 Okay, let's get started first off an announcement after this lecture. We're supposed to meet in the conservatory for a group photo I'm not exactly sure where the photo is going to be taken But I have been told that we're supposed to meet there and then we'll be told where to go for the for the group photo so this lecture is on the Austrian theory of the business cycle and It's it's sort of an interesting step that we're taking in the course of the week Because we're taking a step into the hampered market economy So when we talk about the Austrian theory of the business cycle, we're referring to something that Doesn't happen in an unhampered market economy or at least it's not supposed to so something is something Outside of the market economy is is acting that that causes the boom bust cycle to occur in the Austrian theory So let's just quickly recap what we've learned about the unhampered market economy so that we can better contrast What happens in the in the business cycle? So we've seen probably the best example is with is with Crusoe We've seen how Crusoe alone on his island. He can't economize He sees the the resources around him and he can allocate them towards productive uses based on his preferences And based on his ideas about how those resources can be combined in such a way to to achieve the ends that he has And if he wants so-called economic growth if he wants an increase in his standard of living More consumption goods than what he needs to do is he needs to set aside Consumption goods so suppose he has coconuts and berries He needs to set aside a certain stock of coconuts and berries to last him through The period of production where he would need to create some capital goods that would then allow him to create more consumption goods So he might be in some state In order for him to increase his wealth He has to save first He has to set aside real resources that he doesn't consume immediately He sets them aside for a different purpose and that purpose is to either sustain him through the production process or to accumulate Productive resources factors of production that help him make the things that he needs to make more things that he wants And so that's we have a theory of economic sustainable economic growth for Crusoe that way And it's not really much of a problem I mean it would be Sort of difficult for Crusoe surviving by himself, but intellectually it's not a problem because there's only one mind There's only one person making these choices So he can evaluate everything that's that's around him and make to make these choices on his own Is it's his ideas about how to combine factors of production? It's his preferences that he's trying to to attain His satisfactions that he's trying to you know get towards so there's not really a problem It is it's a little bit more of a problem when we have more than one person in an economy. It's a little bit It's a little bit more difficult because now we have two people with preferences two people with ideas are more than two people And we have to come up with a way to allocate factors of production Allocate savings in such a way as to still economize We still want to achieve our most highly valued ends We want to get the most important stuff and forgo the less important stuff Given our set of resources and the ideas that we have and we've seen through the past two days Lectures on the mechanics of the unhampered market economy how how that happens. So we have market prices Entrepreneurs can engage in economic calculation. So this is how we know that resources are going to their highest value use So we're gonna see a breakdown of that. This is just one example of a breakdown of that system And it's called the Austrian business cycle theory. So Crusoe's one example Before even getting to me this of the slides perhaps a good analogy for the business cycle with Crusoe is that suppose one morning Crusoe wakes up and he sees some colorful mushrooms outside of his den and He partakes some of these mushrooms and then later on of the day, you know, his eyes get big and the changing colors And he starts hallucinating and he's he he looks at his stockpile of coconuts and berries that he's he's been working on and Helucinates that it's just a hundred times bigger than it actually is He thinks he has way more saved resources than he actually has and it's just the effect of these mushrooms, perhaps So you would you might see how Crusoe seeing this much larger set of saved resources Would now undertake different production processes. He would undertake longer Production processes you might build different capital goods more specific capital goods because he thinks he has a larger supply of Saved resources than he actually has so, you know Someday the the effect of the mushrooms wear off and he realizes that he's made all of these mistakes in the past He dedicated factors of production. He created factors of production that aren't for lines of production that can't be completed so he changed his plans based on this Incorrect view of his saved resources and and he's realized that he's made a mistake and he's gonna have to do something about it Now now what should he do? Should he? consume more mushrooms Just pretend that there's not a problem So that's at least one solution that seems like a bad one, right? What he should do is he should you know make do with what he has make make the So he's gonna have to convert some of the specific capital goods that he created in that process for Other purposes for a shorter period of production for different lines than what he had Designed in his you know in his high in it while he was hallucinating