An important question in the research of business cycles is how the market fluctuations, which are naturally inevitable in an imperfect world, are maintained by the economic system itself. In a previous column about the theory of Kalecki it has already been remarked, that indeed the system can under certain circumstances bring itself in a state of oscillation. The present column illustrates this phenomenon by means of an example, which originates from the well-known economists Joan Robinson and John Eatwell. It is a two-sector model.

The example can be found in the popular introductory textbook *Inleiding tot de moderne economie*^{1}. It concerns an application of the theory of business cycles according to Michal Kalecki. The example does not add new knowledge, but it does illustrate what the practical consequences are. In particular for the given situation it is shown, that the theory indeed predicts an economic crisis. The assumption of two branches is not typical for the theory of Kalecki, but she does not change the arguments in a significant way. She is especially interesting, since it becomes apparent how in each branch the crisis develops in a different way. Incidentally, the example in the present column uses different numbers than those of Robinson and Eatwell.

Just like the many preceding columns the present example assumes, that the economic system consists of two branches: the agriculture and the industry. The agriculture produces corn (with the bale as its unit) and the industry generates metal (with the ton as the unit of weight). The agriculture disposes of *l*_{g}=20 units of labour time (for instance 20 man years), which produce nett Q_{g,N}=1.8 bales of corn. The industry disposes of *l*_{m}=10 units of labour time. For the moment the system is in a static situation.

agriculture | industry | nett product | |
---|---|---|---|

corn | q_{gg} | q_{gm}=0 | Q_{g,N}=1.8 |

metal | q_{mg} | q_{mm} | Q_{m,N}=0 |

workers | l_{g}=20 | l_{m}=10 | |

production | Q_{g} | Q_{m} |

The agriculture uses q_{gg} bales of corn as seeds for sowing, and q_{mg} tons of metal for tools, which together form her means of production. The metal is obviously supplied by the industry, in such quantities that the worn-out tools can be just replaced. The industry itself employs merely q_{mm} tons of metal for her means of production, and these tools are produced in her own branch. The table 1 presents the system in the form of a matrix. The rows describe the distribution of the gross product over the branches. The columns describe the production technique of the concerned branch.

The investments I_{g} of the agriculture require payments to the industry, whereas the investments of the industry are done in her own branch. Note, that this concerns *gross* investments. The metal is merely replaced, but not extra expanded. The *nett* investments are zero. In a mathematical form the exchange between the two branches becomes

(1) I_{g} = W_{m} + P_{m}

Here W_{m} and P_{m} are respectively the *wage* sum and the *profit* sum in the industry. The formula 1 has been derived first by Karl Marx^{2}. She must be immediately elucidated, because in the approach of Robinson and Eatwell the depreciations and the replacements are included in the profit - contrary to the idea of Marx. In the following this aspect will be mentioned again, sometimes in the footnotes. The investment I_{g} on the left-hand side is a productive demand, which is satisfied by means of the surplus product q_{mg} = Q_{m} − q_{mm} of the industry. The right-hand side describes the costs, which are made by the industry, and the markup for profit as well^{3}.

For the economic system as a whole the income is designated by the symbol Y (without index), just like in the previous column about Kalecki's theory of the business cycles. That is to say, for a given total wage sum W and profit sum P the definition of Y is

(2) Y = W + P

Since the depreciations are included in the profit P, here Y is the so-called *gross* added value. The economic system chooses to use corn as its only legal currency. Income consists by definition of corn. Then the nett product Q_{m,N} of the industry is naturally zero. The wage level is 0.05 bales of corn per unit of labour, so that the wage sums in the agriculture and in the industry are respectively W_{g}=1 and W_{m}=0.5 bales of corn.

As usual the profit P_{i} of branch i (i=p or m) must conform to the general profit rate r of the system. However, the definition of the profit rate differs somewhat from the usual approach, for she is r = P/W. That is to say, the profit P_{i} is related to the wage sum in the branch, in the form r×W_{i}. It is evident that both the agriculture and the industry dispose of metal tools, but these capital goods do not yield any rent. They are merely present in the *total* product, and not in the *nett* product^{4}. It has already been mentioned, that they do exert influence, by means of the replacements.

