Jevons Sunspot Theory of the Trade Cycle - Coursework Example

Jevons’s sunspot theory of the trade cycle of the of the Contents Contents 2 Introduction 3 Life and Work of Jevons4 Sunspots and Business Cycles 5 Validity of the theory 8 Sunspot Equilibrium 11 Conclusion 12 References 13 Introduction Works of William Stanley Jevons on business cycles can be traced to his early work of “Commercial fluctuations”. Jevons was one of the earliest economists who had first showed inclination towards breaking away from the traditional theories and applying statistical data on economic activities to form a generalized account of the business cycle. The theory developed by Jevons had always been an object of satire among his colleagues. Nevertheless, Jevons had gained recognition by 1870s and his contributions to mainstream economics were formidable (Morgan, 1992). Some of his notable contributions were works on diminishing marginal utility, theory of rational choice based upon marginal utility, equimarginal rule on utility gains from exchange and so on. He had also formulated the theory on index numbers, which is highly relevant even today. His early statistical works had included seasonal fluctuations of money market. The initial hypothesis that was proposed by Jevons stated that the sunspot cycle created weather cycled, which in turn led to harvest cycle; followed by the price cycle. Jevons works on business cycle based on sunspots was developed in 1860s, but was unpublished, which Jevons had called “Statistical Atlas”. Two main results were obtained from this work in 1862. The first one was in the form of two statistical diagrams, one of which was related to the long-term effect of changes of wheat price on the economic activity. The second result was also based on similar lines, but it dealt with quarterly and seasonal fluctuations. The core point of Jevons theory was based on the fact that business cycles are influenced by meteorological fluctuations (Mosselmans, 2013). The purpose of this paper is to discuss the Sunspot theory of trade cycle that had been developed by Jevons. Validity of the theory and its current applications, if any, are to be studied in details. Life and Work of Jevons William Stanley Jevons was one of the most significant figures in the theory of utility and mathematical techniques. Born in 1835 in Liverpool to Thomas Jevons and Mary Anne Jevons, he had made a large number of substantial contributions to economics in his entire lifetime. He had died in 1882 by drowning. He is mostly praised for his works in the field of microeconomics as these had greatly enriched the neo-classical theories. Though he has been more resourceful in his contributions made to the microeconomic theories, yet it was the empirical attempts to establish macroeconomic relationships through econometric methods that he had mostly concentrated upon. He had spent a considerable time researching on causes of the trade cycle in economics, which led to fluctuations in prices. As human behaviour of utility maximization can no way be related to the cyclical behaviour of variables in economics, it had occurred to him that there must be some inherent cause in nature that leads to fluctuations in prices (Economic Theories, 2013). This idea had first led him to believe that it must be the weather conditions that had led to fluctuations in prices of the agricultural produce. As sun is the most important aspect to influence the weather, Jevons considered the idea that fluctuation in the solar activities is a statistically significant factor that entails the same in prices of agricultural products. This idea had made him develop the sunspots theory of trade cycle, which is discussed in the following section (Pressman, 2002). Sunspots and Business Cycles Jevons had found out that business cycles are influenced by meteorological ones in two ways. Firstly, Jevons was of the belief that commercial fluctuations were influenced significantly by meteorological fluctuations and that similar empirical methods could be applied for both the techniques. Secondly, based on this understanding, he had developed the theory of business cycles on meteorological fluctuations; this was termed as the sunspot theory. In the paper called “Solar Period and the Price of the Corn”, which was published in 1875, Jevons had first attempted to examine whether there exists a statistically significant relationship between sunspot period and agricultural product prices. For testing his hypothesis, he had used the data from 1249 to 1400 for agricultural products of England, which were supposed to be entirely determined by local weather conditions. The results from this study were dissatisfactory; yet, Jevons could detect an influence of sunspots on agricultural harvests. One of the explanations for this dissatisfactory results offered by Jevons himself was that there are probably other factors influencing the price of grains, besides the solar activity. This also implies that economic, social and political factors overshadowed effect of