Probably a more straightforward analogy comes from Mises with a with a the master builder So let's go through this So Mises says in human action the whole entrepreneurial class is as it were in the position of the master builder Whose task it is to erect a building out of a limited supply of building materials If this man overestimates the quantity of the available supply He drafts a plan for the execution of which the means at his disposal are not sufficient He over sizes the groundwork and the foundations and only discovers later in the progress of Of the construction that he lacks the material needed for the completion of the structure It is obvious that our master builders fault was not an over investment But an inappropriate employment of the means at his disposal So this is a great analogy because it works in a metaphorical sense So we we see in a business cycle the class of entrepreneurs. They're made they all make a similar Kind of air they they all make errors at the same time what Rothbard referred to as the cluster of errors And so it works in a in a metaphorical sense applying this to the to the business cycle But it also works in a literal sense because we can actually see in some boom bus cycles We have many new Construction projects undertaken where people are building new houses and we literally run into the problem Where we we don't have enough materials to complete the projects that we've started. So this is this is Mises's analogy All right, so now let's get into the to the meat here. Let's let's get towards a definition of of a business cycle Definitions are good because they help us exclude Other things that aren't the thing that we're trying to define Austrians are particularly good at doing that. So let's rule out some things Let's let's try to figure out what are some things that we might initially look at and say and say that's a business cycle But it's actually not so one example that business cycles are not is just typical business Fluctuations so we see in the workings of the market economy changes happening all the time people Production changes maybe due to a change in the level of natural resources Maybe to a change in technology that that we can dream up consumption changes people change their preferences for consumption goods all of the time and So there's just change all throughout the the market economy happening all the time and this does not pose a particular problem We've we've seen how it's the entrepreneur who is tasked with anticipating these changes bearing the uncertainty of of the market bearing the uncertainty of all of these changing changes happening and Then profit or loss results and since they're aiming towards profit We would hope that they're they're Arranging production in such a way that we we do have consumer preferences being satisfied So that's the entrepreneurs task is to satisfy consumer demands So that's not what we mean by a business cycle. It's not just a localized sort of change in in a market What we mean by business cycle is a it's it's marked by a general boom and general bust So it's not localized. It's not a one particular change It's it's what we see in economic data like the following and really what matters is just that you see the shape of the line It's not necessarily what the what we're actually looking what we're looking at but in the in the top left It's the S&P 500 in the top right. It's the unemployment rate in the bottom left It's gross output and in the bottom right. It's the case Schiller Home index home price index So we see that there's this up and down and it seems like things Move up and then they move down for some sort of reason. We see wages go up and then they come down We see capital goods prices Increased and then they come down Employment goes up and then it goes down. And so this is what we're trying to explain Oh, by the way, also the coming down is sort of painful. It seems like, you know Entrepreneurs are earning lots of losses. And so that's another thing that we need to explain in our business cycle theory another feature of the business cycle that we need to explain is is the fact that capital goods Prices fluctuate more than consumer goods prices. And this is noted by Rothbard probably the still the greatest Exposition of Austrian business cycle theory is in Rothbard's America's Great Depression in the first few chapters So he says capital goods industries fluctuate more widely than do the consumer goods industries Okay, so let's do some stock-taking. What does this theory need to take into account? It needs to take into account the shape or the stages of the cycle So there's a boom and you can actually see that in these graphs where on the left. There's the Consumer price index on the right. It's the the Fed zone They probably don't measure themselves, but they report it the producer price index So they're looking at the prices of capital goods. So there's the the boom. There's an increase in price There's an increase in Capital values is an increase in firm values and then a sharp decrease It needs to take into account the clutch the cluster of entrepreneurial errors that are all happening at the same time So what could possibly be an explanation for everybody making the same sorts of mistakes at the same time? It needs to take into account the the fluctuate the difference in the fluctuations in prices and the consumer goods industries and the capital goods industries and Right off the bat. We can look at some suspect areas So we can look at money and the reason that might be a good place to look is because money is a part of all Transactions so in money is called the