THEORIES OF TRADE CYCLES
Business Cycles: Meaning and Nature
Business cycle or trade is a part of the capitalist system. It
refers to the phenomenon of cyclical booms and depressions. In a business
cycle there are wave-like fluctuations in aggregate employment, income output
and price level. The term business cycle has been defined in various ways by
different economists. Professor Haberler’s definition is very simple when he
says, “The business cycle in the general sense may be defined as alternation
of periods of prosperity and depression of good and bad trade.” Keynes’s
definition in his Treatise of money is more explicit: “a trade cycle is
composed of periods of good trade charactertised by rising prices and low
unemployment percentages, altering with periods of bad trade characterised by
failing prices and high unemployment percentages.”
Professor Gordon’s definition is precise: “Business cycles
consist of recurring alternation of expansion and contraction in aggregate
economic activity, the alternating movements in each direction being
self-reinforcing and pervading virtually, all parts of the economy.” The most
acceptable definition is that given by Professor Mitchell in these words:
“Business cycles are a type of fluctuations found in the aggregate economic
activity of nations that organise their work mainly in business enterprise. A
cycle consists of expansions occurring at about the same time in many economic
activities followed by similarly general recessions, contractions, and
revivals which merge into the expansion phase of the next cycle; this sequence
of changes is recurrent but not periodic….” The same idea is expressed by
Professor Estey in a simple way: “Cyclical fluctuations are characterised by
alternating waves of expansion and contraction. They do not have a fixed
rhythm, but they are cycles in that the phases of contraction and expansion
recur frequently and in fairly similar patterns.”
An important point to be noted in the case of business cycles is
that “no cycle is perfectly regular with uniform frequency and amplitude, that
is, the time taken to move from one peak level of output to the next would
always be the same, and the level of output and employment would always vary
in the same proportion between the upper and lower turning-points. But such
cycles have never occurred.” Thus business cycles are recurrent fluctuations
in aggregate employment, income, and output and price level.
TYPES
OF CYCLES:-
Business cycles are usually classified as under:
1.
The Short Kitchin Cycle: -
It is also known as the minor cycle, which is of approximately 40 months
duration. It is famous after the name of the British economist Joseph Kitchin,
who made a distinction between a major and a minor cycle in 1923. He came to
the conclusion on the basis of his research that a major cycle is composed of
two or three minor cycles of 40 months.
2.
The Long Jugler Cycle: -
This cycle is also known as the major cycle. It is defined “as the
fluctuation of business activity between successive crises.” In 1862 Clement
Juglers, a French economist showed that periods of prosperity, crises and
liquidation followed each other always in the same order. Later economists
have come to the conclusion that Jugler cycle’s duration is on the average
nine and a half years.
3.
The Very Long Kondratieff Cycle:-
In 1925, N.D. Kondratieff, the Russian economist, came to the conclusion that
there are longer waves of cycles of more than 50 years duration, made of six
Jugler cycles. A very long cycle has come to be known as the Kondratieff
wave.
4.
Building Cycles: -
Another type of cycle relates to the construction of buildings which is of
fairly regular duration. Its duration is twice that of the major cycles are
associated with the name of Warren and Pearson, two American economists who
came to this conclusion in World Prices and the Building Industry (1937).
5.
Kuznets Cycle: -
Professor Simon Kuznets, the famous American economist, propounded a new type
of cycle the secular swing of 16-22 years which is so pronounced that it
dwarfs the 7 to 11 years cycle into relative insignificance. This has come to
be known as the Kuznets Cycle.
PHASES OF A BUSINESS CYCLE
A
typical cycle is generally divided into four phases: -
1.
Expansion or
Prosperity or the Upswing.
2.
Recession or
Upper-Turning Point.
3.
Contraction or
Depression or Downswing
4.
Revival or Recovery or Lower turning point.
These phases are recurrent and uniform in the case of different cycles. But
no phase has definite periodicity or time interval. As pointed out by
Pigou, cycles may not be twins but they are of the
same family. Like families they have common characteristics that are capable
of description. Starting at the trough or low point, a cycle passes through a
recovery and prosperity phase, rise to a peak, declines through a recession
and depression phase and reaches a trough. This is shown in figure 32.1 where
E is the equilibrium position. We describe below these characteristics of a
business cycle.
