Question

1. List and explain the different approaches to the trade cycle.
2. Which one do you find more helpful explaining the trade cycle? Why?
3. Pick one of the 16 points from the Austrian theory of the trade cycle and relate it to recent economic events in the macro economy.
4. What difference could this information make when you apply them to your daily life and career?

Answer 1

(a)

Trade cycle in other ways called business cycle are the cyclical variations in an economy. The four phases of business cycle are:

• Recovery
• Boom
• Recession
• Depression

In a trade cycle, the upward phase is divided into two which are recovery and boom whereas the downward phase is further divided into recession and depression.

Approaches to trade cycle:

1. Pure Monetary Theory:

Pure monetary theory was proposed by R.G.Hawtrey. According to him, "trade cycle is a purely monetary phenomenon because general demand is itself a monetary phenomenon". According to him the reason for the cyclical variations can be found out in those factors which deals with the money flow. He views that the main criteria that affects the money flow is the money supply ie the variations in income earning and spending are due to changes in amount of bank credits. That is why he view that business cycle is a monetary phenomenon.

2. Monetary over Investment Theory :

Monetary over Investment Theory was proposed by Hayek who pointed out that in order to maintain an equilibrium in economy, the consumption pattern should be in accordance with the spending pattern. The theory views that the aggregate investments are distributed over number of industries and the industries shall produce only that much according to the demand of customers.

3. Schumpeter's theory of innovation :

Joseph Schumpeter view the business cycle to be the outcome of innovative activity of entrepreneurs in a competitive economy. According to him in a capitalist society, business cycles are major part of economic growth process. By innovation, he means the following :

• Variations in methods of manufacturing and transportation
• manufacturing of a new product
• variations in the industrial organisation
• Starting up of new markets

4. Keynes Theory :

Keynes theory is the reply to classical economists which was developed in 1930's. According to classical economists, if there is a situation of unemployment, then demand and supply in the market would perform in such a way to bring back full employment situation. Keynes has proposed three types of propensities to understand trade cycles:

• Propensity to save
• propensity to consume
• propensity of marginal efficiency of capital.

4. Samuelson's model of multiplier :

Samuelson has explained the way the accelerator and multiplier interact with each other to :

• increase demand
• increase consumption
• generate income

Samuelson used 2 concepts such as autonomous concept and derived concept which explains his model in such a way he described.

5. Hick's Theory :

According to Hick's, trade cycles took place parallel with economic growth. so that trade cycles should be described in accordance with the Growth Theory of Harrod-Domar. Following are the concepts Hick's used to explain his concepts regarding trade cycles.

• Relation between investment and savings and Keynes concept regarding multiplier
• Clark's acceleration concept
• Harrod Domar's Growth model
• Samuelson's multiplier interaction concept

(b)

Apart from all these Hick's theory about trade cycles is found more helpful for explaining the concepts of trade cycle because Hick's also consider the concepts explained by Keynes, Clark, Harrod Domar, Samuelson which helps to understand the concept of business cycle very much clear.

(c)
Now a days it is quiet common in economics to speak about trade cycle's Austrian Theory. The Austrian Theory of trade cycles has many critics.

Keynes appeared to be adopting a strategy which is normally pointed to the legal profession. "My client did not borrow your urn, It was in the absolute condition when he give back it and it was already broken when you lent it to him. Here Keynes was arguing like a lawyer that the legal professions focus should be driven away from wage rates and towards interest rates. This view of Keynes is consistent with view of Leijonhufvud.

Keynes theory is deals with the aggregate expending in the economy and its effects on the output and inflation. Keynes often advocated for rise in Government expenditures and reducing taxes to stable market demand and pull the economy out of the phase of depression.

(d)

One thing coming into the mind is the words spoken by Heraclitus that " Change is the only thing that is constant". These changes may be affected by :

• level of employment
• productivity
• total demand for nations goods and services
• total supply of nations goods and services.