Contraction Phase not longer than Expansion Phase: Hicks has been criticised for asserting that the contraction phase is longer than expansion phase of trade cycle. This is unrealistic because financial crisis in a slump may reduce autonomous investment below its normal level. In the words of Dillard, “It is less than a complete theory of the business cycle because it makes no attempt to give a detailed account of the various phases of the cycle.”, Saulnier criticises Keynes’s for lacking in factual proof. According to him, Keynes makes no attempt to test any of his deductions with facts. (4) Innovation financed through Voluntary Savings does not produce a Cycle: Critics point out that if an innovation is financed through voluntary savings or internal funds, there will not be an inflationary rise in prices. 5.Distinction Between Autonomous and Induced Investment not Feasible: Critics like Duesenberry and Lundberg point out that Hicks’s distinction between autonomous and induced investment is not feasible in practice. Thus consumption lags behind income, and the multiplier is treated as a lagged relation. According to Schumpeter, there is nothing that can explain that inventions occur in a cyclical manner. Prof. Culbertson regards this evidence as faulty for two reasons: First, it relates turning points in one series in the money stock to turning points in economic activity. This increases or decreases the flow of money in the economy and thus brings about prosperity or depression. ADVERTISEMENTS: Four phases of a trade cycle are: 1. He explained his theory on the basis of Wicksell’s distinction between the natural interest rate and the market interest rate. Hence this distinction between autonomous and induced investment is of doubtful validity in practice. Unemployment is at its lowest, Business and consumer confidence will be high and also investment and consumer spending will be strong too, Wages, prices and profits will be growing strongly, so inflation will be at a peak, The high level of spending will also mean higher imports, so it is possible that the current account of the balance of payments will be in deficit, Government finances will probably show a __budget surplus __(T > G) as tax receipts rise and spending on unemployment benefits falls, The output gap shrinks. The latter means the economy is actually shrinking. (5) Factors other than Interest Rate More Important: It is an exaggeration to say that the decisions of traders regarding accumulation or depletion of stocks are solely governed by changes in interest rate. The MEC (marginal efficiency of capital) depends on the supply price of capital assets and their prospective yield. A vicious circle is set up, a cumulative expansion of productive activity.”. Recovery Phase! To conclude with Dernburg and McDougall, “The Hicks’s model serves as a useful framework of analysis which, with modification, yields a fairly good picture of cyclical fluctuation within a framework of growth. As the process continues, the initial impacts will spread throughout the economy. With economic growth, banks are more willing to lend, increasing investment. The business cycle is the natural rise and fall of economic growth that occurs over time. (5) The carrying out of the new organisations of an industry. Keynes attributes the downturn to the sudden collapse in the MEC. Momentum effect. negative growth). Copyright 10. It is in this way that the cyclical process will be repeated in the economy. Thus it is a mechanical sort of explanation in which human judgement, business expectations and decisions play little or no part. These factors force the banks to raise interest rates and refuse to lend. Credit is expanded or reduced by the banking system by lowering or raising the rate of interest or by purchasing or selling securities to merchants. The business cycle is the natural expansion and contraction of the production and output of goods and services that happens over a period of time. The expansion phase of the trade cycle starts when banks increase credit facilities. This is because they are very sensitive to changes in the rate of interest. Prof. Keynes says : " A trade cycle is composed of periods of bad trade characterized by falling prices and high unemployment percentages while a period of good trade … With low profits and reduction in loans, producers reduce the production of capital goods and adopt labour-intensive production processes. With these booms and recessions come concurrent increases and decreases in an economy’s production output levels for goods and services. Product prices are equal to both average and marginal costs. Even though the bank rate is very low, there is “credit deadlock” which prevents businessmen to borrow from banks due to pessimism in economic activity. But the actual behaviour of the postwar cycles has shown that the expansionary phase of the business cycle is much longer than the contractionary phase. Uploader Agreement. Depression may retard rather than encourage autonomous investment. These are unrealistic assumptions because the capital-output ratio is itself subject to change due to technological factors, the nature and composition of investment, the gestation period of capital goods, etc. On the other hand, the market rate of interest is the money rate which prevails in the market and is determined by the demand and supply of money. This is because the equilibrium may deviate due to both internal and external reasons. (3) Interest Rate not the only Determinant: Hayek assumes changes in the rate of interest as the cause of fluctuations in the economy. Explanation of Floor and Lower Turning Point not Convincing: Hicks’s explanation of the floor and of the lower turning point is not convincing. With the increase in the purchasing power of consumers, the demand for the products of old industries increases in relation to supply. To explain the course of the Keynesian cycle, we start with the expansion phase. This is not correct. As a result, investment in capital goods also increases and does not fall. Schumpeter’s treatment of the different phases and turning points of the cycle is novel and different from all other economists. One cannot therefore separate the long-run full employment trend from what happens during a cycle.”. @How to control trade cycles# Which one policy control trade cycles# Explain the Monetary and fiscal - Duration: 12:06. But in the downswing, the accelerator does not work so swiftly as in the upswing. Rising asset prices such as houses; this causes a rise in wealth and consumer spending. And also, the more rapid the rate of growth, the shorter the depression.” Another factor which governs the duration of depression is the “carrying costs of surplus stocks.”. These cycles are superimposed over a long run secular growth path, GP, as shown in Figure 3. “Since the rate at which output increases determines the rate at which capital stock changes, the ceiling level of output will differ depending on the time path of output. The trade cycle simply means the whole course of trade or business activity which passes through all phases of prosperity and adversity. Prosperity, 2. Thus explosive cycles are inherent in his model. Schumpeter’s theory starts with the breaking up of the circular flow by an innovation in the form of a new product by an entrepreneur for earning profit. 1. In the diagram above, the straight line in the middle is the steady growth line. (2) Unrealistic Assumption of Equilibrium: The assumption of this theory that in the beginning savings and investment are in equilibrium in the economy and the banking system destroys this equilibrium is unrealistic. 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