widely accepted medium of exchange And so everybody's doing transactions with money on one part of it one side of every exchange is money We can also look at credit since it also Prevades the economy so we could look at those two areas as at least suspect areas where something might be going wrong And we can see you know, what's causing the boom and then the bust Okay, so this is sort of a structure for the rest of the lecture. We need to cover these Bases we need to recap structure of production which professor Wittenauer expertly Explained this morning. We need to recap time preference and interest We can also do that quickly because of a great lecture by professor. Herbner We need to look at sustainable growth or the mechanics of sustainable growth We'll look at it an example That's a little bit more complicated than crew so just saving more and then we'll contrast that with unsustainable growth We'll contrast that with the case where there's it looks like there's an increase in production It looks like there's economic growth that's happening But it can't persist for some reason and we'll get to that in the unsustainable growth part and we'll see that the the the main culprits here the the key features of The boom period that caused it to turn into a bust is the malinvestment in overconsumption that happens during the boom And so we'll single those two Key features out as we go. So first structure of production instead of flourless chocolate cake I'm gonna look at a ham sandwich. This is an exercise that I go through with my Students on the first day of class and usually there's lots of back and forth But for the sake of time, I'm gonna do this sort of quickly. So what do we need to make a ham sandwich? You can imagine you need to Are you want to purchase a ham sandwich from a deli? What are the sort of things that had that had to be there at the deli for you to enjoy the ham sandwich? And some of the things are very obvious you'd ham for a ham sandwich bread lettuce tomato mayo Plate a table and chair to enjoy the ham sandwich on the the actual deli takes up space takes up physical space And so we call that land the physical space that the deli takes up and you need somebody there to put the elements together And that's it, right? That's all that's all we need to explain for where a ham sandwich comes from Yeah, somebody's shaking there's one person shaking their head. No, no, you're supposed to say no They we had to explain where all of these other things come from and so the the structure of production behind this particular Consumer good this ham sandwich is actually much more complex So the ham might come from a butcher the bread from a bakery Lettuce comes from farming and so do tomatoes and the ingredients that go to mayonnaise who even knows what goes into mayonnaise I guess there's eggs also go into mayonnaise. So we need a chicken farm the paper mill helps us Or gives us materials to make paper plates a Furniture manufacturer makes the tables and chairs notice There are no further steps for land and labor and the reason for that is because those are Originary factors of production. So there's we don't need to explain anything Beyond or where we get land and labor from those those are just sort of given to us We start off with those The butcher requires land and labor and a refrigerator and knives and all sorts of things the bakery Requires land and labor and oven flour and this can just go on and on At some point we have big metal machines show up and there's a chicken and the egg problems So we need big metal machines to refine the metals that give us the metals to help us make the big big metal machines So who even knows how that happened? So the whole the whole thing becomes really complicated and if you really take it to its conclusion You get something that looks like this it's just this massively complex network of of Factors of production that are required to be combined in certain ways to get to the consumption good If I look at my students paper sometimes on the first day of class sometimes it just looks like this like they just start They just give up and it's just becoming too complicated Okay, so this is not particularly helpful Well, it's helpful for us to at least see the complexity of production, but it's not helpful if we want to Analyze what's going on here? And so one thing that the Austrian school has done is that they have taken this Very complex structure of production and arranged it in a helpful pedagogical way And the way that they've done that is with the the structure of production of the Hayekian triangle You've seen it there. Sometimes it's arranged vertically where you go from higher order goods to lower order goods The lowest order good being the consumption good And so man this animation took a long time. I hope you appreciate it So here's how we can take all of these features all of these components of creating a ham sandwich and put them in time order so so we start with natural resources we start with a Research and development at the very beginning of this of the stages of production And then we at the very end we end up with the desired Output the ham sandwich and we had the the arrow indicates time so time goes this way So this is still a little bit cluttered as you can see And so what we can do is since all of these elements in a market economy all of these elements have market prices We can tally up the the expenditures on these factors of production in their various Stages and so that would look something like this. Well, first of all this This arrangement should look familiar to figure 32 from Rothbard's man economy in