Samuelson’s Model of Business

Cycles: Interaction between

Multiplier and Accelerator
by Supriya Guru Macro Economics

Samuelson’s Model of Business Cycles: Interaction between Multiplier

and Accelerator!
Keynes made an important contribution to the understanding of the
cyclical fluctuations by pointing out that it is the ups and downs in
investment demand, depending as it is on the profit expectations of
the entrepreneurs, that causes changes in aggregate demand which
affect the levels of income, output and employment.

Further, by putting forward the theory of multiplier, Keynes has

shown how the effect of increase and decrease in investment on output
and employment get magnified when multiplier is working during
either the upswing or downswing of a business cycle.

However, Keynes did not explain the cyclical and cumulative nature of
the fluctuations in economic activity. This is because Keynes did not
give any importance to the accelerator in his explanation of business
cycles. Samuelson in his seminal paper convincingly showed that it is
the interaction between the multiplier and accelerator that gives rise
to cyclical fluctuations in economic activity.

The multiplier alone cannot adequately explain the cyclical and

cumulative nature of the economic fluctuations. An autonomous
increase in the level of investment raises income by a magnified
amount depending upon the value of the multiplier.

This increase in income further induces the increases in investment

through the acceleration effect. The increase in income brings about
increase in aggregate demand for goods and services. To produce more
goods we require more capital goods for which extra investment is
undertaken.
Thus the relationship between investment and income is one of
mutual interaction; investment affects income which in turn affects
investment demand and in this process income and employment
fluctuate in a cyclical manner.

We have shown below in Fig. 27.4 how income and output will
increase by even larger amount when accelerator is combined with the
Keynesian multiplier,
Where ∆Ia = Increase in Autonomous Investment

∆Y = Increase
in Income.
1/ 1 – MPC = Size of Multiplier where MPC = Marginal Propensity to
Consume.

∆ld = Increase in Induced Investment

v = Size of accelerator.

Fluctuations in investment are the main cause of instability in a free

private-enterprise economy. This instability further increases due to
the interaction of the multiplier and accelerator The changes in any
component of aggregate demand produce a multiplier effect whose
magnitude depends upon the marginal propensity to consume.

When consumption, income and output increase under the influence

of multiplier effect, they induce further changes in investment and the
extent of this induced investment in capital goods industries depends
on the capital-output ratio, that is, the interaction between the
multiplier and accelerator without any external shocks can give rise to
the business cycles whose pattern differs depending upon the
magnitudes of the marginal propensity to consume and capital-output
ratio.
The model of interaction between multiplier and accelerator
can be mathematically represented as under:
Yt = Ct + It …(i)
Ct= Ca + c (Yt – 1) …(ii)
It = Ia + v (Y t – 1 – Y t – 2)….(iii)
Where Yt Ct It stand for income, consumption and investment
respectively for a period t, Ca stands for autonomous consumption,
la for autonomous investment, c for marginal propensity to consume
and v for the capital-output ratio or accelerator.
From the above equations it is evident that consumption in a period t
is a function of income of the previous period Yt-1. That is, one period
lag has been assumed for income to determine the consumption of a
period. As regards induced investment in period t, it is taken to be the
function of the change in income in the previous period.
This means that there is two periods gap for changes in income to
determine induced investment. In the equation (iii) above, induced
investment equals v(Y t – 1 – Y t – 2) or v (∆Yt – 1). Substituting equations
(ii) and (iii) in equation (i) we have the following income equation
which states how changes in income are dependent on the values of
marginal propensity to consume (c) and capital-output ratio v (i.e.,
accelerator).
Yt = Ca + c (Yt - 1) + Ia + v (Y t – 1 – Y t – 2) …(iv)
In static equilibrium, the level of income determined will be:
Y = Ca f cY + I
This is due to the fact that in static equilibrium, given the data of the
determining factors-, the equilibrium level of income remains
unchanged, that is, in this case, Yt = Y t – 1 = Y t – 2 = Y t – n so that period
lags have no influence at all and accelerator is reduced to zero.
Thus, in a dynamic state when autonomous investment changes, the
equation (iv) describes the path which a disequilibrium system follows
to reach either a final equilibrium state or moves away from it. But
whether the economy moves towards a new equilibrium or deviates
away from it depends on the values of marginal propensity to consume
(c) and capital-output ratio v (i.e., accelerator).
By taking different combinations of the values of marginal propensity
to consume (c) and capital-output ratio (v), Samuelson has described
different paths which the economy will follow. The various
combinations of the values of marginal propensity to consume and
capital-output ratio (which respectively determine the magnitudes of
multiplier and accelerator) are shown in Fig. 27.5.