the sun on prices of agricultural produce. This according to Jevons had diluted the impact of sun on the harvest cycle and henceforth, on the price cycles. Jevons had also argued that fluctuations in the economy were “mental” in nature. According to Jevons, mood swings of farmers and economic agents could be linked to external factors and the influence of sunspot on mood fluctuations is formidable. Although Jevons was dissatisfied with the results that he had obtained from Europe, a similar analysis done by him using data from India had seemed to confirm his initial hypothesis. Jevons had found that in India, there was a decennial pattern in the harvest during times of abundance or scarcity. He established that when the sunspots were minimum, magnitude of production of the crops were maximum and as a result of inflated supply, price of the crops were relatively lower than in periods when the sunspot was maximum. As a result of cheap prices of food, the population could save more. There would be surplus income of the wage earners and they could spend this income on other produce of the economy, say clothing. This process will stimulate the whole economy (Mosselmans, 2013). When this initial analysis had failed, Jevons tried to establish his hypothesis by using data from commercial credit market, instead of agriculture. This time he had considered the cycles of commercial credit in place of agricultural prices. In 1978, he had published another work that was titled as “Periodicity of Commercial Crisis and its Physical Explanations”. The major purpose of this work was to prove a decennial pattern in the trade activities from 1700 to 1800. In this work, he had proved that mental state of the bankers and merchants was influenced by accomplishment of harvest; this led him to discover the relationship between credit cycle and sunspot theory. Based on these observations, analysis of dates of financial crisis in 19th century revealed to have an average cycle length of 10.8 years, which was slightly less than the sunspot period of 11.1 years. Jevons explained that when the sunspot theory was considered along with the credit cycle (this was influenced by psychological phenomenon), this produced a cycle of average length. In this way, Jevons had finally linked the sunspot cycle to harvest cycle and argued that this helped to maintain the natural cyclical economic motion. This very idea of combination of endogenous and exogenous factors had formed an important element in econometric business cycle models in 1930s. In the later works done by Jevons related to the same topic, two main changes were made by him. On studying the commercial crises of Europe, he considered the new average cycle length to be around 10.3 to 10.46 years. Similarly, he had also recalculated length of the sunspot cycle to be 10.45 years. This made him believe that there was a strong cause and effect relationship between the two cycles that he wanted to establish since the beginning. Despite the strong coincidence between the two cycles, Jevons had not been able to overlook the inherent problem in his theory. Though he could recognize the causal relationship between the two, he still could not explain how sunspots were causing the commercial cycle. The situation was more complicated because he could not establish the relationship between agricultural prices and solar activity. In order to solve this crisis, Jevons had used the example of India. He stated that in tropical or sub-tropical countries, affect of the sun was much stronger than other disturbing factors and this was evident in prices of products. Nevertheless, in industrialized countries, like, Britain, this effect was weaker. Jevons had theorized that when agricultural production was low, the price of agricultural products were consequently high due to which wage earning peasants did not have sufficient money to buy industrial imports from Britain; these imports mainly comprised of cotton textiles. This in turn indirectly affected the British cotton textiles industry and consequently, the export volume of Britain fell. Such chain of events had inevitably produced a commercial cycle in Britain. Jevons did not find his sunspot theory of trade cycle to be contradictory to the other theories relating to business cycles, like, bank failure. He simply provided a new angle of thinking to the already existing literature (Mosselmans, 2013). This basic version of Jevons theory was highly criticized by his peers ever since its formulation. However, works of Peart (1991) had suggested that the theory that was proposed by Jevons could be interpreted beyond that of a mere meteorological phenomenon in economics. He had believed that Jevons’ particular attention to the mood swings had quite high relevance. Peart was of the view that harvest failures automatically led to fluctuations in price and in turn influences moods of the economic agents. Due to fluctuations in mood of the economic agents, investment decisions were often altered and if the investment decisions were wrong, then