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Theoretical Explanations for Cycles
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Many theories explain the causes for economic fluctuations illustrated by
the business cycle.
These differing theories appear in almost all economic discussions and are
used to make predictions about the future direction of the economy.
Karl Marx’s theory for fluctuations in
the business cycle stemmed from his
beliefs in class conflict between labor
and capital. Marx believed that an
unplanned economy was created by
capitalists’ overproduction of goods,
which created periods of excess supply.
Any period of excess supply or excess
demand will shift the equilibrium GDP
and cause the economy to fluctuate.
His solution was more government
planning to regulate production.
Austrian economist Joseph Schumpeter
believed that entrepreneurs created
economically destructive technology.
The disorder and chaos that were
created from new technological
innovations were responsible for the
ups and downs of the economy.
John Maynard Keynes believed in a
demand-driven economy and a
business cycle based on spending in
the economy.
He proposed government spending
should equal consumer saving.
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New classical economists believe that
the business cycle is a naturally
occurring phenomenon, and no one
should intervene.
The new classical solution is to let the
“law of the jungle” rule.
Real business cycle theory holds that
the economy is driven by the supply of
real factors.
Follow the chain reaction on the left as
oil prices rise to the end result of
recession. The real business cycle
theory states that these changes in
natural resources and technology are
responsible for fluctuations in the
economy.
Monetarists believe that active control
of the money supply causes the
business cycle to fluctuate. Refer to
the example above. Note that as the
Fed tightens the money supply, the
economy falls into a recession. The
monetarist solution states that the
government should not use monetary
policy to regulate the economy.
There are almost as many theoretical explanations for the business cycle as
there are economic schools of thought.
Economists’ explanations play a crucial role in economic studies and making
predictions about the future of the economy.
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Copyright ã 2006, Thinkwell Corp. All Rights Reserved.
1191.doc –rev 11/07/2006