This trade theory was presented by the economist W. H. Beveridge. He says… “The common element is found in the simple and well – high universal fact of industrial competition.” Prof. Pigou adds, “What we have to deal with are the waves of pessimism and optimism generated by the nature of human beings and the conditions of modern business life.”

According to this theory the entrepreneurs are so sensitive that they generate cyclical situation simply by their own feelings of optimism or on other hand, pessimism. Whenever the entrepreneurs feel that future business prospects will be bright they would take full advantage of the situation. For example, when entrepreneurs feel that prices will shift upwards in the near future, they will take steps to ensure that their profits are equally increased. Thus, with this optimism in mind, they increase their investment and output level. Hence, income and employment level goes up and the economy expands.

However, this exposition is not well-founded and hence entrepreneurs, being so sensitive quickly lose confidence and feel that prices will generally fall in due time which will leave to them recurring losses. With this feeling of pessimism working around entrepreneur’s wind-up that investment, and income and employment level falls. Hence, prices also fall due to the fall of demand for the goods and services. Losses will take place. Hence, the wave of pessimism generates depression.

In reality it is the economic factors take place first, and only then do entrepreneurs have a tendency towards optimism or pessimism. Therefore, psychologist factors are of secondary importance whereas factors play the key role in the theory of trade cycle. The economic factors are e.g. the price change and changes in employment and investment level etc. This theory has failed throughout the regular recurrence of all the factors phases of a trade cycle.