Boom and Bust


Kurt Bouwhuis, Mackinac Center Intern

I am reading “Economics for Real People” by Gene Callahan and have found an interesting analogy.

Daily Article by | Posted on 8/9/2000

Imagine that you are a bus driver at the edge of a desert, about to take a busload of passengers across it. You have left all gas stations behind, and are now faced with a decision. There are a number of towns on the other side of the wasteland before you, each a different distance away. The farthest away of these towns also happens to be the closest to your final destination. You can try to reach any of them, but there is a trade-off: the farther away the town, the less the passengers can use the air-conditioning to alleviate the desert heat, as running the AC will use up the gas more quickly.

In order to make your decision, you look at your fuel gauge and determine how much gas you have. You tell the passengers that they must now make a trade off between comfort on the way and distance traveled, as the more air conditioning they choose to use, the faster the bus will consume fuel. Then you collect votes from the passengers on what temperature to keep the bus. You perform some calculations on mileage, speed, and fuel consumption, and pick the farthest city you can reach given the amount of gas you have and the passengers’ vote on the use of air conditioning.

The passengers had to decide whether to cross the desert in greater comfort but arrive farther from their final destination, or in less comfort but with a closer arrival. The science of economics has nothing to say about the combination that they picked, other than that it seemed preferable to them at that moment.

However, also imagine that, before you began your calculations, someone had sneaked up to the bus and replaced the passengers’ real votes with a fake set that choose a higher temperature, in other words, less fuel consumption. You made your choice as if the passengers would tolerate a temperature of, say, 80 degrees, whereas in reality they will demand to have the bus cooled to 70. Obviously, your calculations will prove to have been incorrect, and the trip will not come out as you had planned. Your plans will be overly ambitious. You will begin by driving as if you had available more resources than you really do, and end by phoning for help when the deception is revealed by the sputtering of your engine.

I offer the above as a metaphor for the Austrian theory of the trade cycle, which offers an explanation of why the economy swings through boom times and recessions. You, the driver, represent the entrepreneurs. The gas is the stock of capital goods. The trip across the desert is the next “round” of production. The passengers represent the consumers, and their choice on how much to use the air conditioning is analogous to how much consumers are willing to put off consumption today in order to save for the future — their time preference for current consumption over future consumption. The ultimate destination is the satisfaction of as many wants as possible. And it is the central bank — in America, the Federal Reserve — that has sneaked up and tampered with the consumers’ votes.

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