Recovery:-
We start from a situation when depression has lasted from some time
and revival phase or the lower-turning point starts. The “originating forces”
or “starters” may be exogenous or endogenous forces. Suppose the semi-durable
goods wear out which necessitate their replacement in the economy. It leads
to increased demand. To meet this increased demand, investment and employment
increase. Industry begins to revive. Revival also starts in related capital
goods industries. Once begun, the prices of revival become cumulative. As a
result, the levels of employment, income and output rise steadily in the
economy. In the early stages of the revival phase, there is considerable
excess or idle capacity in the economy so that output increases without a
proportionate increase in total costs. “But as time goes on, output becomes
less elastic; bottlenecks appear with rising costs, deliveries are more
difficult and plants may have to be expanded. Under these conditions, prices
rise.” Profit increases. Business expectations improve. Optimism prevails.
Investment is encouraged which tends to raise the demand for bank loans. It
leads to credit expansion. Thus the cumulative process of increase in
investment, employment, output, income and prices will feed upon itself and
becomes self-reinforcing. Ultimately, revival enters the prosperity phase.
Prosperity:-
In the prosperity phase, demand, output, employment and income
are at a high level. They tend to raise prices. But wages, salaries,
interest rates, rentals and taxes do not rise in proportion to the rise in
prices. The gap between prices and cost increases the margin of profit. The
increase of profit and the prospect of its continuance commonly cause a rapid
rise in stock market values. “All securities including bonds rise under the
influence of improving expectations. The outstanding change is in stocks
that, reflecting the capitalised values of prospective earnings, register in
an exaggerated form the rising profits of enterprise.” The economy is
engulfed in waves of optimism. Larger profit expectations further increase
investment which is helped by liberal bank credit. Such investments are
mostly in fixed capital, plant, equipment and machinery. They lead to
considerable expansion in economic activity by increasing the demand for
consumer goods and further raising the price level. This encourages
retailers, wholesalers and manufacturers to add to inventories. In this way,
the expansionary process becomes cumulative and self-reinforcing until the
economy reaches a very high level of productions, known as the peak or boom.
The peak or prosperity may lead the economy to over full
employment and to inflationary rise in prices. It is symptom of the end of
the prosperity phase and the beginning of the recession. The seeds of
recession are contained in the boom in the form of strains in the economic
structure which act as brakes to the expansionary path. They are:
1.
Scarcities of labour, raw materials, etc. leading to rise in costs
relative to prices.
2.
Rise in the rate of interest due to scarcity of capital.
3.
Failure of consumption to rise due to rising prices and stable
propensity to consume when incomes increase.
The first factor brings a decline in profit margins. The second makes
investments costly and along with the first lowers business expectations. The
third factor leads to the piling up of inventories indicating that sales or
consumption lags behind production. These forces become cumulative and
self-reinforcing. Entrepreneurs, businessmen and traders become over cautious
and over optimism gives way to pessimism. This is the beginning of the upper
turning point.
Recession:
Recession starts when there is a downward descends from the
‘peak’ which is of a short duration. “It marks the turning period during
which the forces that make for contraction finally win over the forces of
expansion. Its outward signs are liquidation in the stock market, strain in
the banking system and some liquidation of bank loans, and the beginning of
the decline of prices.” As a result, profit margins decline further because
costs start overtaking prices. Some firms close down. Others reduce
production and try to sell out of accumulated stocks. Investment, employment,
incomes and demand decline. This process becomes cumulative.
Recession may be mild or severe. The latter might lead to a
sudden explosive situation emanating from the banking system or the stock
exchange, and a panic or crisis occurs. “When a crisis, and more particularly
a panic, does occur, it seems to be associated with a collapse of confidence
and sudden demands for liquidity. This crisis of nerves may itself be
occasioned by some spectacular and unexpected failure. A firm or a bank or a
corporation announces its inability to meet its debts. This announcement
weakens other firms and banks at a time when ominous signs of distress are
appearing in the economic structure. Moreover, it sets off a wave of fright
that culminates in a general run on financial institutions…Such was the
experience of the United States in 1873, in 1893 and in 1907.” In the words
of M.W.Lee, “A recession, once started, tends to build upon itself much as
forest fire, once under way, tends to create its own draft and give internal
impetus to its destructive ability.
