Distinction Between Business Cycles and Business Fluctuations (C2-C5)

8/12/2019 Distinction Between Business Cycles and Business Fluctuations (C2-C5)

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International Business Conjunctures

Courses 2 -5

I. The Distinction between BusinessCycles and Business Fluctuations


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The distinction between business

cycles and business fluctuations

Main topics:

Business fluctuations (1)

Business cycles (boom and bust) (2)

The Theory of Money (3)

Specific features of a depression (4)


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Business fluctuations (normal, non-

problematic) (1) Society is in continual change (dynamic) and the future is uncertain

in economics uncertainty is the cause of human action (uncertaintyisthe only thing certainconcerning future); human action takes place intime, which is a scarce resource (it must be economized/properly

allocated)

forecasting uncertainty (the business of entrepreneurs) has nouniversal recipe; thus fluctuations are normal; it is a process of trialand error

the final purpose of economic activity (production) is consumption;thus fluctuations are given by the level of consumerssatisfaction

Q&A: What kind of fluctuations will you encounter asentrepreneur if consumer satisfaction is low? What if high?


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problematic) (1)

Fluctuations are induced by changing consumer preferences, changingseasons, change in technology, labor force, natural resources, climatevagariesand natural hazards

time preference change (the degree in which people prefer present tofuture satisfactions)

consumer tastes change (e.g.: people prefer more organic food thanconventional)

some business are profitable only within a season (e.g.: the umbrellassector is high profitable within the rainy season, anti-viral drugs are soldespecially when viroses are frequent, in the cold season etc.)

technology can change the production possibilities (e.g.: a technicalupgraded machinery can improve the efficiency in production)


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problematic) (1)

labor force can change in quantity, quality and location

some natural resources are depleted, others are discovered

climate vagaries can alter crops, force people to use winter tires untilspring etc.

natural hazards (an earthquake can change the quantity of laboravailable and the supply of medical services; a snow storm change thesupply of services for removing snow)

All these determine natural/normal changes in demand andsupply of various economic goods (consumption and capitalgoods); if demand and supply change then prices change

discussion: the error of stabilization(preferences, prices, wealth etc.; stems from the impossibilityto understand and accommodate with given natural conditions; L. v Mises there is in the socialsystem of market society no other means of acquiring wealth and preserving it than successfulservice to consumers)


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problematic) (1) Business fluctuations will always lead to shrinking of some sectors

and expansion of others; it is not correct to name them cycles, butnormal features of economic activity fluctuations do not involve a phenomenon of generalbust and general

depression, but sectorial ones; In the market, fluctuations are specific,

meaning that they deal with a specific sector/industry the problem of attributing a general business depression to

depressions in some specific sectors (untenable because problems insector X do not necessarily lead to problems in all sectors)

Business fluctuations are normal (current business) and non-

problematic fluctuations are features of any economic system (governed by laws

like purposeful human action and scarcity)e.g. you can have even wildfluctuations and profits/successful business at the same time

entrepreneurs and consumers are engaged in the business offorecasting them and they usually succeed


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problematic) (1)

The business of forecasting is uncertain; thosesuccessful entrepreneurs who correctly forecast theconditions of supply and demand (satisfy consumers)make profits while those unsuccessful (make errors)receive losses entrepreneurs judgments are based on economic

calculation in monetary terms

the market imposes a process of selection (the good one

stays, the bad one leaves) which means a strong effort-reward connection (incentives)

Our concern is with general fluctuations/cycles (when agreat number of sectors decline)


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Business cycles (Abnormal, problematic)

(2) Simple crises vs. Business cycles

They have the same symptoms (mass entrepreneurialerror, unemployment, dis-coordination within thestructure of production etc.)

Simple crises they have an (intuitively) obvious cause: natural disaster,

famines, earthquakes, epidemics etc.

they are unsystematic, not recurrent and not cyclical

discussion: socialism in crisiswhat does that mean?

