Extraordinary cyclical fluctuations-hayek explaination, Managerial Economics

Hayek explaination

Under a fractional reserves system, it is possible for the banking system to supply resources to entrepreneurs for investment in excess of resources that are voluntarily saved even at full employment through a process of forced saving. Since commercial banks are essentially profit making institutions, they expend their loans when excess reserves accrue to them. When banks expand their lending operations through credit creation. They lower the market rate of interest below the nature rate of interest the rate at which the demand for and the supply of real savings are equal and entrepreneurs are lured into utilising the artificially created banks credit to wean away resources from consumer goods industries. The resultant increase in the prices of consumer goods reduces the real income and consumption of the community forcing it to save.

The inflationary boom caused by this process of artificial credit creation can last only as long as the low market rate of interest can prevail in the economy. However as due to increase in investment outlay consumers money incomes rise their spending on the purchase of consumption goods increases raising the prices of consumer goods further. In the process the production of consumer goods becomes more profitable and entrepreneurs indulge in competitive bidding to suck away resources from investment goods to consumption goods production. This tendency continues as long as bank continue to expand credit. However the capacity of the banks to create credit is by no means limitless. As their reserves deposits ratio falls in the process of credit creation. They curtail further lending and the market rate of interest rises. At the higher market rate of interest many of the new investment projects that were deemed profitable when the market rate of interest was low become unprofitable and have to be abandoned. A vertical maladjustment overtakes the economy and recession sets in.

Hayek has explained the extraordinary cyclical fluctuations in the production of capital goods under the assumption of the full employment and constant real income. In real life, the typical recession is, however, marked by unemployment resources making it possible for the simultaneous expansion of consumption and capital goods in the economy. The increase in the production of investment goods in greater proportion than consumption is explained by the fact that in the short period the percentage of income spent on consumption falls as income increase .

Its severe limitations notwithstanding, Hayek theory explains that the actions of the banking system could sustain a boom and that a boom that was artificially so sustained could make the recession that follows the boom all the more serious if investment was made in those lines where no true long run profit prospects existed.

Posted Date: 12/1/2012 6:18:13 AM | Location : United States







Related Discussions:- Extraordinary cyclical fluctuations-hayek explaination, Assignment Help, Ask Question on Extraordinary cyclical fluctuations-hayek explaination, Get Answer, Expert's Help, Extraordinary cyclical fluctuations-hayek explaination Discussions

Write discussion on Extraordinary cyclical fluctuations-hayek explaination
Your posts are moderated
Related Questions
Supply and Demand Discuss and analyze following statement: The Wall Street Journal reported that recent law school graduates were having a very difficult time obtaining jo

Q. What do you mean by External Economies? External economies arise outside the firm as a result of improvement in industrial environment in that the firm operates. They are ex

Disadvantages of Perfect Competition There is a great deal of duplication of production and distribution facilities amongst firms and consequent waste. Economies of sc

Q. Illustrate the sources of monopoly? Merger for Large-scale Production: Thirdly monopoly undertaking can be a consequence of the necessity to produce on a large scale to de

Bank of Issue The central bank enjoys the monopoly of bank note issue i.e. no bank other than the central bank is authorised by law to print currency notes. Printing of paper

Producers Equilibrium or Optimal Combination of Inputs  The analysis of production function has demonstrated that alternative combinations of factors of production that are tech

The supply of money Refers to the total amount of money in the economy. Most countries of the world have two measures of the money stock - broad money supply and narro

Features of Planned Economy The command economies relies exclusively on the state.  The government will decide what is made, how it is made, how much is made and how distribut

Problem 1: a) Explain what is meant by ‘price discrimination' and what are the different types of price discrimination. b) Under what conditions is it possible and profitabl

CLASSIFICATION OF TAXES Taxes can be classified on the basis of: a.     Impact of the taxes It means on whom the tax is imposed.   On the other hand, incidence of the