Depression:
-
Recession leads to depression when there is a general decline in
economic activity. There is considerable reduction in the production of goods
and services, employment, income, demand and prices. The general decline in
economic activity leads to a fall in bank deposits. Credit expansion stops
because the business community is not willing to borrow. Bank rate falls
considerably. According to Professor Estey, “This fall in active purchasing
power is the fundamental back ground of the fall in prices. That, despite the
general reduction of output, charactertises the depression.” Thus a
depression is characterised by mass unemployment; general fall in prices,
profits, wages, interest rate, consumption, expenditure, investment, bank
deposits and loans; factories closedown; and construction of all types of
capital goods buildings, etc.—comes to a standstill. These forces are
cumulative and self-reinforcing and the economy is at the trough.
The trough or depression may be short-lived or it may continue at
the bottom for considerable time. But sooner or later limiting forces are set
in motion which ultimately tends to bring the contraction phase to end and
pave the way for the revival. A cycle is thus complete.
The behaviour of a business cycle is difficult to determine
because of the multitudinous factors and circumstances that lie behind
cyclical fluctuations. Attempts to explain them have brought forth a large
number of theories. Some attribute cycles to exogenous causes and others to
endogenous causes. Some economists classify business cycle theories them into
real, psychological, monetary and those relating to variations in spending,
saving and investment.
HAWTREY’S
MONETARY THEORY OF THE TRADE CYCLE
According to Prof. R.G. Hawtrey, “The trade cycle is a purely
monetary phenomenon.” It is changes in the flow of monetary demand on the
part of businessmen that lead to prosperity and depression in the economy. He
opines that non-monetary factors like strikes, floods, earthquakes, droughts,
wars, etc. may at best cause a partial depression, but not a general
depression. In actually, cyclical fluctuations are caused by expansion and
contraction of bank credit which, in turn, lead to variations in the flow of
monetary demand on the part of producers and traders. Bank credit is the
principle means of payment in the present times. 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. This increases or decreases
the flow of money in the economy and thus brings about prosperity or
depression.
The expanded phase of the trade cycle starts when banks increase
credit facilities. They are provided by the reducing the lending rate of
interest and by purchasing securities. These encourage borrowings on the part
of merchants and producers. This is because they are very sensitive to
changes in the rate of interest. So when credit becomes cheap, they borrow
from banks in order to increase their stocks or inventories. For this, they
place larger orders with producer who, in turn, employs more factors of
production to meet the increasing demand. Consequently, money incomes of the
owners of factors of production increase thereby increasing expenditure on
goods. The merchants find their stocks being exhausted. They place more
orders with producers. This leads further increase in productive activity, in
income, outlay, demand and a further depletion of stocks of merchants.
According to Hawtrey, “Increased activity means increased demand, and
increased demand means increased activity. A vicious circle is set up, a
cumulative expansion of productive activity.”
As the cumulative process of expansion continues, producers quote
higher and higher prices. Higher prices induce traders to borrow more in
order to hold still larger stocks goods so as to earn more profits. Thus
optimism encourages borrowing, borrowing increases sales, and sales raise
optimism.
According to Hawtrey, prosperity cannot continue limitlessly. It
comes to an end when banks stop credit expansion. Banks refuse to lend
further because their cash funds are depleted and the money in circulation is
absorbed in the form of cash holdings by consumers. Another factor is the
export of gold to other countries when imports exceed exports as a result of
high prices of domestic goods. These factors force the banks to raise
interest rates and refuse to lend. Rather, they ask the business community to
repay their loans. This starts the recessionary phase.
