8 Theories Of Business Cycles | Causes of Business Cycles

Several theories were offered to explain the causes of business cycles. The following are some of them

1. Climatic theory: This theory was stated by Prof. W. S. Jeveons. According to him, sun spots appear on the face of the sun. This affects rainfalls. As a result, agricultural production will suffer. Income of the agriculturists will fall. This fall in agricultural production will affect the demand for industrial goods. Thus, changes in climate are responsible for business cycles.

2. Psychological theory : This was stated by Prof. Pigou. According to this theory, changes in the psychology of the business people are responsible for business cycles. Sometimes, they will be optimistic and confident of getting good profits. They increase investment and production. When they become pessimistic about future and curtail their production. There will be unemployment, Wages fall, Income fall. Thus, depression sets in.

3. Over investment or Over production theory: According to this theory, business cycles emerge due to over investment. Over investment is the result of competition. This over investment will result in over production. Supply exceeds demand. Prices will fall. This will result in loss and this depression spreads from one industry to another. According to this theory. over investment is responsible for business cycles.

4. Over saving or under Consumption theory: This theory was stated by Malthus, Hobson etc. In a capitalistic country rich people have large incomes and they invest more. This will increase production. But in capitalistic society the majority of the people are poor. They cannot make effort to purchase more of goods. Hence the demand for goods will be less than supply. Then prices will fall. Finally it leads to depression. According to this theory, under consumption is responsible for business cycles.

5. Monetary theories : According to Hawtrey and Hayek the monetary factors are responsible for business cycle. According to them changes in money supply are causes for trade cycles. Many business people carry on businss with bank credit. By taking credit from banks in larger amount they will invest more in the business. Production, employment and incomes increase, leading to a further demand for bank credit. Banks multiply credit. Thus, it will lead to expansion of business. But banks cannot go on providing more and more credit. After a limit they adopt restrictive credit policy. They increase interest rate. They ask the people to repay loans. As a result, the business people cannot expand the business. This reduces the production leading to unemployment. Thus, depression sets into economy.

6. Innovation theory: According to Schumpeter, innovations cause business cycles. Introduction of a new product, new techniques creation of a new market, use of new type of raw-materials etc., are called as innovations. Organisers introduces these innovations. Innovations increases the demand for capital. Banks expand credit prices rise. Production, employment and incomes of the people increase. Thus, the introduction of an innovation leads to a spurt in economic activity and a period of prosperity. But the effect of an innovation gradually dies and the economic activity takes a downward turn. Again, after sometime another innovation takes place resulting in an upward movement of economic acitivity.

7. Keynes theory : According to Keynes, changes in the marginal efficiency of capital are responsible for the business cycles. Marginal efficiency of capital means expected rate of profit from a new unit of capital. When the Marginal efficiency of capital is high, investment, employment and income will increase. It will lead to expansion of business and prosperity. But when production exceeds demand, the marginal efficiency of capital will fall. Investmenl will fall. Production and employment will fall, leading to the depression. Thus, according to Keynes business cycles are caused by fluctuations in the maginal efficiency of capital and in the volume of investment.

8. Hicks theory: Keynes theory takes multiplier effect only into account. He neglects acceleration effect. Hicks taked both multiplier and acceleration effects into account.

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