The Economics of Business Cycles Numerical Model Role of Fixed Costs

Abstract

This paper presents a simple numerical model of the economics of business cycles with illustrated demand and cost curves. This is a purely theoretical model inspired by the writings of John M. Clark (1884-1963). The model shows industry long-run equilibrium ( ) under perfect competition for manufacturers to supply hypothetical fluctuating demand schedules, off- peak and peak, for a single non-durable product such as cement. The model has two plant types: old high fixed-cost Plant L and modern low fixed-cost Plant K . The model assumes linear total cost curves with absolute capacity limits for the two plant types. Both plant types have the same SACmin. Under perfect competition neither plant type will dominate. The plant assets are assumed durable, to last for 50 years, and specific to manufacturing only one product, Q . The model, with its rigid assumptions, shows that industry composed of only modern low fixed-cost Plants K will increase the amplitude of the business cycle, the range of industry outputs between peak and off-peak, versus an industry composed of only old high fixed-cost Plants L . The implication is that under conditions of perfect competition and the model, reduction of fixed costs even while not reducing the SACmin — will lead to wider amp litude business cycles. The model shows a positive aspect of fixed costs: that one can expect that industry with high fixed costs to have reduced amplitude of the business cycle. Fixed costs in the model narrow the output levels between the trough and the peak of the business cycle. Some may find this a surprising result.