After fixing the productive sphere of the system in this manner, now the consumption must be modelled. The society has two classes, one for the factor labour and the other for the factor capital. The class of the capitalists is formed by the entrepreneurs themselves. The factor labour expends his complete income on food and other household ware (*workers spend what they earn*)^{5}. Since there is no permanent staff, all labour is productive. Therefore the wage sum is proportional to the gross added value Y_{i} in the branch (i=g or m), where the constant of proportionality equals the labour productivity ap_{i} = Y_{i} / *l*_{i}.

The consumption function of the capital owners is

(3) C_{k}(t) = C_{a} + c_{k} × P(t-θ)

In the formula 3 C_{a} is the autonomous consumption, which in this example is put equal to zero. The marginal consumption quote c_{k} is put equal to 0.25, and the time lag θ equals a unit of labour time (for instance a year). The lag expresses the delayed adaptation of the consumption pattern of the capitalist to changes in their income (the profit of the concerned branch). In the present situation, which for the moment is static, the profit does not vary with time.

In the previous column it has been stated that *capitalists earn what they spend*. Their profit is determined by the amount of investments. The application of the formula 6 in that column, together with the insertion of C_{a}=0, leads to

(4) P = I / (1 − c_{k})

That is to say, the entrepreneurs invest 75% of their profit. Now the profit rate r can be computed first, and next the seize of the total income Y. The application of the formula 1 leads immediately to r=0.8, or 80%^{6}.

The determination of Y raises the question how the investments I_{m} of the industry in itself must be computed. This column follows the approach of Robinson and Eatwell in their book. Since that approach is rather cumbersome, and actually does little to increase the insight, your columnist refers for the explanation of their argument to a footnote^{7}. There it is shown that one has Y_{m}=0.9 (measured in bales of corn). The quantity Y_{g} (the gross added value, or the total income of the branch) is conputed simply from Y_{g} = (1+r) × W_{g} = 1.8 bales of corn. The table 2 summarizes all these numbers, and the figure 1 depicts the situation.

agriculture | industry | total | |
---|---|---|---|

W | 1 | 0.5 | 1.5 |

P | 0.8 | 0.4 | 1.2 |

Y | 1.8 | 0.9 | 2.7 |

I | 0.6 | 0.3 | 0.9 |

Some explanatory remarks with regard to the table 2 and the corresponding figure 1 are in place. First, it is obvious, that the table contains several double counts. A part of the profit sum P_{g} reappears in the industry in the shape of the wages W_{m}. But also the profit sum P_{m} creates extra employment in the industry. Within the industry, profit is converted into wages as well. This has been explained in the footnote. The double count is due to the absence of a time index in the static situation. In fact a part of the profit originates from the investment in wages during the previous time step θ ^{8}.

The investment I_{g} is a demand for tools (metal), which represents a value of 0.6 bales of corn. Here the exchange relation of bales of corn and tons of metal is irrelevant. The same holds for the investment I_{m} with a value of 0.3 bales of corn. Both investments are paid from the profit sum of the concerned branch. In the footnote it has been explained, that the investment I_{m} (and thus also the profit P_{m}) contains a part with a value of 0.1 bales of corn, which is merely required for book-keeping, and which is not really expended.

It can be concluded from the preceding arguments, that the system is a collection of causal relations. They illustrate how investments influence among others the total income^{9}. In each branch the profit sum has a size P=r×W. And the investments are I = (1 − c_{k}) × P. Since according to the formula 2 the total income Y equals W+P, the investments equal Y × (1 − c_{k}) × r / (1+r). In numbers this is Y = 3×I. This explains once more, now in a different manner, why, due to the sum 0.1 in the book-keeping of I_{m}, the agriculture must not invest Y_{m}, as suggested by the formula 1, but merely Y_{m} − 0.3.