state You had to turn your head sideways. Yeah, some people are doing that But you could see that the factors of production land labor and capital are arranged in a way where we end up with the consumption good at the end So here's here's where we stack up the spending in the various stages So and on the left-hand side We have spending in the first stage of production and then we end up with total consumption spending on the right-hand side It's the same thing. We're just we've arranged all of the stages of production by time and we've also added up the spending on factors of production the cost of production at each stage and One thing that we know is that in the ERE once we take away all Uncertainty about the future the only remaining spread between stages is just interest So we'll we're going to see in fact on the very next slide We're going to see a loanable funds market, but this is the really the more important aspect of the of the time market It's the capital structure where capitalists are parting with present consumption today They're parting with present resources today, so they can't consume in In hopes for in the future they want revenue from the sale of their output Which means that they're making an inter temporal Exchange, which means that they they have to Reckon their time preferences in that process. So the interest rate applies in the capital structure Just as much as it does in the loanable funds market, which we'll see here So all that to say the all that to say Production is interest rate sensitive. So Production and the length of the production process Has to do with our inter temporal preferences or time preferences Okay, so let's take a closer look at time preference So we prefer a given satisfaction sooner rather than later However, there are different rates of time preference, which means that we can exchange and in fact you can put All the people who have present money available to be lent to others You can put them on a supply curve and all the people who want present money today and are willing to pay a future Amount of money for the money that they get today. We can put them on the demand curve Including people who might borrow so that they can purchase factors of production and produce So that's what happens in in this loanable funds market as we as we build out Roger Garrison's Graphical exposition of the Austrian business cycle theory So here's just one example of a trade that can happen between two people who have a different rates of time preference So the the present money goes from Jeff over to David and exchange David agrees to pay the future amount of one thousand one hundred dollars or a ten percent interest rate Over over what over over whatever the the time period is So if we have a bunch of people then we can make a demand curve and a supply curve and we see the equilibrium interest rate in this in this loanable funds market we're going to Take this loanable funds market and though in the amount of borrowing that happens the total amount of transactions that happens between Savers and and borrowers and we're going to allow that to correspond to the level of investment spending in a trade-off between Investment spending and consumption spending so in in this top graph here. This might look familiar to you If you've seen a production possibilities frontier, it's not exactly a production possibilities frontier because that shows two different Goods or two different factors of production that somebody might use to produce something in this case It's just a trade-off between consumption and investment and this should this should make sense So if we have a given set of resources, we can either use them for present consumption or future consumption With a given set of resources We can consume them today or we can set them aside and use them for future production And that can either look like you know plane saving where we just hold on to you know some set of consumption goods that allow us to Consume during a production process or we actually have resources that are factors of production themselves that are productive So that that represents the the investment side of things so you can you can see how You can see how this lines up with the loanable funds market in the bottom and all you have to say is that All all of the funds that are used for investment are subject to Time preference and some of that money is trading hands in the market for loanable funds And some of it is is is entrepreneurs who are lending to themselves But they still need an interest return and so either way we can line up so that the total level of investment spending in this economy Is the same as the the quantity of loans that are transacted in the in the bottom graph the loanable funds market? Okay, so here's just one quick example What happens if we have an increase in savings? If we have an increase in savings or a decrease in the rate of time preference people increase their supply of Saved funds so the supply of loanable funds increases We we just move down the demand curve. We have a new lower Interest rate in this market We have an increase in the quantity of loans that are transacted and we can see how that corresponds We we move across the the consumption and investment trade-off So now we're consuming less and investing more so these tell the same story We're just looking at it for in in different ways So in the bottom graph we said there's an increase in the supply of loanable funds Before that we said there was a decrease in the rate of time preference that synonymous was saying we're going to consume less today we're going to decide to consume less