Economics Part I: Trade cycles, Keynesian theory of Effective demand, consumption and investment functions
Trade Cycles (6)
Periodic changes in the level of economic acclivities in the long run are commonly termed as trade cycles. The level of economic activity periodically, increases and reaches a peak, shows a change in trend, decreases and bottoms out and finally, changes trend towards increase. Such cyclical changes in the level of economic activities constitute the trade cycle. Trade cycle is a neoclassical concept of macro economics which tries to explain the changes in the economic activities with respect to time. The concept of trade cycle was initially developed by Joseph Schumpeter. The different phases in the trade cycle are named in relation to the full employment level.
Accordingly, there are five phases of trade cycle:
5. Depression, and
Please use notes as per Class room instructions SY BCom: Economics Part I Dr Ranga Sai 2
1. Inflation: When the economic activity increases after full employment level, it is called inflation. During inflation, the demand pressures will be high. Increasing demand leads to increasing product prices, increasing demand for factors, higher wages and then increasing demand again.
2. Boom: Boom refers to the peak in the level of economic activity after full employment. The demand pressures will be at the peak. The price level will be very high.
3. Deflation: It is the downward trend in the economic activities after boom. At boom level the Government will take corrective measures due to which the economic activity will show a change in trend. 4. Recession: When the economic activity reduces below full employment It is called recession. The level employment will decreases, the prices will decrease and the economic activity shrinks. 5. Depression: This is the lowest level of economic activity. The markets collapse. Large scale unemployment will lead to poverty and suffering. The world experienced Great depression during 1929 and 1933.
6. Recovery: From the lowest levels of economic activity the markets recover due to positive Government policy. The economic activity will increase towards full employment. Three will be increase in the level of employment, incomes, investment and demand.
The reasons for the occurrence for the trade cycle has been not yet explained satisfactorily. The Sun spot theory relates the level of economic activity with the number of sun spots. In absence of any other theory, the Sun Spot theory still holds valid.
Phillips curve is the modern concept which relates unemployment and inflation. According to Phillip, there is a trade off between inflation and unemployment; one can be reduced only at the cost of the other. If inflation SY BCom: Economics Part I Dr Ranga Sai 3
is reduced, unemployment increases and if unemployment is reduced inflation may increase.
In such case the ideal alternative is to find such a point on the curve which is closest to the origin. By selecting such a combination, both inflation and unemployment can be maintained at tolerable levels.
Classical Theory of Employment
Macro economic theories provide relationship between various macroeconomic variables like consumption, imports, savings, interest, invest, taxes, exports and employment. These relationships are studied with respect to employment. Hence macro-economic theories are called theories of employment.
Say’s Law Of Markets
The classical theory in general believes in laissez faire. Following are relationships advocated by classical theory.
1. Full employment is natural state. It is known that the objective of macro economic exercise is full employment. Thus full employment is natural tendency of...