In order to repay bank loans, businessmen start selling their
stocks. This sets the process of falling prices. They also cancel orders
with producers. The latter curtail their productive activities due to fall in
demand. This, in turn, leads to reduction in the demand for factors of
production. There is unemployment. Incomes fall. Falling demand, prices and
incomes are the signals for depression. Unable to repay bank loans, some
firms go into liquidation thus forcing banks to contract credit further. Thus
the entire process becomes cumulative and the economy is forced in to
depression.
According to Hawtrey, the process of recovery is very slow and
halting. As depression continues, traders repay bank loans by selling their
stocks at whatever prices they can. As a result, money flows into the reserves
of banks and funds increase with banks. 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. This deadlock can be broken by
following a cheap money policy by the central bank which will ultimately bring
about recovery in the economy.
It’s Criticism
Monetarists like Friedman have supported Hawtrey’s theory. But
the majority of economists have criticised him for over-emphasising monetary
factors to the neglect of non-monetary factors in explaining cyclical
fluctuations. Some of the points of criticism are discussed below:
None can deny that expansion of credit leads the expansion of
business activity. But Hawtrey believes that an expansion of credit leads to
a boom. This is not correct because the former is not the cause of the
latter. As pointed out by Pigou, “Variations in
the bank money supply is a part of the business cycle, it is not the cause of
it.” At the bottom of the depression, credit is easily available. Even then,
it fails to bring a revival. Similarly, contraction of credit cannot bring
about a depression. At best, it can create conditions for that. Thus
expansion or contraction of credit cannot originate either boom or depression
in the economy.
Haberler has criticised Hawtrey for “his contention that the
reason for the breakdown could be prolonged and depression staved off
indefinitely if the money supply were in exhaustible.” But the fact is that
even if the supply of money is inexhaustible in the country, neither
prosperity can be continued indefinitely nor depression can be delayed
indefinitely.
Hamberg has criticised Hawtrey for the role assigned to
wholesalers in his analysis. The kingpin in Hawtrey’s theory is the trader or
the wholesaler who gets credit from banks and starts the upturn or
vice-versa. In actuality, traders do not depend exclusively on bank credit
but they finance business through their own accumulated funds and borrowings
from private sources.
Further, Hamberg also does not agree with Hawtrey that traders react to
changes in interest rates. According to Hamberg, traders are likely to react
favourably to a reduction in the interest rate only if they think that the
reduction is permanent. But they do not react favourably during the
depression phase because traders expect a further reduction every time the
interest rate is reduced. On the other hand, if traders finance their stocks
with their own funds, interest rate changes will have little effect on their
purchases.
Again 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. As a matter of fact, factors other than the rate of interest are more
important in influencing such decisions. They are business expectations,
price changes, cost of storage, etc.
Hamberg further points out that in Hawtrey’s theory cumulative movements in
economic activity are the results of changes in stocks of goods. But
fluctuations in inventory investments can at best produce minor cycles, which
are not cycles in the true sense of the term.
The theory also fails to explain the periodicity of the cycle.
Finally, Hawtrey’s theory is incomplete because it emphasises only monetary
factors and totally ignores such non-monetary factors as innovations, capital
stock, multiplier-accelerator interaction, etc.
SCHUMPETER’S
THEORY OF INNOVATIONS
The innovations theory of trade cycles is associated with the name of Joseph
Schumpeter. According to Schumpeter, innovations in the structure of an
economy are the source of economic fluctuations. Trade cycles are the outcome
of economic development in a capitalist society. Schumpeter accepts Juglar’s
statement that the cause of depression is prosperity,” and then gives his own
view about the originating cause of the cycle.
Schumpeter’s approach involves the development of his model into two stages.
The first stage deals with the initial impact of innovation and the second
stage follows through reactions to the original impact of innovation.
The
first approximation starts with the economic system in equilibrium with every
factor fully employed. Every firm is in equilibrium and producing efficiently
with its costs equal to its receipts. Product prices are equal to both
average and marginal costs. Profits and interest rates are zero. There are
no savings and investments. This equilibrium is characterised by Schumpeter
as the “circular flow” which continues to repeat itself in the same manner
year after year, similar to the circulation of the blood in an organism. In
the circular flow, the same products are produced every year in the same
manner.