The four paths or patterns of

movements which the economic activity (as measured by gross
national product or income) can have depending upon various
combinations of the values of marginal propensity to consume (c) and
capital-output ratio (v) are depicted in Fig. 27.6.
 When the combinations of the value of
marginal propensity to consume (c) and capital-output ratio (v) lie
within the region marked A, with a change in autonomous investment,
the gross national product or income moves upward or downward at a
decreasing rate and finally reaches a new equilibrium as is shown in
panel a) of Fig. 27.6.
If the values of c and v are such that they lie within the region B, the
change in autonomous investment or autonomous consumption will
generate fluctuations in income which follow the pattern of a series of
damped cycles whose amplitudes go on declining until the cycles
disappear as is shown in panel (b) of Fig. 27.6.

The region C in Fig. 27.6 represents the combinations of c and v which

are relatively high as compared to the region B and determine such
values of multiplier and accelerator that bring about explosive cycles,
that is, the fluctuations of income with successively greater and greater
amplitude.

The situation is depicted in panel (c) of Fig. 27.6 which shows that the
system tends to explode and diverges greatly from the equilibrium
level. The region D provides the combinations of c and v which cause
income to move upward or downward at an increasing rate which has
somehow to be restrained if the cyclical movements are to occur.

This is depicted in panel (d) of Fig. 27.6. Like the values of multiplier
and accelerator of region C, their values in region D cause the system
to explode and diverge from the equilibrium state by an increasing
amount.

In a special case when values of C and V (and therefore the

magnitudes of multiplier and accelerator) lie in region E, they produce
fluctuations in income of constant amplitude as is shown in panel (e)
of Fig. 27.6.

It follows from above that region A and B are alike, they after a
disturbance caused by a change in autonomous investment or
consumption finally bring about stable equilibrium in the system. On
the other hand, the values of c and v and therefore the magnitudes of
multiplier and accelerator of region C and D resemble each other but
are such that they cause great instability in the system as both of these
values cause successively greater divergence from the equilibrium
level and the system tends to explode. The case of region E lies in
between the two as the combinations of values of c and v in it are such
that cause cyclical movements of income which neither move toward
nor away from the equilibrium.

It is worth noting that all the above five cases do not give rise to
cyclical fluctuations or business cycles. It is only combinations of c and
v lying in regions B, C and E that produce business cycles. The values
of accelerator and multiplier in the region A are such that with a
disturbance caused by a change in autonomous investment or
autonomous consumption, the economic activity (as measured by the
level of income or Gross National Product) moves smoothly from an
initial equilibrium to a new equilibrium with no cyclical fluctuations or
oscillations.

On the other hand, the values of c and v (and therefore of multiplier

and accelerator) of the region B produce cyclical fluctuations which
are of the type of damped oscillations that tend to disappear over time,
that is, the amplitude of the cycles shrinks to zero over a period of
time. However, this contradicts the historical experience which reveals
that there is no tendency for the cyclical movements to disappear or
die out over time.

However, it is worth noting that the case B explains the impact of a

single disturbance on income and employment. For example, the
effect of a onetime increase in autonomous investment goes on
diminishing over time if no other disturbance takes place.

However, in reality, further disturbances such as technological

advances, innovations, natural disasters and man-made disasters such
as security scam in India in 1991-92 do take place quite frequently and
at random intervals and in a way they provide shocks to the system.