today and Because we want to consume more in the future. So we we do that sort of trade-off the result of this is Economic growth we have more resources To consume and to invest in the future So if we decide to dedicate more resources to production today that means in the future We have additional resources and so that real resource constraint is depicted by the boat outward curve there it expands outward and Really the only assumption that we have to make there is that the additional investment that we've made is net investment It's it's more than just what we need to replace or maintain our existing capital stock So we have positive net investment. So we're adding to our capital stock. We're adding to our productive capabilities. We have Economic growth we have an increase in the in the amount of resources that we can use for both consumption and investment Okay, so back to our starting point here. Let's add another component here We have our familiar hierarchy and triangle So before I just had the the dollar signs stacked up on top of each other, but here's it's just sort of smoothed out here It's the structure of production. So we start with Land and labor and we end up with consumption spending at the very end So spending is depicted in the in the horizontal excuse me in the vertical dimension and then the stages of production The the length of production in time wise is in the horizontal dimension One thing that Roger Garrison like to add to this diagrammatical Exposition is a stage specific labor markets and the reason for that is because he liked to compare this this sort of setup to What Keynesians were saying about the macro economy and they're they're very interested in and saying what's happening to employment So here we have a late-stage labor market and an early stage labor market So on the right hand side, we might have a labor market for a retail store So Walmart this could be the supply and demand for retail workers notice the price There is a lowercase w for wage and the quantity is a uppercase L for a quantity of laborers or number of labor hours And same in the early-stage labor market. This might be for lumberjacks or miners. So labor that is in the earliest stages of production So let's recap what we have here we have in the top left a Hayekian triangle. It's our structure of production and The top right we have a trade-off between consumption and investment and that black line shows our real resource constraint in the Bottom right. We have a loanable funds market or a typical credit market By the way time markets are visible in two locations here So in the bottom right we have a loanable funds market But the capital structure also at least gives you the gist of a time market for production You remember the the slope of the Hayekian triangle gives you the the interest rate because Capitalists are also engaged in intertemporal exchange and in the in the bottom left. We have some stage specific labor markets Okay, so let's do an example with all of these elements of Sustainable growth. So what does it look like for? This economy to lower their rate of time preference and increase savings So the first step is to increase the supply of loanable funds We see that this results in a lower equilibrium interest rate and increase in the funds available and also that are transacted because we move down this demand curve more people are willing to borrow at The slower interest rate. They're happy to to borrow the these additional saved funds This corresponds to a lower level of consumption and increased investment in the top right in the in the trade-off Our Hayekian triangle our structure of production makes this sort of shift So it gets shorter because we have less consumption going on but it gets longer and the the explanation here Is that you'll notice that the the interest rate fell? So and the slope of the Hayekian triangle is the interest rate So what what entrepreneurs in effect are doing is they see the these additional saved funds and they're responding Appropriately they're responding in such a way as to say okay consumers. You you have lowered your rate of time preference You don't want as much consumption goods now You're waiting on more consumption goods in the future You decreased your rate of time preference fine. We'll we'll start new lines of production that are longer We'll make new capital goods will make new specific capital goods and make things that won't come to completion until later And that's exactly what consumers have said when they've increased their savings in the vulnerable funds market So it's it matches up quite well what does this mean for the demand for labor in Early and late stages. Well, there's an increase in demand for labor in the early stages and a decrease in demand for labor in the late Stages and this is simply because the the discounted marginal revenue product of the workers in these different In these different stages has changed so the discount that you would apply To the workers in these different stages has decreased and so now there's increased demand and as you go further back in time To the earlier stage Workers, so we see this sort of change an increase in the wage rates for early stage workers and a decrease for the late stage workers So everything corresponds with what consumers want consumers have said we're going to increase our savings We're not going to consume as much and entrepreneurs have responded likewise. They said okay we'll start new production projects that take longer and We've already seen the long run results of this as we increase productivity if we have more capital goods if we've expanded