Learn about the Hicks Theory of Business Cycle and its implications for businesses. Understand how economic fluctuations impact operations and decision-making.
Hicks Theory of Business Cycle;
Departures of an economy’s real output above and below the rising trend is viewed as business cycle. Hicks has beautifully combined interaction of multiplier and accelerator with the theory of growth to explain the business cycle. Thus business cycles are the outcome of the growing process of any economy.
Hicks explains his theory of business cycle with the help of growth process. He defines a long—run equilibrium growth path of the economy that is determined by the growth rate of autonomous investment. The magnitudes of accelerator and multiplier determine the ratio of equilibrium income to autonomous investment.
The autonomous investment, it is assumed, grows at a fairly constant rate over the long—run with the fairly stable values of accelerator and multiplier, the equilibrium income will also exhibit the same constant percentage rate of growth as autonomous investment does. The business cycles is identified by the failure of actual output to move along this equilibrium growth path. The actual output moves, at times, above the long—run growth trend and, at others, below it.
Hicks, then, introduced the concepts of ceiling and floor output paths. The ceiling output corresponds to full employment of all the available resources. The floor output is defined as the constant multiple of autonomous investment, l-fe defined as the autonomous investment to include putilic investment that occurs indirect response to invention and pays for only in the long-run. The remaining of the investment is induced investment and takes place as a result of changes in the past level of output.
Hicks explains this theory with the help of a diagram.
For this purpose, fig is constructed. AA curve shows autonomous investment which is exogenously determined. EE represents equilibrium growth path of the income that is based upon AA. Overtime equilibrium in income is given by EE or FF curves, shows the growth pattern of the economy taking place in long—run. The line CC shows growth path of ceiling output that can be produced with full employment of resources of the economy. The line FF describes the path of lower limit or floor to which real income can fall during the contraction phase of a cycle.
We assume that due to innovation, etc., Io is increased. Because of increase in investment, due to interaction of multiplier and accelerator, the national output has a tendency to move upward. But when economy reaches point ‘b’ the Nl does not rise in the previous manner while moving from a to b. According to Hicks, the CC curve represents full employment in the country. The real output of the economy cannot cross full employment.
Thus through the interaction movement Nl will reach the ceiling point like C, then a bag is required for the contraction to start—as shown by the gap between the point b and C. But sooner or later, the contractionary forces come into being. Once the contraction sets in; the reverse accelerator plays its role. As during contraction, income starts falling. It will have the effect of reducing the induced investment. Thus, during contraction, the accelerator becomes ineffective.
During depression, it is the multiplier which plays its role in the determination of Nl. This is the reason that FF curve— representing floor of the economy, comes into being because of role of multiplier and autonomous investment (Io). In other words, according to Hicks,, due to interaction of multiplier and accelerator Nl cannot cross the level of full employment during boom while Nl falls during depression. It does not fall below the FF—the level of income settled by the multiplier value and autonomous investment.