What Are The Internal And External Theories Of Business Cycle?

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Tariq Habib Profile
Tariq Habib answered
Over the years macroeconomics has been energized by vigorous debates about the sources of the business cycle. What causes aggregate demand to shift suddenly? Why should market economies blow hot and cold? There is certainly no end of possible explanations, but it is useful to classify the different sources into two categories, external and primarily internal.

The external theories find the root of the business cycle in the fluctuations of factors outside the economic system in wars, and elections; in oil prices, gold discoveries, and migrations, in discoveries of new lands and resources, in scientific breakthroughs and technological innovations, even in sunspots or the weather. The 1990 to 1991 recession, which was triggered by consumer anxieties after the Iraqi invasion of Kuwait, exemplifies the external approach.

By contrast, the internal theories look for mechanisms within the economic system itself that give rise to self-generating business cycles. In this approach every expansion breeds recession and contraction, and every contraction breeds revival and expansion in a quasi-regular repeating chain. One important case is the multiplier-accelerator theory. I think this explanation will satisfy your question.

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