our capital stock We've engaged in new longer lines of production and those new longer lines of production were undertaken because we The entrepreneurs foresee this increased consumption in the future So consumers have said that they want that so there's an expanded set of resources and also the structure of production can expand as well So this if you remember a long time ago, I talked about Crusoe. This is what happens at Crusoe. He said I'm going not the mushroom example though I I'm going to set aside more consumption goods. I'm going to set aside more coconuts and berries Today so that I can pursue a longer production process and produce more capital goods that helped me produce more coconuts and berries for example and That additional productivity that he has by producing the the capital goods allows him At least it makes it easier for him to produce even more capital goods So creating more capital goods makes it easier to make more capital goods and that's what we see here We've expanded our set of resources in the top right diagram. We see the real resource constraint is is nicer It's easier. We have more resources to consume and invest and also the structure of production has expanded Okay, so let's summarize this in a qualitative way as opposed to a graphical way So saving involves freeing up resources for production in credit markets saved funds are made available to entrepreneurs to purchase factors of production Entrepreneurs take those funds the new longer lines of production are started which is in line with Consumer consumers time preferences the additional investment in excess of what is required for the maintaining or replacing of the capital stock Pays off with an expanded set of resources in the future said another way this economy experiences Sustainable economic growth. So there's nothing here That says that this economy is going to have to contract Like they there's nothing here that is unsustainable and if anything This economic growth paves the way for even more economic growth sustainable economic growth because this economy now has more capital goods Okay, so that's that's how things can work right here. Let's now change things up and Let's suppose that there's an increase in the supply of loanable funds that does not originate with the change in consumers time preferences So what if we have Just this brand new source of funds That does not come from people saying I'm going to forego consumption today I'm going to forego present consumption so that I could have future consumption In fact, let's keep people's time preferences the same so that we can isolate the effect of this sort of artificial increase in loanable funds all right, so just a Reminder from yesterday when we talked about banking you'll remember that in both fractional reserve banking without a central bank And in fractional reserve banking with the central bank It's possible for there to be Increases in the supply of credit that don't originate from people saying I'm going to increase my saving So we can have an increase in saving that does not Excuse me We can have an increase in the supply of credit that does not come from people saying I'm going to relinquish The ability to consume present resources today and the reason that works is because fractional reserve banks They take people's deposits and they use that to issue new loans So the loans are not coming from savings They're coming from people's deposits that that people have said that they want to be able to redeem at par on demand So they haven't said that I'm going to relinquish present consumption If anything they've said I want to be able to spend this money over the foreseeable future and We've also seen the example where the central bank decides to purchase government bonds and this expands The level of reserves in the fractional reserve banking system Which also serves as a basis for an increase in in the supply of loans in the economy Notably without a change in time preference without a change in people saying I'm going to save more Okay, so the central bank and or the fractional reserve banking system can Expand credit without an economy-wide increase in real saving Said another way an economy-wide decrease in the rate of time preference These newly create this newly created money enters the economy through credit markets And so they represent an increase in the supply of loanable funds despite the fact that people have not decided to increase their Saving there is an increase in the supply of loanable funds There are new green pieces of paper or ones and zeros in a bank account that look like Saved funds, but it's not real savings the interest rate falls But not because of a decrease in the rate of time preference at the lower interest rate saving actually Decreases and we'll see that in the graphs in just a moment consumption consumption and borrowing Increase firms take the new funds and invest in new longer lines of production because they can't they can't necessarily tell the difference So they see this increased availability of saved funds It looks like the new longer lines of production will be profitable It looks the same from the entrepreneurs perspective It looks the same as the case where on where consumers decided to withhold from consuming today So factor prices are bid up across the board wages increase employment increases Consumption increases investment spending increases, and it's just great. It's wonderful all the numbers are up Stock prices are up stock indices are up wages are up It's a happy party Until So we have this boom So the reason this can't last the reason this is an explanation for