impacts on the harvest cycle was multiplied. Most of the contemporaries of Jevons were suspicious regarding the domain and methodology of the theory. Mostly, it can be concluded that ideas developed by Jevons were much ahead of 19th century. During this period, most economists had formulated their ideas based from existing facts, which were true based on their own personal knowledge; whereas, Jevons had developed his ideas based on an inductive process, which was based on statistical evidence. The concept of periodic economic cycles in the 19th century was an idea much ahead of its times. Other economists like, Marx and Juglar, were aware of the economic cycles, but were too not convinced with explanations of Jevons. As sun was an entity outside the economic origin, economists did not believe that economic cycles can be a plausible explanation for business cycles. Validity of the theory As far as trade cycle is concerned, there are around ten theories that had been developed till date; and sunspot theory that was developed by Jevons was one of the earliest ones. According to economic literature that has been established till date, this theory is obsolete. Though once useful in explaining the trade cycle in 1930s, this theory has apparently lost its validity in contemporary times. During the period of 19th century, the theory was highly criticized and belittled; until in 1930s, when Dr. Carlos Garcia-Mata and Dr. Felix I. Shaffner published their research in the Quarterly Journal of Economics in 1934. Their research had confirmed persistence of a very high degree of correlation between business cycle and solar activity. Their study could clearly identify the presence of a statistically significant relationship between the 11 year solar cycle and total production in the economy, excluding production of agriculture, considering the time period of 1875-1930. The only exceptions were only found during 1903-04 and 1913-14; this was due to presence of high amount of volcanic dust blown into the atmosphere that had impacted production. This study provided a much required empirical backing to the initial theory that was proposed by Jevons. Two main advancements were made by researchers regarding the sunspot theory (Williams, 1984). Firstly, mass psychology was affected by mass optimism or pessimism depending on variations in ultraviolet rays emitted by the sun and these variations could be directly related to sunspots. Secondly, the electromagnetic field of earth is altered by changes in the solar activity and in turn affects the electric field of humans. This change affects the optimism. Economist, H.L. Moore, was also one of the advocates of sunspots theory and had observed trade cycle to be a natural phenomenon. He propagated the view that meteorological impacts are transmitted through agriculture to other sectors of the economy. The economists who supported this analysis strongly believed that Great Depression of 1930s could be traced to climatic factors, particularly in the developing countries. As the developing countries like, India, were in trade relations with developed countries like, Britain, the depression had eventually found its way in the developed countries. Though a few economists and researchers could find relevance of the sunspot theory, majority of the other economists did not. The main criticisms against the sunspot theory came from three major grounds: Firstly, other economists did not find a plausible explanation for the climatic changes with the trade cycle. They were strictly of the view that weather conditions including the sun did not form any part in the economic domain and therefore, plausibility of this theory was questioned. Secondly, according to majority of the economists, there was no element of scientific nature in the theory proposed by Jevons. Thirdly, it was observed that there are various phases in the trade cycle and the sunspot theory could hardly explain these phases. Finally, meteorological factors cannot solely explain variations in the trade cycle and other factors, like, political, economic and social, were given more preference over the meteorological ones (Jain & Khanna, 2008). It was argued that Jevons had developed his views of inductive reasoning on evidences that were unsubstantiated. Critics had pointed out that Jevons theory of sunspots could at best be termed as speculation and not a proper scientific theory, besides an ineffective conclusion of causality through correlation (Ifrim & Mursa, n.d.). It is an established economic convention that correlation between two variables does not necessarily imply a causal relationship between the two. Stephen Stigler (1982) had argued that though Jevons had done a commendable job in manipulating data and extracting information from them, yet his works in relation to the trade cycles was nothing more than an anomaly. According to Barbara McLennan (1972), the works of Jevons had only considered fluctuations in the statistical data, without considering the relevant theories. She expressed the