Next consider the following example. Let the economic system be static, but with investments I_{g} in the agriculture, which are 0.1 larger than in the table 2. How will these two situations differ (this implies a static comparison, not a transition from one situation to the other)? Then the economic structure dictates a larger profit in the agriculture, namely 0.1333. According to the formulas, just mentioned, the total income in the agriculture must be increased with 0.3 bales of corn. And the total income in the industry (the gross added value, including the term for book-keeping) rises by 0.15 bales of corn.

This increase is actually caused by the higher income of the industry, which creates an extra demand in the agriculture. The agriculture must produce more in order to satisfy the demand, but this creates once more an extra demand, namely those of her own extra employed labour and capital. Thanks to the expansion the profit is raised in such a way, that the agriculture can pay for the extra investments (*capitalists earn what they spend*!).

The previous paragraph may give food for thought, yet it is actually only presented as an introduction for the calculation of the conjuncture in the system with two branches. The approach in the model of Robinson and Eatwell is again used, albeit with adapted numbers^{10}. Here all aspects of Kalecki's theory of business cycles become visible. First, this requires the assumption, that the agriculture and the industry dispose of a certain reserve in their production capacity. In other words, the *utilization* of the production factors (including the factor labour) is less than 100%. In a situation, where labour is added, idle tools must naturally be available for that extra labour.

The approach of Robinson and Eatwell models the system by computing all quantities by means of discrete time steps θ. The size of θ can be chosen at will, for instance a man year of labour. Since θ appears in the formula 3, the consumption of the entrepreneurs has a lag of exactly one time step. Contrary to the situation of the previous paragraph, here θ influences the level of consumption during the business cycle.

Robinson and Eatwell choose for the agriculture an investment function of the shape, which has been proposed by Kalecki (see the formula 8 in the previous column). Her formula is

(5) I_{g}(t) = I_{g}(t-θ) − 0.0565 + 0.5 × ΔP_{g}(t-θ)

The reduction by 0.0565 implies that the entrepreneurs in the agriculture are somewhat more reluctant than in the previous paragraph, and they reduce their investments even for the case of a steady profit P_{g} ^{11}. According to the formula 5 the entrepreneurs in the agriculture are willing to expand and do *nett* investments, when the rise of the profit is appreciable. Also here the lag in the behaviour is exactly one time step large.

The calculation of the business cycle starts with the situation in the table 2. The entrepreneurs in the industry invest still their total profit, as far as they do not consume it themselves. In the initial situation (t=0) one has I_{g}(0) = I_{g,a}. That is to say, they consist of the autonomous investments, which are just sufficient for the replacement of the worn-out tools. At the time t=0 an external "disturbance" occurs. Namely, the entrepreneurs in the agriculture for once take up a credit at a bank, because they want to do a nett investment. They place an extra order with the industry for tools. In order to execute the order the industry must hire 5 extra units of labour. Then the production capacity of the industry is completely utilized.

The utilization of the branches is an essential aspect in the study of business cycles. Kalecki points out, that after a full utilization of the capacity the economy can not grow further, at least for the moment^{12}. She has reached her *ceiling*. So in the example this phenomenon occurs in the industry. From that moment onwards the development of the system will be followed step-by-step, in intervals with a duration of θ. The computation herself is wisely moved to a footnote^{13}. The findings are presented in the table 3. Moreover, the figures 2 and 3 display the developments in respectively the separate branches and the economic system as a whole.