Business cycles They do not have an intuitively obvious cause, they seem to

come out of the blue

They seem to be inherent in the workings of the market

They are cyclical, recurrent, systematic


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Business cycles (Abnormal,

problematic) (2)

Business cycles deals with general depression (agreat number of entrepreneurs fail)

All prices go up (boom), or all prices go down

(depression) Normally, this would not happen given a

fixed/constant money supply

Given a money supply an increase in some prices must leadto a decrease of other prices

The element that connects all markets and all sectorsis money

it follows that changes in monetary sphere must haveoccurred


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Excursus

Crisis = depression = cycles (interchangeable) Cycle = boom (period of expansion) + bust (period of contraction) Crisis and depression can both be associated with the entire

process of credit expansion and then contraction oronly with theperiod of contraction (bust) because in the latter, the economicactivity is visibly depressed/ in crisis

Types of explanations of crises: A-theoretical

Mere description

Cycles as in the nature of things

Theoretical (based on actual theories or systematic explanations) Non-economic: greed, over-optimism/over-pessimism, self-fulfilling

prophecy, irrational exuberance, herdeffects, animalspirits

Economic Non-monetary: under-consumption/deficit in aggregate demand,

overproduction, real business cycle theory (RBCT)

Monetary: monetarist, Austrian business cycle theory (ABCT)


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If business cycles involve monetary issues then it isnecessary to study a theory of money

Some common definitions of money Non-economical

money is the blood of the economy (nice analogy but whats thepoint?)

moneyis a convention between people who use it to acquire certaingoods

moneyis a fiction accepted by civilized society

Economical money is a good like any other that became general medium of

exchange

moneyis a medium of payments(it misses its fundamental feature)


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Three necessary discussions:

The fundamental theorem of exchange

Direct exchange (Barter)

Indirect exchange (Money)


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The fundamental theorem of exchange

Given 2 individuals (A and B)

Two economic goods (physical goods, services, money

or properties, in general)a belongs to A and bbelongs to B

With the hierarchy of preferences that for A good b ismore important than a (b>a) and for B good a is moreimportant than b (a>b)

Then:

Exchange takes place

Exchange is mutually profitable


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The fundamental theorem of exchange (cont.) Two qualifications:

The theorem does not describe aggression but free trade,voluntarily

The theorem is independent of natural error

My TV is broken and I go quickly and buy a tube for it (because Isuppose this component is damaged) and when I come backhome I realize that I have a transistor-based TV; the previousexchange (money for the tube) does not look so advantageous;ex-ante looked advantageous; ex-post it is considered an error whosfault? (errare humanum est)

A synthetically reformulation of the theorem: non-aggressive and non-erroneously exchanges are alwaysmutually profitable


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The fundamental theorem of exchange (cont.)

The theorem implies a double inequality of exchangeand not an equivalent exchange

The theory of equivalent exchanges

Implies an objective theory of value

A gain from exchange is possible only by exploitation or fraud

The market becomes a jungle/zero-sum game (one can gain onlyif other lose)

The theory of double inequality of exchanges

Implies an subjective theory of value

Explain the mutually profitable exchange

The market becomes an arena of social cooperationpositivesum game, all the players can gain


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Who gains more (A or B)?

Economically the problem is irrelevant as long as each ofthem gain more by involving in exchange than not

An important problem arises: the impossibility ofinterpersonal utility comparisons

The problem of envy (A versus B)

The problem of third parties

Are they affected? Their physical property remains unharmed

No one can have property on the value of his property

The problem of envy (third parties A versus third parties B)


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Applications:

Nationals and foreigners

Rich and poor

Cultural advanced versus cultural retrograde

Powerful and weaker

Christian and pagane

Obs: if the theorems conditions are fulfilled thenexchanges between the aforementioned areprofitable, in spite of the differences


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The Theory of Money (3) Direct exchange/barter

An economic good (b1) is exchanged on other good (b2) in the logic of thefundamental theorem of exchange

Good b2 is used in consumption orproduction

The problem of double coincidence of wants

Indirect exchange

Possible only with minimum three individuals (Crusoe, Friday and Jim) One good (b1) is exchanged on other good (m) that is not used in

consumption or production but it is exchanged for another good (b2)(desired for consumption or production)

mis a medium of exchange; it does the service of facilitating exchanges

m is demanded for its higher marketability

the exchange is broken into buying and selling

In time, marketability (brings together qualities such as divisibility, portability,relative scarcity, homogeneity, durability etc.) of some goods increases andtransform them into money or general medium of exchange; this process ishappening inside the market

Examples of goods that played the role of medium of exchange (even money):salt, cows, skins, seashells, precious metals (gold, silver), cigarettes (inconcentration camps)


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Therefore there are goods with monetary properties (which are

ready to become or became money; they have a monetarydemand); but before a good can become money first it must hasnon-monetary properties (people to demand it for its non-monetary uses; to have a non-monetary demand)

Discussion: if this is correct, what can we say about currencies (money)like euro, dollar, leu (RON)?