Thus, the values of c and v of region B can generate cyclical

fluctuations over time without dying out if the above-mentioned
disturbances are occurring frequently at random. This results in
business cycles whose duration and amplitude are quite irregular and
not uniform.

As a matter of fact, the business cycles in the real world also reveal
such irregular pattern. To sum up, “what otherwise shows up as a
tendency for the cycle to disappear in case B may be converted into
unending sequence of cycles by the addition of randomly disturbed
erratic shock system.”

In case of the values of multiplier and accelerator falling within the

region C, though they generate continued oscillations, the cycles
produced by them tend to become ‘explosive’ (i.e. their amplitude
tends to increase greatly). But they are not consistent with the real
world situation where oscillations do not become explosive.

However, the values of multiplier and accelerator falling within region

C can be made consistent with the actual world situation by
incorporating in the analysis the so called buffers. Buffers are the
factors which impose upper limit or ceiling on the expansion of
income and output on the one hand or impose a lower limit or floor on
the contraction of output and income on the other.

With the inclusion of these buffers the otherwise explosive upward

and downward fluctuations arising out of values of multiplier (or
MPC) and accelerator (or capital-output ratio) of the region C can
become limited cyclical fluctuations, characteristic of the real world
situation.

What has been said about case C above also applies to region D where
the values of multiplier and accelerator are such that give rise to
directly explosive upward or downward movement which can be
restrained by the factors determining the ceiling and floor.

However, the adequate explanation of the business cycles in this case

would require the reasons why the system starts moving in the reverse
direction, say, after striking the ceiling. Hicks in his famous theory of
the business cycles provide the reasons which cause movement of the
system in the reverse direction after it hits the ceiling or the floor as
the case may be. Hick’s theory of business cycles will be explained
below at length.

Lastly, the case E represents a situation where the business cycles

neither try to disappear, nor try to explode, they go on continually
with constant amplitude. This however contradicts the real world
situation and is quite impossible. This is because in the real world
situation, business cycles differ a good deal in amplitude and duration.

Summing Up:
We have explained the interaction of multiplier and accelerator in case
of various values of marginal propensity to consume (c) and capital-
output ratio (v). On the basis of the interaction of the multiplier and
accelerator the two categories of business cycle theories have been put
forward.
One category of these business cycle theories assumes the values of
multiplier and accelerator which generate explosive cycles. For
example, Hicks’ theory of business cycles falls in this category. On the
other hand, Hansen has propounded a business cycle theory based on
the interaction of multiplier with a weak accelerator which produces
only damped oscillations.

Further, as indicated above, the interaction theories have been

modified either by incorporating in the analysis erratic shocks or
random disturbances or by including so called buffers which check the
upward movement of income and output by imposing ceiling of
expansion and checking a downward movement by imposing a floor
on the contraction of output.

One of the famous theories of business cycles based on the interaction

of multiplier and accelerator which also incorporate buffers in his
analysis of fluctuations is that put forward by the noted English
economist J.R. Hicks. We discuss below his theory of business cycles
in detail.
A Numerical Example of the Interaction of the Multiplier
and Accelerator:
How the interaction between the multiplier and accelerator gives rise
to the cyclical movements in economic activity (as measured by
income or output) will become clear from Table 27.1. In formulating
this table we have assumed that marginal propensity to consume (c)
being equal to 2/3 or 0.66 and capital-output ratio (v) or accelerator
being equal to 2. Further, one period time lag has been assumed which
implies that an increase in income in a period induces the increase in
consumption in the next period.

It is assumed that initially in period t + 1, autonomous investment is of

Rs. 10 crores. In period t + 3, with autonomous investment being
maintained constant at Rs. 10 crores, the deviation of total income in
the period t + 3 as compared to the base period will be equal to 10 +
20 + 26.6 = Rs. 56.6 crores.

