression enters the economy.         ,

 Critical Analysis:

This theory explains only the phase of recession and does not explain phase of prosperity.


This theory of trade cycle has been presented by Joseph Schumpeter. According to Schumpeter innovations deal’ with searching for new market, adopting new techniques of production and discovering new resources. When some entreoreneurs introduce new products in the

market by adopting new innovations, demand for their goods increases and they make excessive profit. The other entrepreneurs imitate these innovations and produce goods by adopting new techniques of production. In this way, due to the increase in investment phase of boom starts in the economy. But when the supply of goods exceeds demand as well as the costs of production increase, profits of product: go down. As a result investment falls and unemployment increases.

‘ The wages and incomes start falling. This is the beginning of recession in the economy. When economic activities are somewhat revived in the phase of slump, some entrepreneurs start producing goods by adopting modem innovation once again and some producers again follow them in production of goods, due to which investment starts increasing. Prices of goods and incomes of people increase again and the phase of boom starts.

Critical Analysis:

Social factors bring about innovations but it is very difficult to explain the role of social factors in bringing about trade cycles.


Modem economists J.R. Hicks and Prof. Samuelson explain trade cycles by the interaction of multiplier and accelerator. Multiplier is number of times the income changes to a given amount of investment during a specific period. For example, if the income rises to Rs. 1000/- with the investment of Rs. 200/-, then value of the multiplier will be 5. Accelerator is the numerical value of the relation between change in income and the resulting change in investment. For example, if there is an increase of 200 rupees in consumption with the 200 rupees increase in income and investment of 1000 rupees is needed to meet additional * consumption then accelerator will be 5.

Under the influence of multiplier, national income increases many times as a result of increase in investment. While under the influence of accelerator, consumption increases as a result of increase in national income which causes many times increase in investment.Thus, changes occur in national income and employment under the influence of multiplier and accelerator, which are named as trade cycles.

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