Business Cycle Economic Model Definition

Business Cycle Theory, What Is Business Cycle Economic

Business Cycle Model and Definition

Although fluctuations in business activity and in the level of income and employment had been occurring since the beginning of merchant capitalism and were acknowledged by orthodox theorists, economists made no systematic attempts to analyze either depression or the business cycle until the 1890s. Heterodox theorists, the most important of whom was Marx, had pursued these issues with greater vigor. But Marx's works were largely ignored by orthodox theory. Thus, until the last decade of the nineteenth century, orthodox economic theory consisted of a fairly well developed theoretical microeconomic structure explaining the allocation and distribution of scarce resources, a macroeconomic theory explaining the forces determining the general level of prices, and a loose set of notions concerning economic growth. Prior to 1890, orthodox "work on depressions and cycles had been peripheral and tangential."

One major exception to this generalization is the work of Clement Juglar (1819-1905), who in 1862 published Des crises commerciales et de leur retour periodique en France, en Angleterre et aux Etats-Unis. The second edition of this work, published in 1889, was considerably enlarged with historical and statistical material. Juglar is a spiritual predecessor of W C. Mitchell in that he did not build a deductive theory of the business cycle, but rather collected historical and statistical material that he approached inductively. His main contribution was his statement that the cycle was a result not of forces outside the economic system but of forces within it. He saw the cycle as containing three phases that repeated themselves in continuous order:

The periods of prosperity, crisis, liquidation, although affected by the fortunate or unfortunate accidents in the life of peoples, are not the result of chance events, but arise out of the behavior, the activities, and above all out of the saving habits of the population, and the way they employ the capital and credit available.

Although Juglar's work initiated the study of the business cycle, the modern orthodox macroeconomic analysis of fluctuations is grounded in the writings of a Russian, Mikhail Tugan-Baranowsky (1865-1919). His book Industrial Crises in England was first published in Russian in 1894; German and French editions followed. After reviewing past attempts to explain the business cycle, he pro­nounced them all unsatisfactory. The chief intellectual influences on Tugan-Bara-nowsky were Juglar and Marx, particularly Marx. Tugan-Baranowsky's main contribution to our understanding of the business cycle was his statement of two principles: (1) that the economic fluctuations are inherent in the capitalist system because they are a result of forces within the system, and (2) that the major causes of the business cycle are to be found in the forces determining investment spending. The sources of the Keynesian analysis of income determination, with its emphasis on the inherent instability of capitalism and the role of investment, run from Marx through Tugan-Baranowsky, Juglar, Spiethoff, Schumpeter, Cassel, Robertson, Wicksell, and Fisher on the orthodox side; and from Marx, Veblen, Hobson, Mitchell, and others on the heterodox side.

Some of the mercantilists, the physiocrats, and a host of heterodox econo­mists who followed had suggested earlier that there were forces inherent in capitalism that would bring about depressions. Even mainstream economists' consideration of cycles, such as Jevons's sunspot cycle, were generally disre­garded. After 1900 more serious work was done on business cycles by orthodox theorists, but curiously enough this work existed alongside a continuing funda­mental belief that the long-run equilibrium position of the economy would provide full employment. Thus, we see economists such as Friedrich Hayek (1898-1992) exploring problems of aggregate fluctuation as a coordination failure while maintaining a solid belief in the self-equilibrating properties of the market economy. No one, either heterodox or orthodox, had been able to challenge this belief, because no one had built a theory of income determination to show that equilibrium was possible at less than full employment. When J. M. Keynes in 1936 developed a theory arguing that equilibrium at less than full employment could exist, a new phase of orthodox macroeconomic theory commenced.