Similarly, the changes in induced consumption and induced

investment and hence in income brought about by the initial increase
in autonomous investment of Rs. 10 crores which is maintained
throughout, can be found out. It will be seen from column 5 of the
Table 27.1 that there are large fluctuations in income.
Under the influence of the interaction between the multiplier and
accelerator, the income increases up to the period t + 6. In other
words, period up to t + 6 represents the expansion phase or upswing
of the business cycle. Therefore, the period t + 6 is the upper turning
point of the business cycle beyond which the contraction phase or
downswing of the business cycle begins. It will be further observed
that beyond the period t + 13, income again starts rising that is,
recovery from the depression begins.

Thus, t + 13 represents the lower turning point of the business cycle.

In this way we see that the interaction between the multiplier and
accelerator can give rise to the cyclical movements of the economic
activity and its various phases.

It is worth mentioning that we have taken particular values of

marginal propensity to consume (which determine the size of the
multiplier) and capital-output ratio (which determines the size of the
accelerator). The other values of multiplier and accelerator that have
been explained above would give rise to the different patterns of
fluctuations

Trade Cycle: 4 Phases of a Trade

Cycle | Explained
by Smriti Chand Microeconomics

Four phases of a trade cycle are: 1. Prosperity, 2. Recession, 3.

Depression, 4. Recovery Phase!

1. Prosperity phase — expansion or the upswing.

2. Recessionary phase — a turn from prosperity to depression (or

upper turning point).

3. Depressionary phase — contraction or downswing.

4. Revival or recovery phase — the turn from depression to prosperity
(or lower turning point).

The above four phases of a trade cycle are shown in Fig. 2. These
phases are recurrent and follow a regular sequence.

This means that when prosperity ends, recession starts; depression

follows recession; recovery follows depression; prosperity comes after
recovery and in turn gives way to recession. Thus, each phase always
appears when the immediately preceding phase has run its course. It
should be remembered that no phase has any definite periodicity or
time interval.

1. Prosperity:
Haberler defines prosperity as “a state of affairs in which the real
income consumed, real income produced and level of employment are
high or rising and there are no idle resources or unemployed workers
or very few of either.”

As Haberler points out, the characteristic features of prosperity are (i)

a high level of output and trade, (ii) a high level of effective demand;
(iii) a high level of employment and income; (iv) a high marginal
efficiency of capital; (v) a price inflation; (vi) a rising structure of
interest rate; (vii) a large expansion of bank credit; (viii) overall
business optimism, and (ix) tendency of the economy to operate at
almost full capacity along its production possibility frontier.

The prosperity phase comes to an end when the forces favouring

expansion become progressively weak. Bottlenecks begin to appear at
the peak of prosperity. In fact, the profit-inflation and over-optimism
which increase the tempo carry with them the seeds of self-
destruction.

In view of high profits and business optimism, entrepreneurs invest

more and expand further. But scarcity of resources, particularly, the
shortage of raw materials and labour causes bottlenecks and business
calculations go wrong. Hence entrepreneurs become over-cautious
and the peak of prosperity and their over-optimism pave the way to
over-pessimism. Thus, prosperity digs its own grave.

2. Recession:
When prosperity ends, recession begins. Recession relates to a turning
point rather than a phase. It lasts relatively for a shorter period of
time. It marks the point at which the forces that make for contraction
finally win over the forces of expansion. Liquidation in the stock
market, repayment of bank loans and the decline of prices are its
outward symptoms.

The stock market is the first to experience the downfall as there will be
sudden and violent changes in the prevailing atmosphere. During a
recession, businessmen lose confidence. Everyone feels pessimistic
about the future profitability of investment. Hence, investment will be
drastically curtailed and production of capital goods industries will
fall.

During the recessionary phase, the banking system and the people in
general try to attain greater liquidity. Therefore, credit sharply
contracts. Business expansion stops, orders are cancelled and workers
are laid off. There is a general drive to contract the scale of operations,
leading to increase in unemployment; thus, income throughout the
economy falls. Reduced income causes a decrease in aggregate
expenditure and thus, the general demand falls, in turn, prices, profit
and business decline.

3. Depression:
During a depression, the most deplorable conditions prevail in the
economy. Real income consumed, real income produced and the rate
of employment fall or reach subnormal levels due to idle resources and
capacity.