Schumpeter’s model starts with the breaking up of the circular flow by
innovations in the form of a new by an entrepreneur for earning profit.
By
innovation Schumpeter means “such changes in the production of goods as cannot
be affected by infinitesimal steps or variations on the margin.” An
innovation may consist of:
1.
The introduction of a new product.
2.
The introduction of a new method of production.
3.
The opening up of a new market.
4.
The conquest of a new source of raw materials or semi-manufactured
goods.
5.
The carrying out of the new organisations of any industry.
Innovations are not inventions. According to Schumpeter, there is nothing
that can explain that inventions occur in a cyclical manner. It is the
introduction of a new product and the continual improvements in the existing
ones that are the principal causes of business cycles.
Schumpeter assigns the role of an innovator not to the capitalist but to an
entrepreneur. The entrepreneur is not a man of ordinary ability but one who
introduces something entirely new. He does not provide funds but directs
their use.
To
perform his economic function, entrepreneur two things: first, the existence
of technical knowledge I order to produce new products, and second, and the
power of disposal over the factors of production in the form of bank credit.
According to Schumpeter, a reservoir of untapped technical knowledge exists in
a capitalist society which he can make use of. Therefore, credit is essential
for breaking the circular flow.
The
innovating entrepreneur is financed by expansion of bank credit. Since
investment in an innovation is risky, he must pay interest on it. With his
newly acquired funds, the innovator starts bidding away resources from other
industries. Money incomes increase. Prices begin to rise thereby stimulating
further investment. The new innovation starts producing goods and there is an
increased flow of goods in the economy. Consequently, supply exceeds demand.
Prices and cost of production of goods start declining until recession sets
in. Because of the low prices of goods, producers are not willing to expand
production. During this period of recession credit, prices and interest rates
decline but total output is likely top average larger than in the preceding
prosperity.
Thus Schumpeter’s first approximation consists of a two-phase cycle. The
economy starts at the Equilibrium State, rises to a peak and then starts
downward into a recession and continues till the new equilibrium is reached.
This new equilibrium will be at a higher level of income than the initial
equilibrium because of the innovation, which started the cycle
The
second approximation of Schumpeter follows through the reactions of the impact
of original innovation. Once the original innovation becomes successful and
profitable, other entrepreneurs follow it in “swarm-like clusters.”
Innovation on one field induces innovations in related fields. Consequently,
money incomes and prices rise and help to create a cumulative expansion
throughout the economy. With the increase in the purchasing power of
consumers, the demand for the products of old industries increases in relation
to supply. Prices rise further. Profits increase and old industries expand
by borrowing from the banks. It induces a secondary wave of credit inflation
which is superimposed on the primary wave of innovation. Over optimism and
speculation add further to the boom. After a period gestation, the new
products start appearing in the market displacing the old products and
enforcing a process of liquidation, readjustment and absorption.
The
demand for the old products is decreased. Their prices fall. The old firms’
contract output and some are even forced to run into liquidation. As the
innovators start repaying bank loans out of profits, the quantity of money is
decreased and prices tend to fall. Profits decline. Uncertainty and risks
increase. The impulse for innovation is reduced and eventually comes to an
end. Depression sets in, and the painful process of readjustment to the
“point of previous neighborhood of equilibrium” begins. Ultimately the
natural forces of recovery bring about a revival. To Schumpeter, cyclical
swings are the cost of economic development under capitalism, a permanent
feature of its dynamic time-path.
Schumpeter believes in the existence of Kondratieff long-wave of upswings and
downswings in economic activity. Each long-wave upswing is brought about by
an innovation, which leads to abundance of goods for the masses. Once the
upswing ends, the long-wave downswing begins.
Thus the second approximation of Schumpeter’s theory of trade cycle develops
into a four-phase cycle with the recession which was the second phase in the
first approximation continuing downward to give the depression phase and this
extension of cycle is followed by a period of revival which continues till the
equilibrium level is reached. This is shown as the “Secondary Wave”
Schumpeter has also advanced an hypothesis integrating the minor Kitchen cycle
of 40 months duration, the intermediate Juglar
cycle of 8 to 9 years’ duration and the long Kondratieff cycle of 50 to 60
years’ duration. He postulates in his theory that one Kondratieff cycle is
made up of six intermediate Juglar cycles and each
Juglar cycle includes 3 Kitchen minor cycles.