view that theoretical explanation of the data was meagre compared to detailed treatment of the data. According to the view of Mark Blaug (1962), Jevons “failed to show theoretically how this [sunspot] or any other exogenous disturbance is capable of generating endogenous fluctuations”. Economists like, Schumpeter, have also been critical about the approach of Jevons to explain fluctuations in trade cycle (Peart, 1996). Sunspot Equilibrium Though the theory of Jevons has been long rejected, yet the concept of sunspot equilibrium has gained importance in economics. This concept was later developed by Cass and Shell (1983), who had defined sunspot equilibrium as a part of general equilibrium. The basic concept of sunspot equilibrium was that during certain times, market outcome and allocation of resources are affected in a way that is not related to fundamentals of economics. The outcome can depend on a random variable that is extrinsic. This implies that random influence is able to affect outcomes because people perceive that they can affect the outcome. The development of this idea can be traced to Jevons’ sunspot theory. Nevertheless, in Jevons’ work, uncertainty regarding the sunspots was treated as an intrinsic variable as sunspots were assumed to impact the agricultural prices. In modern literature, however, there is no relation of economic activities with solar cycles; but, a non-fundamental variable could affect economic outcomes if that variable can alter expectations of the people (Spear, 2011). The current global economic meltdown of 2008 can be seen as an outcome of sunspot equilibrium. Panic created in financial institutions had deferred them from lending to one another and to their clients. The liquidity crunch faced by financial institutions reinforced the panic and the situation kept on aggravating. The behaviour of the institutions had made consumers panic as well and reduce their spending; this in turn had brought down profits of financial institutions. As a result of this situation, outcome was far divergent from the theory that is proposed by free markets. This can, therefore, be treated as a classic case of sunspot equilibrium. Liberal pessimism and sunspot equilibrium can be treated as drivers of the financial meltdown (Hassett, 2008). Conclusion This paper has discussed in details about the sunspot theory of trade cycle of William Stanley Jevons. Jevons has mostly been remembered for contributions that he had made in the field of microeconomics; yet, he had spent a considerable time in researching on macroeconomic trends. Jevons was mainly of the view that fluctuations in the economic activities can be traced to exogenous and natural factors. Initially, he had a difficulty to prove his hypothesis through use of agricultural data. Then later, he had used the data from commercial credit market to establish his idea. Using that data, he had found a strong correlation between average length of the solar cycle and that of the credit cycle. The basic problem with the theory that was developed by Jevons was that it lacked strong empirical backing. This model was, however, employed in the 19th century to explain the trade cycle theories. Regarding validity of this theory, few researchers like, Carlos Garcia-Mata and Dr. Felix I. Shaffner, have tried to provide empirical verification. The works of Peart had also considered the theory relevant once the variations in moods are considered. Even so, on a broader scale, the theory has been rejected by most economists on account of weak scientific factor in the theory. Others have pointed out that the theory can be considered as a speculation in economics, but not a real theory. The modern day relevance of the theory can be weakly related to development of the concept of sunspot equilibrium by Cass and Shell. The sunspot equilibrium can even explain the financial meltdown of 2008. References Economic Theories. (2013). Jevons Theory of Sunspot Empirical Analysis. Retrieved from http://www.economictheories.org/2008/08/jevons-theory-of-sunspot-empirical.html Hassett, K. A. (2008). Dont Let Sunspots or Headlines Make You Panic. Retrieved from http://www.aei.org/article/economics/financial-services/dont-let-sunspots-or-headlines-make-you-panic/. Ifrim, M. & Mursa, G. (n.d.). S. Jevons, Harvest Fluctuations and Business Cycle. Retrieved from http://www.revagrois.ro/PDF/2009_2_434.pdf. Jain, T. R. & Khanna, O.P. (2008). Macroeconomics Management. New Delhi: FK Publications. Morgan, M. S. (1992). The History of Econometric Ideas. Cambridge: Cambridge University Press. Mosselmans, B. (2013). William Stanley Jevons and the Cutting Edge of Economics. London: Routledge. Peart, S. (1996). The Economics of S. Jevons. Taylor & Francis. Retrieved from http://digamo.free.fr/peart96.pdf. Pressman, S. (2002). Fifty Major Economists. London: Routledge. Spear, S. (2011). The Collected Scientific Work of David Cass, Part 2. Bingley: Emerald Group Publishing. Williams, D. (1984). Financial Astrology. Arizona: American Federation of Astr. Read More