Hayek’s “Prices and Production” (1933) explains the Austrian business cycle theory, where credit expansion leads to malinvestment in capital goods, causing a boom followed by a crisis when credit expansion stops and consumers revert to time preference spending patterns.
The structure of production is influenced by credit expansion, with consumer spending at the base affecting wholesalers, manufacturers, and miners through a ripple effect, rather than by consumers saving more.
Government support payments to unemployed workers during crises caused by credit expansion intensify the crisis by giving new money to people who then buy more goods, making the situation worse.
The Austrian perspective on business depressions, explained through Hayek’s diagrams, provides a more detailed and accurate view of the boom-bust cycle than mainstream circular flow diagrams.
In Hayek’s diagrams, circulating capital goods are produced in a 5-stage process, from raw labor and natural resources to finished consumer goods, with each stage spending $8 on the previous stage’s goods and hiring more labor and resources.
Consumer spending alone is insufficient to sustain production; capitalists must reinvest their gross income in gross investment to maintain the production process, even in a stable long-run equilibrium.
Government relief spending makes recessions worse by artificially lengthening the production structure through credit expansion, leading to an unsustainable structure that collapses when credit expansion stops, causing a depression.
The Hayekian Triangle diagram illustrates how a small volume of consumer spending can support a larger total of producer goods spending if there are more stages in the production structure, as the public’s time preferences don’t fall to match the artificially lengthened structure.