Thus Schumpeter provides a three-tier scheme of cycles in his theory.
It’s Criticism:
Schumpeter’s analysis is based on the innovator. Such persons were to be
found in the 18th and 19th centuries who made innovations. But now all
innovations are the part of the functions of a joint stock company.
Innovations are regarded as the routine of industrial concerns and do not
require an innovator as such.
Schumpeter’s contention that cyclical fluctuations are due to innovations is
not correct. As a matter of fact, trade cycles may be due to psychological,
natural or financial causes.
Schumpeter gives too much importance to bank credit in his theory. Bank
credit may be important in the short run when industrial concerns get credit
facilities from banks. But in the long run when the need for capital funds is
much greater, bank credit is insufficient. For this, business houses have to
float fresh shares and debentures in the capital market. Schumpeter’s theory
is weak in that it does not take these factors into consideration.
Again critics point out that if an innovation is financed through voluntary
savings or internal funds, there will not be an inflationary is in prices.
Consequently, in an underdeveloped economy an innovation financed voluntary
savings might not generate a cycle.
Finally, Schumpeter’s analysis is based on the unrealistic assumption of full
employment of resources to begin with. But the fact is that at the time of
revival the resources are unemployed. Thus the introduction of an innovation
may not lead to the withdrawal of labour and other resources from old
industries. Thus the competitive impact of an innovation would not increase
costs prices. Since full employment is an exception rather than the rule,
Schumpeter’s theory is not a correct explanation of trade cycles.
KEYNES’S THEORY OF THE TRADE CYCLE:-
The
Keynesian theory of the trade cycle is an integral part of his theory of
income, output and employment. Trade cycles are periodic fluctuations of
income, output and employment. Keynes regards the trade cycle as mainly due
to “a cyclical change in the marginal efficiency of capital, though
complicated and often aggravated by associated changes in the other
significant short-period variables of the economic system.”
According to Keynes, the principal cause of depression and unemployment is the
lack of aggregate demand. Revival can be brought about by raising aggregate
demand which in turn can be raised by increasing consumption and/or
investment. Since consumption is stable during the short run, therefore
revival is possible by increasing investment. Similarly, the main cause of
the downturn is reduction in investment. Thus in the Keynesian explanation of
the trade cycle, “the cycle consists primarily in the rate of investment,
according to Hansen. And fluctuations in the rate of investment are caused
mainly by fluctuations in the marginal efficiency of capital. The marginal
efficiency of capital (MEC) depends on the supply price of capital assets and
their prospective yield. Since the supply price of capital assets is stable
in the short run, the marginal efficiency of capital is determined by the
prospective yield of capital assets, which in turn depends on business
expectations. Fluctuations in the rate of investment are also caused by
fluctuations in the rate of interest. But Keynes gives more importance to
fluctuations in the marginal efficiency of capital as the principal cause of
cyclical fluctuations.
To
explain the course of the Keynesian cycle, we start with the expansion phase.
During the expansion phase, the marginal efficiency of capital is high.
Businessmen are optimistic. There is rapid increase in the rate of
investment. Consequently, output employment and income increase. Every
increase in investment leads to a multiple increase in income via the
multiplier effect. This cumulative process of rising investment, income and
employment continues till the boom is reached.
As
the boom progresses, there is a tendency for the marginal efficiency of
capital to fall due to two reasons. First, as more capital goods are being
produced steadily, the current yield on them declines. Second, at the same
time the current costs of new capital goods rise due to shortages and
bottlenecks of materials and labour. “Thus the prevailing optimistic estimate
of future yields of capital good is increasingly displaced by disillusion.
