Endogenous Business Cycle Models

Moral hazard can contribute to market bubbles (like the Nasdaq in 2000) and insurance cycles in which premiums collectively drop as companies compete for to lower them, but go to low and are all forced to raise them. It is not moral hazard, but durable capital goods, also have an investment cycle in which a high price for, say cranberries, induces many entrepreneurial farmers to invest in new cranberry bogs, but it takes several years for new production to come on line and once a perennial cranberry bog is created, the marginal cost is quite low, so prices suddenly drop to an a level that requires bankruptcy to close some of the farms in order to get back to a normal profit again. Cranberries went from nearly $1/# down to $0.18/# in 1997 with this kind of boom and computer memory chips have long suffered from this kind of cycle.

Richard Goodwin (1967) drew upon the biological 'predator-prey' model to explain the business cycle on the basis of 'class struggle'. The idea comes from biology in which there are natural cycles of booming populations and population decline because when a population of caribou grows, that reduces their food supply which weakens the caribou and increases the food supply of wolves. The wolf population then grows which reduces the caribou population until some of the wolves are near starvation and then the wolf population declines. The decline of the caribou population means more food supply for the survivors and once the predator population also declines, the remaining caribou begins growing once again. In Goodwin's model, businesspeople expand their businesses when wages are cheap, but in doing so, they bid up the cost of labor (wages) which makes them shrink their businesses which then causes them to reduce employment. It works for explaining fluctuations in an industrial economy, but it is less clear how it explains economic fluctuations in the service sector. Still, it is a good metaphor for economics in which there is an equilibrium model which is inherently unstable. The wolves and caribou (and grazing) are in an equilibrium that prevents massive overpopulation, but they still produce pretty big population swings. The "equilibrium" models of the macroeconomy have similar dynamics.

Goodwin's Predator-Prey Model of The Business Cycle:

Goodwin's model attempted to demonstrate the cyclical relationship between employment and wage share in a working economy. Goodwin's model is in fact not as controversial as it may sound: 'class struggle' and 'predator-prey' can invoke strident images of revolution and reaction, but nothing more radical than a standard Phillips Curve and a Kaleckian profit mechanism is at work.

The basic features of Goodwin's (1967) model can be stated simply: high employment generates wage inflation which can increase the wage share of workers in output; but this will, in turn, reduce the profits of capitalists and thus, in Kaleckian fashion, reduce future investment and output. That reduction in output will in turn reduce labor demand and employment and consequently lead to lower wage inflation or even deflation and thus reduce the wage share of workers. But as workers wage share declines, then profits increase and, with them, investment. This will lead to greater employment and thus improve the bargaining power of workers and consequently wages in Phillips Curve fashion and thus greater wage share in output - and the rest of the cycle then repeats itself. For good measure, Goodwin adds exogenous growth components - namely, labor supply growth and productivity growth.