unsustainable growth is because we didn't actually increase The set of available resources There was an increase in the amount of money, but there was not new wealth created There was an increase in the supply of credit But there that that didn't correspond with people's willingness to not consume today And in fact people because of the decrease in the interest rate people might consume more. In fact, they do consume more It's called overconsumption So consumers did not show that they preferred future output to present output In fact, they decreased saving at the lower interest rate The credit expansion does not represent an increase in real resources available for consumption or investment and the results here are Factors of production become increasingly scarce I like the analogy that I like to use here is it's like a hungry hungry hippo's game for capital goods So there's only like this fixed set of of capital goods and entrepreneurs are you know, just they start tapping on the lever even faster Because it looks like new longer lines of production are profit are profitable So prices are bid up for those Capital goods and they're bit up higher than entrepreneurs expected Which means that the cost of production increase if it was Unexpected if that increase in cost was unexpected then they wouldn't they would not have pursued those new longer lines of production And so losses ensue those profits that they anticipated Turn into losses and projects are abandoned as a result and this was actually a very prominent feature of the most Recent completed boom bus cycle that we saw we saw plenty of new housing developments that were totally abandoned Halfway finished houses halfway finished neighborhoods that just they didn't get finished for a long time So entrepreneurs were led to believe consumers had saved real resources had saved and real resources were available for production They also were led to believe that longer more capital intensive production would be profitable. Okay, so let's look at the we have time Let's see what this looks like with Roger Garrison's graphs So in the bottom right we have the loanable funds market There's going to be an increase in the supply of loanable funds But this increase in the supply of loanable funds is not because of an increase in real savings It's just the new money that has entered the economy through credit markets. So through the fractional reserve banking system There's this increase in the supply of loanable funds, but that a writ that Dotted supply curve there is actually still in effect in the form of people's time preferences And we see this sort of a bifurcation we see two points now So since that existing supply curve represents consumers time preferences that that shows what they're going to do So at this new lower interest rate, they're going to decrease the quantity of loans that they supply on this market They're going to increase their consumption and save less and that's what the the dot that goes down into the left signifies the the new equilibrium point that's down into the right signifies the new funds that perhaps businesses and and Some consumers are taking because of this increased availability of funds. So they are taking the new funds But savers are actually saving less which sounds backwards the difference is made up by the new paper the new money in this economy Okay, so what does that mean for this trade-off? This is sort of an interesting thing So this the black line as I said represents the real resource constraint So we can only consume and invest a certain amount But we have an increase in consumption and an increase in investment So what gives how do we depict this in this two-dimensional graph here where so many things are happening? So the way Roger Garrison depicts it and and I don't know if he fully explained this When when he would give this lecture is he would show a point that's beyond the PPF And so some people are like wait you can't do that because it's a production possibilities front It's a trade-off if you could go beyond it then where should you actually draw that boundary? It's not really a boundary if you can put a point beyond it my response is this There's a difference in the real and nominal values now that the new money in the economy Means that we can increase spending beyond what our real resource constraint would otherwise give us So we can increase consumption spending and increase investment spending even though our real resource constraint is what it is We just we just the numbers don't line up with the real resources at this point So we have this sort of like virtual unachievable point beyond Where we're spending that much but it's beyond we're consuming and investing beyond our our real resource constraint As we'll see Okay, so what does this mean for the hierarchy and triangle for the structure of production? This also goes in two different directions. So you sort of see the Discoordination here, so you see the the on the consumption and retail end of things the triangle gets steeper and taller So there's an increase in consumption But Entrepreneurs are also taking these new funds and they are pursuing new longer lines of production So there's this this Lengthening of the structure of production at the same time and you'll notice that the what suffers what's not getting attention is the middle Of the of the structure of production So and that's the that's the point where entrepreneurs will realize that they've made mistakes perhaps So this so there's the the structure of production is really going in two different directions We've got consumers pulling at one direction and