Business Cycles

Overview

One of the primary questions of macroeconomics and growth theory is why an ecomomy experiences cyclic behaviour. In particular, the oscillation between and boom and bust that often seen in all national economies.

Classical Theory

The Classical Theory - in the classical theory, the supply curve is fixed and independent of price. Changes in aggregate demand will only affect the overall price level, but will have no impact on production and/or consumption. (in accordance with Says Law.)

The classical model was incapable of explaining the business cycle, and was incapable of explaining recessions and depressions.

Schools of Thought

• Schumpeters Creative Destruction - Schumpeter emphasized the disruptive effects of changes in technology on the enomic climate.
• Mal-Investment (Austrian Theory) - the Austrian school believed that the failure of the market to clear was due to govenment influence, in particular on interest rates, which led to mal-investment which would have to be cleared before the economy could resume full productivity.
• Keynesian Theory - John Maynard Keynes focused on the effects of a changing aggregate demand and rejected the notion that such changes will only affect the overall price level.
• Monetarism

Models

• IS-LM : a model describing Keynes view of aggregated demand and its impact on production and income.
• Credit Cylces - credit cycles are often identified as the driver of business cycles, and can be a key component of financial crises.

Forecasting