The collapse in the marginal efficiency of capital precipitates a sharp
increase in liquidity preference. This causes a rise in the rate of interest,
and thus the situation is aggravated….But the cyclical swings in the marginal
efficiency of capital are made more violent than the facts justify by the
uncontrollable and disobedient psychology of the business world.'
During the downturn, investment falls due to a fall in the marginal efficiency
of capital and rise in the rate of interest. This leads to a cumulative
decline in employment and income via the reverse operation of the multiplier.
Further, the fall in the marginal efficiency of capital may shift the
consumption function downward thereby hastening the depression. Keynes
attaches more importance to the sudden collapse of the marginal efficiency of
capital than to a rise in the rate of interest as an explanation of the
downturn of the cycle leading to the crises and the depression.
Unlike the sudden collapse of the economic system, the revival takes time. It
depends on factors, which bring about the recovery of the marginal efficiency
of capital. “The time which must elapse before recovery begins, depends
partly upon the magnitude of the normal rate of the economy and partly upon
the length of life of capital goods. The shorter the length of life of durable
assets, the shorter the depression. 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.” According
to Keynes, the carrying cost of surplus stocks during the depression is seldom
less than 10 per cent per annum. So for a few years disinvestment in stocks
will continue till the surplus stocks are exhausted. Optimism takes the place
of pessimism. The marginal efficiency of capital increases. Fresh investment
starts taking place. Revival has started.
Its Criticism:-
Keynes’s theory of the trade cycle is superior to the earlier theories because
“it is more than a theory of the business cycle in the sense that it offers a
general explanation of the level of employment, quite independently of the
cyclical nature of changes in employment.” However, critics are not tacking
in pointing out its weaknesses.
Keynes has been criticised for his analysis of business cycle based on
expectations. In fact, he overemphasized the role of expectations in
influencing the marginal efficiency of capital. According to Hart, Keynes
relied on “convention” for forecasting changes in business expectations and
failed to confront ex-ante and ex-post reasoning. The reliance on the
conventional hypothesis makes Keynes’s concept of expectations superfluous and
unrealistic. According to Ozga, “No expectations
need to be taken into account. The businessmen are supposed to behave neither
as if they were adjusting their positions nor to their expectations but
observable date.”
Keynes considers the trade cycle as mainly due to fluctuations in the marginal
efficiency of capital. The marginal efficiency of capital, in turn,
determines the rate of investment. And investment decisions depend upon the
psychology of businessmen or producers. Thus Keynes’s theory is not much
different from Pigou’s psychological theory of the
trade cycle.
Further, Keynes attributes the downturn to the sudden collapse in the marginal
efficiency of capital. According to Hazlitt, the term marginal efficiency of
capital being vague and ambiguous, ‘Keynes’s explanation of the crises of the
marginal efficiency of capital is either a useless truism or an obvious error.
Another weakness of Keynes’s theory of the trade cycle is that some of its
variables such as expectations, marginal efficiency of capital and investment
cannot explain the different phases of the cycle. 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 eriticises Keynes’s Notes on the trade Cycle for lacking in factual
proof. According to him, Keynes makes no attempt to test any of his
deductions with facts. Dillard also points toward this defect when he writes
that Keynes “does not examine closely the empirical data of cyclical
fluctuations.”
One
of the serious omissions of Keynes’s theory of the trade cycle is the
acceleration principal. This made his theory one-sided because his
explanation centers round the principle of multiplier. As pointed out by Sir
John Hicks, “The theory of acceleration and the theory of multiplier are to
sides of the theory fluctuations, just as the theory of demand and the theory
of supply are the two sides of the theory of value.”
The Rise and Fall of shares: -
Share in the market offer a high capital
appreciation but the movement of the share price is always like a wave and
tide motion of the sea. The waves of the sea never surrounded it will rise
again and again only the magnitude will vary if the weather is run then the
sea will high waves. Similarly to see the stock market will also rise high
waves when the market booms, it will get depress in slum. The rise and fall of
the share is linked to a number of conditions such as political climate,
economic cycle, economic growth, international trends, budget, general
business conditions, company profits, product demand likewise.
Why Do
Stock Prices Change?
Stock prices are changed everyday by the market.