agriculture | industry | |||||||
---|---|---|---|---|---|---|---|---|

t/θ | W_{g} | P_{g} | C_{k,g} | I_{g} | W_{m} | P_{m} | C_{k,m} | I_{m} |

0 | 1 | 0.8 | 0.2 | 0.6 | 0.5 | 0.4 | 0.1 | 0.3 |

1 | 1.313 | 1.05 | 0.2 | 0.85 | 0.75 | 0.6 | 0.1 | 0.5 |

2 | 1.453 | 1.163 | 0.263 | 0.9 | 0.75 | 0.6 | 0.15 | 0.45 |

3 | 1.488 | 1.191 | 0.291 | 0.9 | 0.75 | 0.6 | 0.15 | 0.45 |

4 | 1.445 | 1.156 | 0.298 | 0.858 | 0.708 | 0.566 | 0.15 | 0.416 |

5 | 1.341 | 1.073 | 0.289 | 0.784 | 0.639 | 0.511 | 0.145 | 0.366 |

In the first row (t=0) the numbers from the table 2 reappear. In both branches the wage- and profit-sum maintain a ratio of 1/r = 1.25. In the second row (t=θ) the extra investment ΔI_{g} = 5 × 0.05, which results form the order by the agriculture, affects the profit sum P_{g}, and in the industry it affects the wage sum W_{m}. For the following rows the calculation is straightforward. First, for each t=n×θ the change of the profit ΔP_{g}((n-1) × θ) is computed. Next I_{g}(t) is computed from the investment function (formula 5).

The change of the profit at (n-1)×θ yields also the change of the consumption ΔC_{k,g}(t) of the entrepreneurs in the agriculture. There the change of profit is ΔP_{g}(t) = ΔC_{k,g}(t) + ΔI_{g}(t). And ΔW_{g}(t) is 1.25 times as large. Furthermore the change of the profit ΔP_{m}((n-1) × θ) yields the change of the consumption ΔC_{k,m}(t) of the entrepreneurs in the industry. Next there the wage sum can be computed from ΔI_{g}(t) = ΔW_{m}(t) + ΔC_{k,m}(t). Then the profit P_{m}(t) and the investment I_{m}(t) are also known.

The reader will perhaps believe, that the fall continues after t=5×θ. Actually, with this investment function the fall will never stop. But the point has been made, namely that *due to the structure of the economic system a crisis can occur by itself, without exogenous causes*. And that was the whole purpose of the effort. The figure 3 shows that even a constant investment can already lead the system in a crisis. The quantity C_{k}/Y illustrates that in the recovery phase the entrepreneurs are less inclined to consume^{14}. In the fall the consumptive behaviour has a lag, so that the consumptive demand improves, at least in a relative manner. This anti-cyclical behaviour underlies the under-consumption theories.

Several concluding remarks must be made. The implicit assumption is, that the agriculture will not hit the ceiling. As soon as the order at the time t=0 has been completed, the production capacity in the agriculture will be larger than before. It has not been stated, when those extra tools will be delivered. For that is not very relevant. And the question can be raised, whether the example is useful. Robinson and Eatwell believe it does. It may indeed help to see how the crisis develops.

- See the chapter 6 about the effective demand in
*Inleiding tot de moderne economie*(1977, Uitgeverij Het Spectrum). The English title is*An introduction to modern economics*. This book is very original, because economics is completely described and explained*without*making use of the neoclassical paradigm. The book is well written, but it does make demands on the reader - like this column proves. The approach of Robinson and Eatwell underlies also the paragraphs 9.5 and 11.8 of the reader*Vooruitgang der economische wetenschap*(2011, uitgeverij E. de Bibelude) by E.A. Bakkum. Incidentally, the text in the present column differs slightly from the reader. (back) - See for instance the column about the dynamic growth model of Marx. Let the industry be equal to the department I, and the agriculture be equal to the department II. Take in both branches the accumulation quote a equal to zero. Then both branches are static, so that α=0 and G=1. Now the formula 6 in that column implies, that one has K
_{II}= L_{I}+ C_{I}. Here K represents the investments, L the wage sum and C the profit. The idea of this formula corresponds to the formula 1 in the present column.

