Definition: Hicksian Theory of Trade Cycle was proposed by Hicks, who considered Samuelson’s multiplier-accelerator interaction theory and Harrod-Domar growth model in combination to explain his theory of the trade cycle. According to him, the business cycles have historically occurred against the background of economic growth and hence the theory of the trade cycle should link with the growth theory.
Hicksian Theory of Trade Cycle includes the Keynesian concept of saving-investment relation and the multiplier effect, Clarke’s principle of acceleration, Samuelson’s multiplier-accelerator interaction and Harrod-Domar growth model. Thus, these are the main ingredients of the hick’s model.
Hicksian model is based on the following assumptions:
- It is assumed that there is an equilibrium rate of growth in the economy where the realized growth rate (Gr) is equal to the natural growth rate (Gn). The autonomous investment increases at a constant rate, which is always equal to the rate of increase in the voluntary savings. Thus, the rate of autonomous investment and voluntary savings determine the equilibrium growth rate.
- Hicks assume Samuelson-type consumption function, i.e.,
Ct = aYt-1 with one-year lag in consumption. The reasons for such a lag in the consumption are a time lag between the expenditure and income, lag in non-wage income behind the fluctuations in GNP (Gross National Product). The saving function typically becomes the past year’s income function. With a time lag between income and saving-investment relation, the multiplier process will have a less intense (damp) effect on the economic fluctuations.
- It is assumed that the autonomous investment is the function of current output and is undertaken to replace worn out or old capital. The derived investment, in this model, is considered as the function of the change in output. The change in output leads to the derived investment which brings the principle of acceleration into action. It is to be noted that, here the acceleration interacts with the multiplier effect upon income and consumption.
- Hicks specified ‘ceiling and bottom’ for the expansion (upswing) and depression (downswing). The ceiling on upward expansion is imposed by scarcity of employable resources. With regards the limit of the downswing, as such there is no direct limit on contraction. But, however, an indirect limit is imposed by the accelerator principle on the downswing.
The following are the major shortcomings of Hicksian Theory of Trade Cycle:
- Like, other theories of the business cycle, Hicksian theory of trade cycle too, does not provide the reasons for the constant multiplier and the linear consumption function. It is quite obvious that during the phases of contraction and expansion the incomes are redistributed thereby affecting the consumer’s marginal propensity to consume and hence the multiplier.
- It is assumed that multiplier and the acceleration principle remain constant, which is quite skeptical under the dynamic conditions. No empirical studies have provided evidence of constant multiplier and an accelerator.
- The Hicksian theory like some other theories is considered as highly abstract and incapable of explaining the fluctuations in the real life situations.
Despite these bottlenecks, Hicksian theory of trade cycle is considered to be the most sound theory of the trade cycle. It is an up-to-date, most modern and a highly streamlined theory which incorporates all the best attributes of earlier models and scrapped all those which were not proved out in the past.