Buyers and sellers cause prices to change as they decide how valuable each
stock is. Basically, share prices change because of supply and demand. If more
people want to buy a stock than sell it - the price moves up. Conversely, if
more people want to sell a stock, there would be more supply (sellers) than
demand (buyers)- the price would start to fall.
Stock represents ownership in a company. Therefore, the price of
a stock shows what investors feel the company is worth. Stock prices can
change at any rate, some have dramatic swings in one day while others stay the
same for a long time. There are hundreds of variables which drive stock
prices, the most important of which is earnings.. Think of earnings as the
profit of a company, the money left after all expenses have been paid, this is
what share holders desire.
There is also a common misconception that a stock that has risen will always
come back down, this is false. Stock prices reflect the interests of
investors, not the laws of gravity. Historically over the long term stocks
have appreciated by 10-12%.
Three level of shares:-
1) Undervalued or deflated zone
2) Real valued or correct valued zone
3) Over valued or inflated zone
Generally we can say a company is in speculative zone when the 12-day rate
of change of the price is more than 75% to 100 %. The ideal time for buying
shares would be in deflated zone or real valued zone. Over value or inflated
zone will create excess speculation and the prices fall shortly after entering
inflated zone.
MARKET TRENDS:-
1) Primary market trends. 2) Secondary market trend.
The major trend of the stock prices was being up or down. It is also called as
correction or reaction some of the physical signs when business cycle changes.
Good time to buy shares.
1. General pessimism & fear about the business.
2. Public sentiments are at low ebb.
3. Demands for goods are low.
4. Public participation is low in share market.
5. Real Estate prices are very low.
6. Company profit margin fall.
7. Interests rates are high.
8. No response to new issues.
9. Commodity market week.
10. Band market seems attractive.
11. Corporate profits low, dividends low even skip.
12. Employment increases factories are going.
13. Industries start partial lay off.
14. Heavy industries are dull.
15. Some leading shares say market leaders are bullish
16. Everybody things market will go lower but market fails to record new low
actually
Good time to sell shares:-
01.
High demand for consumer goods.
02. Corporate profits high.
03. Extra dividend, bonus rights being offered.
04. Investors rushing to the stock offices kept open till now time.
05. Real estate boom, Housing shortage, high rain.
06. High bank loans.
07. High industrial production.
08. Labour shortage.
09. Overexpansion of credit.
10. Oversubscription in new issues.
11. Commodity markets rising.
12. Fixed interest yielding, bonds debentures, fixed deposits seem out of
favour.
13. Share market news appears as headlines of in all magazines.
14. Shares fail to record new high.
15. Labour strikes for more wages.
16. Business morality very low, Black market. Seller’s market.
]
In general a fundamental analysis tells the latest developments,
profitability, sales of the company and the industry. We can conclude with
the present status of the company and the merits. At the same time we have to
look what may be the future trends of the same company. The market always
discounts the future. A fertilizer company with good results may go down when
the news of monsoon failure even though it is not affected profits
immediately. Many companies with excellent results may go down when a
political instability occurs. This indicates that investors worry about the
future and mostly forget the past things.
The super timing of the market is nothing but a pure technical
analysis. There are various types technical analyses. Technical analysis are
art not a science and hence the accuracy varies and it is the probabilities
only.
1. Using moving averages.
2. Trend lines.
3. Patterns.
4. Business cycle theories like
Elliott Wave Theory.
5. Fibonacci Studies.
6. Stock Market Indicators.
Elliott wave theory says that the market is like a wave and tide
motion of the sea. The waves of the sea never surrender. Only the degree of
impulse varies. In a rough weather the sea roars with amplitude of waves and
thereafter a heavy undercurrent and pull back occurs towards the sea.
Similarly in a boom time the stock market rise abnormally in speculative or
overbought zone and thereafter a sudden fall occurs due to (no buyers or)
surging of buyers. It is always suggested to buy in normal market condition
and take profits when prices move in overbought zone. An investor can be
assumed as best if he could sell around 80% of the rally.
Investment is better than
speculation.
We advise each and every one to
be an investor than a speculator.
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