The next explanation to be examined is known as the over­investment theory. The essence of this theory is that industries producing machinery and other equipment (producers' or capi­tal goods industries) expand faster than consumers' goods in­dustries. The former are not as sensitive as the latter and react more strongly to fluctuations. That is, an increase in demand for capital goods reflecting an increase in demand for consumers' goods sets in motion a production process that is not closely adjusted to demand and may easily over-supply the market. Since many economists hold this theory, in general, it is natural that great variations should exist in the way they work out details. Gottfried von Haberler, in his extensive treatment of the theories of business cycles entitled Prosperity and Depression, classifies the explanations of this type into three groups: Over­investment which appears as a result of monetary and credit changes; over-investment which arises from non-monetary influ­ences such as inventions, discoveries, and the opening of new mar­kets; and over-investment which is caused by changes in the de­mand for consumers' goods—which reacts more slowly but more violently upon capital goods industries. We shall review the gen­eral explanation and each of these modifications briefly. Since all three represent the particular viewpoints of several noted econo­mists we can do no more than mention their names in connection with the discussion.

The monetary explanation of over-investment differs only slightly from the monetary theory of business cycles itself as dis­cussed above. In fact this doctrine differs from that of R. G. Hawtrey primarily in the question of emphasis. The representa­tives of this body of ideas include Frederick A. von Hayek, formerly of Vienna, now of the University of London, Ludwig von Mises (1881- ) the Austrian economist, and Knut Wicksell (1851-1926), the Swedish economist, all of them out­standing in the contemporary period. As in Hawtrey's explana­tion, the interest rate is here believed to be the key to credit ex­pansion and contraction, which in turn controls prices and the demand for goods. When low interest rates set in motion the se­quence of events leading to greater demand and still higher prices, the tendency is for investments in capital equipment to increase, since by the use of machinery expenses are reduced and profit is made larger. The increasing emphasis upon the building of capital goods reduces the consumers' goods available and naturally increases their price. But by the introduction of ma­chinery, production is made more roundabout and less flexible. Consequently when banks can no longer advance more credit to meet the rising costs of consumers' goods the interest rate rises. The result is a complete stoppage in the production of new capi­tal equipment, for the high margin of profit necessary to en­courage production of capital equipment is no longer present. Frequently it is impossible for manufacturers to maintain the long and expensive mass production methods that capital equip­ment makes inevitable. Booms slow down and ultimately turn into recessions. Haberler in describing this process uses the Rus­sian 5 Year Plan as an illustration. When the first 5 Year Plan was introduced it called for unprecedented building of capital equipment.

Consumers' goods were produced at a minimum. If the strain of low consumption had been too great for the Rus­sians, the government might have been forced to abandon its capital equipment program and resort to the quickest and most direct method of meeting consumers' needs. The cause of the crises, without the use of money, would have been the neglect of consumers' goods for producers' goods. The depression would have been increased in severity because of waste in the abandon­ment of the capital goods program. If the condition in Russia had existed in a free exchange economy, the net effect would have been to raise the prices of consumers' goods to extremely high levels. Profits from the production of consumers' goods would have been high and the surplus would have been used to finance the production of more capital equipment. But interest rates would rise and the amount of credit would be curtailed by the simple fact that saving does not keep pace with investment. The hardship of higher interest rates hits the capital goods industries first, for although consumer demand is brisk it does not bear di­rectly upon the heavier industries. If credit could be expanded indefinitely, new borrowing could always keep pace with the de­mands of industry brought on by higher prices. But since credit does have limited expansion, when it is curtailed and eventually contracted, the high price structure which it supported inevitably collapses.

The difference between the monetary and non-monetary over­investment theories of the business cycle lies mainly in the fact that money and credit are paramount in the former and merely passive agents in the latter. Professor Gustav Cassel, the great Swedish economist, is an advocate of the latter explanation of the business cycle, although his explanation of the depression of the 1930 period emphasized the monetary causes. In the early period of the upswing the increase in production is caused by or en­couraged by an increase in saving which goes to increase capital equipment. But near the end of the boom, wages tend to rise, reducing the amount of ready capital which can be used to pur­chase equipment. By this time, however, the huge productive mechanism necessary to turn out such equipment, made possible by investments and credit advanced in the early period of the upswing, is just hitting its full stride. Thus the demand for capital goods, that is equipment, falls, while the production of such equipment rises. It is this shift in the flow of money, from saving to payment of wages, which eventually brings about the crisis and the subsequent depression. The real cause of the depression is an over-estimate of the supply of ready capital, or the amount of savings available to purchase the capital equipment produced.

Now the revival begins not as a result of the more rapid move­ment of consumers' goods, as so many economists contend, but because of increased investment. The principal stimulus to in­vestment is the decrease in production costs such as wages, price of raw materials, lowering of interest rates. Professor Cassel looks upon the fall of the rate of interest as the most powerful influence. Other authorities following this general analysis consider the appearance of new inventions, the opening up of new territories, and the introduction of new business techniques as necessary to encourage new investment.
A further modification of the over-investment theory is that changes in consumers' demand are the real cause of over-invest­ment. One is seldom successful in pigeonholing the ideas of different men on a given subject. To say that J. M. Clark of Columbia University, Thomas N. Carver of Harvard, and A. C. Pigou of Cambridge have done much to formulate this ex­planation of the business cycle would be open to fault. However, they seem to emphasize what has been called the acceleration principle, which implies that the effect of variation in consumers' demand for finished goods increases as it moves backward to the heavier industries which produce unfinished, durable goods. In other words, minor variations in consumers' demand for finished goods may produce violent fluctuations in the demand for capital goods and equipment used in their production. This happens because a small acceleration in demand, if it is to be met, requires an increase in equipment which is expensive and long-lived. Haberler in analyzing this proposition shows by hypo­thetical cases that a 10% increase in demand may lead to a 100% increase in the production of durable equipment. As John M. Clark points out, this condition stimulates the business cycle when the new productive equipment is fed by an expansion of credit. From this point on the description of the business cycle follows the pattern described by those adhering to a monetary explanation of the cycle.

Credit advanced for new capital equip­ment feeds consumer demand which continues to expand. The principle of acceleration causes a new demand for capital equipment. But the necessity of restricting credit and the rising interest rate, or the failure of investment, sooner or later react upon both consumer demand and production of capital equip­ment. Then the principle of acceleration acts in reverse. The decline in consumer demand causes a complete and immediate cessation of production in the capital equipment industries. Since the payments of these industries for raw material and labor contributed largely to consumer demand, their closing further reduces consumer demand. The depression is then inevitable.