producers pulling it in the in the other direction But like I said, it's a party so wages are up and everybody's happy So on both the retail end and also the lumberjacks and miners They've got an increase in their pay So there's an increase in wages across the board and this this sort of shows us what's happening in factor markets in general So capital goods prices are increasing as consumers are Making retail shops more profitable The entrepreneurs who are taking the these new these newly available funds They're also increasing the wages and prices that they pay for factors of production So incomes across the board are increasing However, it can't last and the reason it the reason it can't last is because we didn't actually have a a Real restructuring of the of the structure of production or at least we didn't have a Restructuring of the structure of production that was in line with people's time preferences. Well, we had was Crusoe hallucinated and he thought he had this Available set of resources, but it was false So aren't all of the the lines of production that Entrepreneurs pursued all these new longer lines. They'll turn out to be unprofitable. So the capital goods Don't actually exist. They thought that there would be capital goods available for them to complete these projects But but there is an increasing scarcity They'll realize that the resources that they need to complete their projects aren't actually there and so that means that those Those prices will increase Consumers are the ones who have final say over where real resources are going now And so there was actually consumption of our total set of resources in the economy consumption increased Saving saving decreased real saving decreased So that we actually we might have actually eaten into our capital stock as a as opposed to to bolstered it or increased it So the the economy shrinks. We have our bust. So what does the bust look like? firms attempt to liquidate the Malinvested capital So they made all these mistakes. They're gonna have to fix the mistakes. They're gonna have to Liquidate they're gonna have to you know fetch the or get the best price that they can for the capital goods that they invested in Wages decrease and workers are laid off. So we see a decrease in demand for workers across the board credit markets dry up so as as consumers impose their real-time preferences, it becomes More difficult to to get loans credit markets dry up prices readjust to reflect consumer demands, which is it's a very good thing So that's what we needed all along. So we made mistakes during the boom phase where we we were allowing factor prices Especially to not reflect consumer demands So the bus is a recovery phase as people try to find profitable uses for land labor and capital So we we made the wrong sorts of capital goods. We pursued the wrong lines of production we pursued lines of production that were longer than what consumers actually wanted and The real resources for those new lines of production didn't actually exist So everything comes to a halt and we have to we have to make do with what we actually have just like Crusoe Once once he realizes his actual set of resources He has to make do with what he actually has and and make changes that way So what are the lessons learned if you just look at the highly aggregated data, so if you just look at The data that you can find at the Federal Reserve Economic Data website, then you're not going to see the real problem You're not going to see the changes in the structure of production So the errors were in the structure of production the errors were Malinvestment we we produce the wrong capital goods But if you're looking at total investment spending or really just total spending in the economy You're not you're not going to see that problem You're going to misdiagnose the problem and you're also probably going to give bad solutions But if you misdiagnose the problem and you see that all of a sudden there's this big decrease in spending The solution is more spending, right? That's that's the sort of problems that arise when you just look at highly aggregated data Another lesson that we've learned is that to properly analyze a hampered market economy You have to at least have a good understanding of how the unhampered market economy functions So we looked at an example of sustainable economic growth before we looked at the unsustainable and and that way We were able to contrast the two and this goes back to a maxim by high where he said Before we can meaningfully ask what might go wrong. We should first understand how things could ever go right Finally we saw how sustainable Production sustainable economic growth is based on a real Reallocation of resources away from consumption So we had to have real savings first. That's the prescription. That's what we really need to have sustainable economic growth And we saw how unsustainable booms are caused by artificial increases in credit So where we confuse entrepreneurs about the real availability of resources We also saw how recessions are the time when we fix the mistakes of the past So a lot of policies are directed at quelling the recession They're about, you know, like not making the recession so bad or like just trying to increase spending during the recession and All of these government interventions that are instituted during the recession phase actually work to our detriment They actually make it more difficult for us to find the profitable uses of factors of production In our very complex capital structure So I've run out of time. Once again, I've got a recommended reading slide. You can snap a picture. Thank you