Money has a purchasing power (PP): the purchasing power ofmoney (PPM)

It is the purchasing power of a unit of money (e.g.: 1 gram of gold, 1

EUR, 1 RON etc.) It is determined by the demand and supply of money on the market

Demand for money = the necessary quantity of money for the economicactivity of people; it is linked to the PPM

Supply of money = the existent/produced quantity of money given by demand

PPM is the price of money or the quantity of goods that a unit ofmoney can buy ( 1l of milk, 1 cinema ticket, 1 kilo of tomatoes etc.)


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The Regression Theorem: TodaysPPM is inseparable ofyesterdaysPPM and regressively until the last dayofbarter and firstday of monetary use of that good

Discussion: it is a matter of confidence in money

There is a compatibility between a monetary economyand a complex structure of production (money enableseconomic calculation in monetary terms which allowsfor the rational selection of entrepreneurialalternatives)

Being the result of a voluntary social cooperationprocess, the development of money is a proof for theexistence of an extended division of labor:specialization and efficiency


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The production of money If money is a good with similar features of other goods, the production

of money (supply of money) must follow the same rules (supply &demand): the quantity produced is determined by the quantitydemanded

The producers of money are called private producers of money andthey are in competition; on the market there is free entry in the

production of moneydiscussion: the possibility of monopoly: not impossible but the point is if it is alegal or economic monopoly (Jrg Guido Hlsmann, The Ethics of MoneyProduction)

Popular misconception about the private production of money:

A private regime of money production will lead to frauds and

counterfeiting the moneydiscussion: technically it is not impossible, the point is if the fraud can behidden; besides, if the government pretend that it can protect privateproperty why wouldntbe the same thing in the case of private productionof money? (Murray Rothbard, What Has the Government Done to OurMoney)


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The Theory of Money (3) Fiat money

Are the consequence of a monopoly on the private production of money (theyappear only by parasitizing a pre-existent money; see the regression theorem)

Discussion: what type of money is Euro?

The previous necessary step (theoretically and historically) is to impose legal

tender laws (the state decrees a certain good to pay the debts, independent

of that chosen by the marketdebtors and creditorsand courts take as paid

debts those which use the decreed good/medium of payment)

Accounting will use the legal money; with the exception of the exchange

market, payments are made in legal mediums of payment; taxes are also paid

in legal mediums of payment

The necessity of a central bank (later)

Control of exchange rates and Greshams Law (when a currency is artificially

overvalued in terms of another currency, the latterthe undervalued - will

disappear; normally, on a free market, the stronger currency becomes more

expensive in terms of the weaker currency)


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Specific features of a depression (4)

The cluster of errors (cluster = collection, group)

entrepreneurs seems to be all mislead in theirmonetary calculations and incentives actions(question: is it plausible?)

error is the consequence of a bad forecasting of

consumer wants (the market penalizes with lossesentrepreneurs who commit errors and rewards withprofit those with better judgments in forecasting)

a cluster of errors (a great number of entrepreneurs

go bankrupt) suggests that economic calculus andmarket incentives (effort-reward) are distorted(question: what is the cause of this distortion?)

discussion: the explanation of suddenchanges (improbable, for thatis the business of forecasting)


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Specific features of a depression (4) An increase in the quantity of money and a decrease of it during the

depression (and it is not a simple increase in money supply! butcredit expansion therefore a theory of banking is needed)

The expansion of capital goods sector (therefore a theory of capital

and interest is needed)

there are two types of economic goods: consumer goods (lower/inferior

order) and capital goods (higher/superior order)

the proportion of consumer vs. capital goods is determined by the time

preference/rate of interest; the latter is determined by the proportion

of savings vs. spending

bank credit expansion allows an expansion of capital goods industries

(long term projects) which does not correspond to the existent rate of

savings; conversely it depress consumer goods industries (short term

projects)

capital goods industries are hit far more severely in the depression

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Distinction Between Business Cycles and Business Fluctuations (C2-C5)