Many feel nostalgic about the vision of Marx. Thus the poet Garmt Stuiveling writes in*Tijd en taak*(p.73 of the volume*Elementen*): Like a clarion call the word has sounded: / "Proletarians of all countries, unite!" / Oh wake-up call, oh promise, where still shone / and shine visions, where is now / in these dark postwar years / your strength, your truth now on all sides / proletarians fight proletarians / till within the borders of that same country? (back) - The means of production q
_{mm}are produced by the industry herself. This requires an investment I_{m}of the industry, which she pays from her profit markup. Thanks to the investment I_{m}the total income Y_{m}of the industry increases. However, the difference Y_{m}− I_{g}is not settled with the agriculture, but it is paid by the industry herself. The sum is used for bookkeeping within the branch. See the following. (back) - Usually an efficiency is required for the aggregated capital, which consists of the stock of tools and, in the agriculture, the seeds for sowing. However in this system the means of production are not included in the calculations of the efficiency. Therefore the tools (in case the metal) do not generate income. Due to this assumption the model does not need knowledge about the exchange ratio of metal and corn. And just like Sraffa has shown, then a possible change of the income distribution does not affect the value of the aggregated capital goods. The definition r=P/W of the rate of profit is a bit strange, but on the other hand price formation is always subjective. Thus the definition is not
*bizarre*. Note that r is identical to the marxist rate of surplus value. (back) - Therefore Willem van Iependaal in
*De pionier*(p.45 of the volume*Op drift*) writes an ode for the plougher: He knows the luxury of merely giving: / In the circle of germination there is no perishing! / Again, deeper, the plough-share is driven in / And further, always further the path goes ... / He has not paid attention to his effort: / That which has been ploughed is no longer observed! / He knows: the day has gone too soon ... / Yet a late bird sings in the wood ... (back) - The formula 3 states that I
_{g}= (1 − c_{k}) × r×W_{g}. The formula 1, wherein I_{g}also appears, is more difficult to explain. It would seem that one has P_{m}= r×W_{m}in the formula 1, but Robinson and Eatwell show on p.134 of*Inleiding tot de moderne economie*that this is not true. Namely the part (1 − c_{k}) × r×W_{m}is invested as I_{m}in the industry herself. In other words, the income (1 − c_{k}) × r×W_{m}creates a demand for metal, and not for corn. The investment I_{m}is a supply of metal, which is paid by metal. The transaction can be settled on mutual terms, as it where, within the industry herself. She does not create costs. Therefore the term P_{m}in the formula 1 equals merely c_{k}× r × W_{m}. It concerns the*nett*added value, without replacements. Insertion of the known wage sums gives the result 0.75×r = (1 + c_{k}×r)/2 = 0.5 + 0.125×r, with as its solution r=0.8. (back) - For the calculation of Y the total income Y
_{m}of the industry must be known. Unfortunately it requires some effort to calculate Y_{m}. In the first instance one has Y_{μ1}= W_{μ1}+ P_{μ1}. This is the sum, which the agriculture invests and pays to the industry (in bales of corn). It is obvious that the investments of the entrepreneurs in the industry have a size I_{m}= (1 − c_{k}) × P_{μ1}= (1 − c_{k}) × r×W_{μ1}. It is as though the industry has a separate company, where the others can order their tools. Robinson and Eatwell actually include this company in their example. In their approach the separate company does make profit, but it does not invest for itself. Thus the capital owners of the company receive merely their consumption part in corn. Their investment part of the profit is purely virtual and meant for book-keeping. For otherwise the system would expand further. Therefore one has I_{m}= W_{μ2}× (1 + c_{k}×r), where W_{μ2}is the wage sum of the separate company. Apparently the investment creates extra employment in the industry. Combining both expressions for I_{m}yields the result W_{μ2}= W_{μ1}× (1 − c_{k}) × r / (1 + c_{k}×r). Thus the total employment in the industry implies that W_{m}= W_{μ1}+ W_{μ2}= W_{μ1}× (1+r) / (1 + c_{k}×r). Insertion of W_{m}=0.5, r=0.8, and c_{k}=0.25 yields the result W_{μ1}= 0.3333 and W_{μ2}= 0.1667. The rest of the industry has twice as much workers as the separate company. However, now a comment must be made with regard to the