What cause booms and busts? Explanation of Austrian Business Cycle Theory metaphor

February 7th, 2007

Share |

In our previous article, What cause booms and busts? Introduction to the Austrian Business Cycle Theory, we introduced the Austrian Business Cycle Theory (ABCT) with a metaphor. Today, we will explain the meanings of the metaphor from the book, Economics for Real People.

As we all know, since we live in a world of scarcity, the economy has a finite amount of resources (e.g. land, capital, labour, technology, raw materials, etc) to produce the goods and services that consumers want. Thus, the gas in the bus represents all the available finite resources in the economy.

The economy is always producing goods and services. Thus, the trip across the desert represents a period of time of economic activity.

In any economy, there is a class of people called the ?entrepreneur.? They are the business people who take risks by anticipating what consumers may want in the future and create the products and services that meet these anticipated needs. A very good example of an entrepreneur is Henry Ford who introduced the motor car to the world. In the metaphor, you, the bus driver, represent the entrepreneurs in the economy.

Then there is a class of people called the ?consumers.? Basically, consumers enjoy the fruits of the economy?s production of goods and services?they ?consume? resources of the economy. The passengers in the metaphor represent the consumers of the economy. As we said before in The myth of financial asset ?investments? as savings, there is a need to make a choice ?between producing consumer goods for current consumption or capital goods which will help in producing future consumer goods.? In the metaphor, the choice to use how much air-conditioning for comfort represents the choice of the consumers in how much they want to consume now at the expense of saving for future consumption.

In the economy, the entrepreneurs will borrow capital to engage in investment spending in order to fulfil what the consumers may want or need in the future. The speed of the bus represents the amount of investment spending to undertake.

Finally, the bogey man who tampered with the passengers? survey results is the central bank, which sets the interest rates. Please note that we are not accusing the central banks of any misconduct?they happened to fit the villain in our choice of metaphor.

So, how do all these fit into the explanation of the business cycle? Stay tuned!

Tags: , , , ,