A schumpeterian heterogeneous agent model of the Business Cycle

Abstract

S chumpeter's business cycle theory is rooted in chapter 6 of the Theory of Economic Development: ,An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle which he published in 1911.1 This book, which laid the foundations for Schumpeter's scientific work, did not become famous because of its explanation of the trade cycle. Instead, it was Schumpeter's analysis of the market process that was regarded as the most important part of the Theory. The point of departure was the traditional notion of an equilibrium economy with goods and money moving in a constant circular flow. Because all of the resources were allocated to their optimal utilization, there was no economic reason to depart from the familiar path. For equilibrium theorists, changes of a given setting could only be triggered by disturbances originating from non-economic events such as wars or natural catastrophes which alter the scarcity conditions of the economy. This would affect relative prices which would force the agents to adapt their plans to the situation. Once the disturbance had been digested, the economy would assume another stationary state, which would be a stable one because nobody would have a reason to depart from it (Schumpeter 1949b, chap. 1 ). The problem with this equilibrium notion was that it was not consistent with economic reality. There was no circular flow continuously reproducing itself, and there were not only passive adaptations to exogenous changes of relative prices, but active competition among industrial corporations which introduced products and production processes. To include this form of dynamics into economic theory, Schumpeter introduced the concept of the pioneering entrepreneur, who breaks away from the equilibrium flow by generating new combinations (chap. 2). However, since the equilibrium of an economy is a state in which by definition all assets are employed, neither investment money nor production