As Haberler points out, the characteristic features of a

depression are the reverse of prosperity:
(i) Shrinkage in the volume of output, trade and transactions;

(ii) Rise in the level of unemployment;

(iii) Price deflation;

(iv) Fall in the aggregate income of the community (especially wages

and profits);

(v) Fall in the structure of interest rates;

(vi) Curtailment in consumption expenditure and reduction in the
level of effective demand;

(vii) Collapse of the marginal efficiency of capital and decline in the

investment demand function;

(viii) Contraction of bank credit, etc.

In short, a depressionary period is characterised by an overall

curtailment of aggregate economic activity and its bottom. Thus,
depression and prosperity differ in degree rather than in kind. In the
former economic activity is at its trough, while in the latter, economic
activity is at its peak.

However, a depression cannot be regarded as a permanent feature of

an economy. In fact, the very forces which cause the depression are
themselves self- defeating. For, during a depression, businessmen
postpone replacement of their plant and machinery and consumers
postpone the purchase of durable goods. Hence the need for
replacement and the purchase of durable goods gradually accumulate.

Hence, after a period of time, there will be a moderate increase in the

purchase of durable goods on the consumer’s part and replacement of
plant and machinery on the part of producers. This will call for an
increase in production, in turn leading to an increase in employment,
income and aggregate effective demand. Banks will be anxious to
expand credit by reducing the rate of interest. Gradually, pessimism
vanishes and optimism develops and economic activity once again
gathers momentum. Thus, a stage of recovery sets in.
4. Recovery Phase:
The revival or recovery phase refers to the lower turning point at
which an economy undergoes change from depression to prosperity.
With an improvement in demand for capital goods, recovery sets in.
When the demand for consumption goods rises or when the capital
stock increases, the demand for capital goods will rise and new
investment will be induced.

Such induced investment will cause a rise in employment and income.

The increased income in turn will lead to a rise in consumption which
will push up the demand further which in turn leads to a rise in prices,
profits, further investment, employment and income.

The increased income in turns will lead to a rise in consumption which

will push up the demand further which in turns leads to a rise in
prices, profits, further investment, employment and income. Once the
expansionary movement starts, this is how it gathers momentum.
During the revival period, level of employment output and income
slowly and steadily improve. Stock markets become more sensitive
during this period.

A bullish atmosphere will prevail on the stock exchanges. An increase

in stock prices favours expansion and hasten revival. The expectations
of the entrepreneurs improve and business optimism leads to the
stimulation of development investment.

The wave of recovery, once initiated, begins to feed upon itself. Thus,
during a recessionary period, the expansionary process will be self-
reinforcing and if it is continued for some time, the economy will find
itself in a position of rising level of income, output and employment.
When this happens, revival slowly emerges into prosperity and the
cycle repeats itself.

A business cycle is a complex phenomenon which embraces the entire

economic system. It can scarcely be traced to any single cause.
Normally a business cycle is caused and conditioned by a number of
factors, both exogenous and endogenous.

Various theories have been expounded by different economists to

explain the cause of a trade cycle, the symptoms of which are
alternating periods of prosperity and depression. Different
explanations stressing one or a few factors at a time have been
advanced by economists.

The Hicks’ Theory of Business Cycles

(Explained With Diagrams)
by Supriya Guru Macro Economics

The Hicks’ Theory of Business Cycles (Explained With

Diagrams)!
Hicks put forward a complete theory of business cycles based on the
interaction between the multiplier and accelerator by choosing certain
values of marginal propensity to consume (c) and capital-output ratio
(v) which he thinks are representative of the real world situation.

According to Hicks, the values of marginal propensity to consume and

capital-out- put ratio fall in either region C or D of Fig. 27.5.In case
values of these parameters lie in the region C, they produce cyclical
movements (i.e., oscillations) whose amplitude increases over time
and if they fall in region D they produce an explosive upward
movement of income or output without oscillations.
To explain business cycles of the real world which do not tend to
explode, Hicks has incorporated in his analysis the role of buffers. On
the one hand, he introduces output ceiling when all the given
resources are fully employed and prevent income and output to go
beyond it, and, on the other hand, he visualises a floor or the lower
limit below which income and output cannot go because some
autonomous investment is always taking place.