relation P_{m}= r×W_{m}. She is only valid, when the virtual component in the profit is included. For the entrepreneurs of the separate company have in fact given up their profit share (1 − c_{k}) × P_{μ2}. That part of the profit is merely present for book-keeping, and not in reality. Therefore one has P_{μ1}= 0.2667 and P_{μ2}= 0.1333, where P_{μ2}contains a virtual part of 0.1 bales of corn. The part for book-keeping contributes the the product value, but it can not be consumed. (back) - In a previous column it has been explained how the price of a product is formed by an accumulation of costs, which have been made in the preceding production periods. Precisely because of this phenomenon Eva Müller argues in her book
*Marxsche Reproduktions-theorie*(2005, VSA-Verlag) that in fact the*total*product should be studied, and not just the added value. The theory of Kalecki does not analyze the productive structure, and that is a limitation. The same critique applies to the work of Keynes. (back) - Robinson and Eatwell discuss this extensively in their chapter 6 of
*Inleiding tot de moderne economie*. Here their arguments can be addressed merely in a succinct manner. (back) - See the appendix on p.150 of
*Inleiding tot de moderne economie*. (back) - See p.152 in
*Inleiding tot de moderne economie*for the investment function of Robinson and Eatwell. The sensitivity for ΔP suggests, that the entrepreneurs in the agriculture react on changes in some marginal profit rate, for instance ΔP/ΔW, or ΔP/ΔK, where ΔK is the change in the stock of capital goods (equipment). The approach clearly has an empirical character. (back) - See p.186 in
*Krise und Prosperität im Kapitalismus*(1987, Metropolis-Verlag) by Michal Kalecki. (back) - Five time steps are computed, from t=0 to t=5×θ.
*t = θ*: The wage sum in the industry has risen to W_{m}=0.75 bales of corn. The profit sum must also ris, to P_{m}=0.6, and the gross added value to Y_{m}=1.35. But according to the formula 3 the profit part of the industry does not yet create a demand in the agriculture. Only the increased wage sum creates demand. In the end the order results in a nett investment ΔI_{g}(θ) with a size of 0.25 bales of corn. Now the causal relations come in force. For ΔI_{g}(θ)=0.25 must be taken from the profit P_{g}, which therefore must also rise. However due to the lag in the formula 3 the rising profit does not immediately increase the consumption of the entrepreneurs in the agriculture. Thus ΔP_{g}= ΔI_{g}(θ). In order to create that growth of profit, the wage sum W_{g}must grow together with ΔP_{g}/r = 0.3125 to in total 1.3125. The employment in the agriculture increases.*t = 2×θ*: the rise in profit of ΔP_{g}(θ)=0.25 affects the nett investments by means of the investment function I_{g}(2×θ) (formula 5). However, the industry produces already at its full capacity utilization, so that this extra nett investment can not proceed. The only change is the consumption of the entrepreneurs. According to the formula 3 she becomes 0.15 in the industry and 0.2625 in the agriculture. The wage sum in the agriculture must increase with ΔW_{g}=0.14, and the employment expands in a corresponding manner.*t = 3×θ*: according to the formula 5, the rise in profit of ΔP_{g}(2×θ) = 0.113 will not change the investments I_{g}(3×θ) in the agriculture. Therefore nothing changes in the industry. The consumption of the entrepreneurs in the agriculture rises with 0.0281 bales of corn. Again the wage sum expands, with ΔW_{g}= 0.0352.*t = 4×θ*: the rise in profit of ΔP_{g}(3×θ) = 0.0281 is so small, that the formula 5 makes shrink the investments to I_{g}(4×θ) = 0.858. Since for the time being the consumption of the entrepreneurs in the industry remains stable, the wage sum must fall in accordance with ΔI_{g}, so with -0.0425. The consumption of the entrepreneurs still grows, with 0.007 bales of corn, but due to the shrinking I_{g}the agriculture is in the end forced to fire workers. Apparently both the agriculture and the industry experience a crisis! In spite of the capacity, which is now available in the industry, there are no new orders.*t = 5×θ*: the agriculture is confronted with a*fall*in profit of ΔP_{g}(4×θ) = -0.035. There the entrepreneurs decrease their consumption and diminish the investments further to 0.784. In the industry the wage sum must also fall, but since at the same time the consumptionC_{k,m}falls to 0.145, now one has ΔW_{m}= -0.069.

- See also p.97 and further in
*The business cycle*(1991, Princeton University Press) by H.J. Sherman. (back)