Hayeks Model

Freiedrich Von Hayek an Austrian-British economist and political philosopher developed many theories economics. His main economic theory was the monetary cycle theory. This was the expansion and contraction of a production period to benefit the economy. His entrance into the political arena was with his work of "Road to Serfdom".

Hayek's first work included the monetary cycle. This concept dealt with lengthening and shortening the period of production. This causes a credit expansion at the low because loan able funds have led to the real rate of interest to go above the natural rate of interest causing an increase demand of capital goods. However this could be affected by the economies supply of resources. The initial increase in demand for capital goods could be greater than the supply, causing officials to decide whether or not to produce more capital goods and reduce the consumer goods or remain the same as did before the increase in demand. Hayek argued that an increase in production for capital goods and a decrease production of consumer goods would cause the proportion of capital to consumer goods to increase.

If you were to keep aggregate supply fixed, it would cause the consumers income to be fixed. This would result in not a drop in demand for consumer goods but a decrease in supply for consumer goods. The decrease in supply of consumer goods would cause what Hayek describes as a "forced savings" because consumers would be forced to save because there is no other consumer goods to buy. Due to the consumers being forced to save this would in return cause an increase in credit.

If aggregate supply is not completely fixed then you would be able to bring in resources this would cause capital gods and consumer goods to both rise. This would cause a general increase in production and output which in return would cause a domino affect with an increase in income and then also followed by an increase in consumer demand. In the end the consumer's demands for consumers goods would put pressure on the industry to produce more goods.

The rising demand for consumer goods causes prices to rise in consumer goods relative to the capital goods. This in return would make the consumer goods industry more profitable to the capital goods, allowing them to out compete the capital goods in the factor market. When this happens the consumer market receives the labor and capital that the capital industry used to control causing a bidding war. Causing wages and loan rate to increase, this is the peak of the cycle.

This in turns leads to a decrease in relatively everything that just has risen up.