Another important feature of

Hicks’ theory is that business cycles in the economy occur in the
background of economic growth (i.e., the rising trend of real income of
output over time). In other words, cyclical fluctuations in real output
of goods and services take place above and below this rising line of
trend or growth of income and output.
Thus in his theory he explains business cycles along with an
equilibrium rate of growth. In Hicks’s theory of long-run equilibrium
growth that is determined by rate of increase of autonomous
investment over time and, therefore, long-run equilibrium growth of
income is determined by the autonomous investment and the
magnitudes of multiplier and accelerator.

Hicks assume that autonomous investment, depending as it is on

technological progress, innovations and population growth, grows at a
constant rate. With further assumptions of stable multiplier and
accelerator, equilibrium income will grow at the same rate as
autonomous investment. It follows therefore that the failure of actual
output to increase along the equilibrium growth path, sometimes to
move above it and sometimes to move below it determines the
business cycles.

Hick’s Theory of business cycles has been explained with the help of
the Fig. 27.7. In this figure, AA line represents autonomous
investment. Autonomous investment is that investment which is not
induced by changes in income and is made by entrepreneur as a result
of technological progress or innovations or population growth.

Hicks assume that autonomous investment grows annually at a

constant rate given by the slope of the line AA. Given the marginal
propensity to consume, the simple multiplier is determined. Then the
magnitude of multiplier and autonomous investment together
determine the equilibrium path of income shown by the line LL.

Hicks calls this the floor line as this sets the lower limits below which
income (output) cannot fall because of a given rate of growth of
autonomous investment and the given size of the multiplier. But
induced investment has not yet been taken into account. If national
income grows from one year to the next, as it would move along the
line LL, there is some amount of induced investment via accelerator.

The line EE shows the equilibrium growth path of national income

determined by autonomous investment and the combined effect of the
multiplier and accelerator. FF is the full employment ceiling. It is a
line that shows the maximum national output at any period of time
when all the available resources of the economy are fully employed.

Given the constant growth of autonomous investment, the magnitude

of multiplier and the induced investment determined by the
accelerator, the economy will be moving along the equilibrium growth
path line EE. Thus starting from point E, the economy will be in
equilibrium moving along the path EE determined by the combined
effect of multiplier and accelerator and the growing level of the
autonomous investment.

Suppose when the economy reaches point P0 along the path EE, there
is an external shock—say an outburst of investment due to certain
innovation or jump in governmental investment. When the economy
experiences such an outburst of autonomous investment it pushes the
economy above the equilibrium growth path EE after point P0.
The rise in autonomous investment due to external shock causes
national income to increase at a greater rate than that shown by the
slope of EE. This greater increase in national income will cause further
increase in induced investment through acceleration effect.

This increase in induced investment causes national income to

increase by a magnified amount through multiplier. So under the
combined effect of multiplier and accelerator, national income or
output will rapidly expand along the path from P0 to P1.
Movement from P0 to P1 represents the upswing or expansion phase of
the business cycle. But this expansion must stop at P1 because this is
the full employment output ceiling. The limited human and material
resources of the economy do not permit a greater expansion of
national income than shown by the ceiling line CC.
Therefore, when point P1 is reached the rapid growth of national
income must come to an end. Prof. Hicks assumes that the full
employment ceiling grows at the same rate as autonomous
investment. Therefore, CC slopes gently unlike the very steep slope of
the line from P0 to P1. When point P1 is reached the economy must
grow at the same rate as the usual growth in autonomous investment.
For a short time the economy may crawl along the full employment
ceiling CC. But because national income has ceased to increase at the
rapid rate, the induced investment via accelerator falls off to the level
consistent with the modest rate of growth determined by the constant
rate of growth of autonomous investment.

