Trade Cycle is defined as the existence of fluctuations in National Income over a variable time span. It was first observed by the English economist Sir William Petty.
On Keynesian Trade Cycles
The reason why Keynes referred to it as a ‘cycle’ is mainly due to the way in which Marginal Efficiency of Capital (MEC) fluctuates. [According to Keynes, MEC is equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price.] As investment increases, MEC decreases.
MEC, according to Keynes depends on
-Existing stock of Capital
-Current cost of production of Capital
-Currents expectation as in the future yield of Capital
These Trade Cycles are characterised by ‘Booms’ (Peak) and ‘Crisis’ (Trough).
The causes of ‘Crisis’ was
-A sudden collapse of MEC and not primarily a rise in rates of interest (roi)
A ‘Crisis’ is analogous to a slump in the share markets.
It is characterised by “optimistic expectations as to the future yield of capital goods sufficiently strong to offset their growing abundance and their rising costs of production and, probably, a rise in the rate of interest also.”
During the boom, “disillusion comes because doubts suddenly arise concerning the reliability of the prospective yield.” And “once doubt begins it spreads rapidly.” This eventually results in a crisis.
On Trade Cycle theories
It is a well observed economic phenomenon and the usual time span is of the order of 5 years. The Government tries to reduce the fluctuations of the trade cycles through various stabilization policies.
In 2004, theSveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Finn E. Kydland and Edward C. Prescott “for their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles”
1) The General Theory of Employment, Interest, and Money By J. M. Keynes
2) Dictionary of Economics, The Economist