Development and Underdevelopment in the History of Economic Thought

A New Graphical Exposition of the Austrian Theory of Capital and the Business Cycle

Potuzak Pavel, University of Economics, Prague

This paper develops a simple graphical apparatus that is designed to elucidate basic tenets of the Austrian Theory of Capital and the Austrian Business Cycle Theory. The Austrian capital theory rests on the idea that the production process takes time. Five simultaneous short production methods are introduced that provide consumption goods in one period. A shock to the time preference then triggers gradual restructuring of the production apparatus. The new graphical method shows how the processes are gradually transformed into longer methods of production. The typical U-shaped dynamics of the flow of consumption goods is generated within this graphical method, as well as creation of new intermediated goods. The next section uses the same apparatus to describe lengthening of the production processes that is initiated by a monetary shock. The initial dynamics resembles a fall in the time preference. However, some structures will not be eventually completed, and they will be abandoned. The phenomenon of the forced saving at the top of the boom as well as the destruction of capital in the downswing phase of the cycle are explored in the suggested graphical model. The designed model can thus complement basic exposition of the Austrian theory of capital and business cycle.

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Keywords: Austrian theory of capital, Austrian theory of business cycle, forced saving

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