The business cycle in the last few years has been in a cycle predicted years ago by john Keynes Keynesian theory. This theory provides that the economy is driven by demand and that contraction in demand creates a recession and the subsequent cuts in spending. Keynes was of the idea that the economy had to have influenced demand to keep things running. This was made possible through consumer spending, government spending or purchases, investments, savings and net exports excluded which is basically the formula for the determination of gross domestic output (GDP).
Any change or reduction in demand in one section has to be compensated by an increase in demand b another section. The decrease in spending by consumer through changing consumer habits lowers demand and spending therefore making businesses cut on theirs cash outflow as well. This results to no investments made and thus a contraction in the market. This is where the government comes in through fiscal and monetary policies to increase the level of money supply to regulate the economic position. Keynesian theory has been demonstrated in recent years through recessionary periods and the subsequent counter-fiscal policies that have been introduced to bring back some balance in the economy.
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"Keynesian And Neo-Classical Economic Theories".
Neo-classical model
The Neo- classical theory explains the recent shift in the price stability in the economy with little friction. Prices of items change but the main variable such as input and output do not. A shock in demand or supply is not reflected in the demand or supply. Therefore a shock in a neoclassical economy does not affect the economy significantly, for instance marginal changes in price. This model normally works better for long run periods, when the unemployment rate is very low and general good economic periods.