But the economy cannot crawl along its full employment ceiling for a
long time. The sharp decline in growth of income and consumption
when the economy strikes the ceiling causes a sharp decline in induced
investment.

Thus with the sharp decline in induced investment when national

income and hence consumption ceases to increase rapidly, the
contraction in the level of the income and business actually must
begin. Once the downswing starts, the accelerator works in the reverse
direction.

That is, since the change in income is now negative the inducement to
invest must begin to decrease. Thus there is slackening off at point
P2and national income starts moving toward equilibrium growth path
EE. This movement from P2 downward therefore represents the
downswing or contraction phase of the business cycle.
In this downswing investment falls off rapidly and therefore multiplier
works in the reverse direction. The fall in national income and output
resulting from the sharp fall in induced investment will not stop on
touching the level EE but will go further down. The economy must
consequently move all the way down from point P2 to point Q1. But at
point Q1 the floor has been reached.
Whereas the upswing was limited by the output ceiling set by the full
employment of available resources, in the downswing the national
income cannot fall below the level of output represented by the floor.
This is because the floor level is determined by simple multiplier and
autonomous investment growing at constant rate, while during the
downswing after a point accelerator ceases to operate.
It may be noted that during downswing the limit to negative
investment (disinvestment) and therefore the limit to the contraction
of output is set by the depreciation of capital stock. There is no way for
the businessmen to make disinvestment at a desired rate higher than
the depreciation.

When during downswing such conditions arise, accelerator becomes

inoperative. After hitting the floor the economy may for some time
crawl along the floor through the path Q1 to Q2. In doing so, there is
some growth in the level of national income.
This rate of growth as before induces investment and both the
multiplier and accelerator come into operation and the economy will
move towards Q3 and the full employment ceiling CC. This is how the
upswing of cyclical movement again starts.
Critical Appraisal:
But Hicks’ theory of trade cycles is not without critics. A major
weakness of Hicks’ theory, according to Kaldor, is that it is based on
the principle of acceleration in its rigid form. If the rigid form of
acceleration principle is not valid, then the interaction of the
multiplier and accelerator which is the crucial concept of the Hicksian
theory of trade cycles is not valid.

Thus Duesenberry writes, “the basic concept of multiplier-accelerator

interaction is important one but we cannot really accept to explain
observed cycles by a mechanical application of that concept” and,
according to him, Hicks in his business cycle theory actually tries to do
so.

It may be noted that Kaldor puts forward a theory of business cycles

which does not make use of the rigid or strict form of the acceleration
principle. In his trade cycle theory Kaldor provides for investment
being directly related to the level of income and inversely related to
the stock of capital. Thus Kaldor’s approach which is also supported by
Goodwin abandons the rigid and inflexible relation of investment to
changes in income (output) as implied by the rigid acceleration
principle [i.e., It = Ia+ v (Y t – 1 – Y t – 2)] and instead has used the
following form of the investment function
It = Ia + gVt – 1 – jK1
Where It stands for investment in period t, la for autonomous
investment, Y t – 1, for income in the previous period, Kt for the stock of
capital, and g and j are constants. A look at the above investment
function used by Kaldor will reveal that investment is directly related
to the income and inversely related to the stock of capital. Thus in
Kaldor- Goodwin investment function, the increase in income, the
capital stock remaining constant, will cause an increase in investment
which will enlarge the stock of capital.
On the other hand, according to this new investment function, if
capital stock increases, output or income remaining constant,
investment will fall due to its being negatively related to capital stock.
Thus Kaldor- Goodwin approach to investment while gives up the rigid
acceleration principle but still retains the basic idea of investment
related to income because in this approach investment will cause the
capital stock to expand towards the stock of capital as desired for the
production of output of the preceding year.

However, despite the shortcomings of Hicks’ theory of business cycles,

this is a valuable contribution to the theory of business cycles. Even its
critics such as Kaldor though indicating some of its weaknesses
acknowledge its merit. Thus Kaldor writes that Hicks’s theory of trade
cycles provides us many brilliant and original pieces of analysis”.
Duesenberry considers it as an “ingenious piece of work”