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A theory of economic cycles

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DOI: 10.1556/204.2018.40.2.1

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 Society and Economy 40 (2018) 2, pp. 169–184
DOI: 10.1556/204.2018.40.2.1

A THEORY OF ECONOMIC CYCLES1

IMRE DOBOS1 – ISTVÁN ÁBEL2

1
Professor, Institute of Economic Sciences, Budapest University of Technology and Economics

E-mail: doboskgt.bme.hu
2
Professor of economics, Institute of Finance and Accountancy, Budapest Business School

The theory of economic motion was András Bródy’s main interest. This paper presents a simpli-
fied framework of Bródy’s economics. His multi-sector production and price theory is based on the
Marxian theory of value reinterpreted by using measurement considerations. Economic motion in
this framework is driven by technology represented by the internal proportions of production, not
by external shocks. Prices and proportions jointly determine the economic structure and its motion
(duality of prices and volumes). We derive the laws of motion of production and use of goods (con-
sumption and accumulation) based on technological accounting balances. These laws determine a
cyclical pattern. Using numerical examples we demonstrate how external changes in technology
and valuations are propagated in changing the cyclical pattern of motion.

Keywords: dynamic Leontief model, Bródy’s model, economic growth, equilibrium, economic
cycles

JEL codes: D46, E32.

1
Imre Dobos thanks to the support of the Gambrinus Fellowship Programme of the TU Dort-
mund University, Germany. István Ábel is grateful for the support from the MTA-BGE Macro-
economic sustainability working group funded by the Office of Sponsored Working Groups of
the Hungarian Academy of Sciences.

1588-9726 © 2018 Akadémiai Kiadó, Budapest

170 IMRE DOBOS – ISTVÁN ÁBEL

1. INTRODUCTION

Bródy’s economics is intertwined in input-output analysis. Classical input-output

analysis is mainly used in three areas of research (Raa 2005; Baumol – Raa 2009;
Mariolis – Tsoulfidis 2016). One area is concerned with economic efficiency and
measurement of contributing factors in a multi-sector approach. Another area fo-
cuses on comparative advantage and the factor content of international trade.
While some of the quantified input-output models in these areas seemed obvious
the results of this methodology often surprised practitioners. The Leontief para-
dox was a good example that inspired new applications. Input-output applications
have been extended far beyond these directions leading to a third area of research
including the application to environmental and other wider issues. Bródy’s work
represented a fourth distinct area of input-output economics. His theory of cycle
and his contributions to input-output applications now represent a unique de-
scription of multi-sector economic motion.
This paper gives a simplified but unified summary of the characteristics of
the multi-sector economic processes which Bródy discovered and demonstrated
from several angles in his works. Our summary is a stylized reinterpretation of
his results, not a chronological presentation, and as such, is not intended to give
a comprehensive survey of Bródy’s research interests.

2. ABOUT THE THEORIES OF ECONOMIC CYCLES

Bródy’s first attempt to give a comprehensive synthesis of his theory was pub-
lished only in Hungarian (Bródy 1980) titled “Ciklus és szabályozás” (Cycle
and Regulation). He applied a Leontief type model combined with an approach
used by Goodwin (1967) to describe the cyclical motion of the economy. Bródy’s
second and richer attempt is available in English in Bródy (2004). Motivated
by physics, his intention was to derive the equations of motion from invariance
principles. Similarly to the practice seen in physics he was comfortable to use
teleological arguments based on profit maximization or cost minimization as well
as ontological arguments where the outcome was completely independent of any
intention or purpose of the economic agents. He always paid attention to show
that the characteristics of the cyclical motion can be equivalently described by
using either approach (Bródy 1997; 2000; 2002; 2007; Bródy – Ábel 2010).
Bródy’s work represents an extension of the input-output framework towards a
theory of business cycle in economics, and as such represents a unique field in the
theory of cycles. There are two major approaches to business cycles in econom-
ics. Most theories assume that the internal mechanisms drive market economies

Society and Economy 40 (2018)

 A THEORY OF ECONOMIC CYCLE 171

towards a fundamentally stable system. The observed large fluctuations are the
consequences of exogenous disturbances. The dominant school in this vein is the
real business cycle theory (RBC) initiated by several scholars, most notably by
Nobel laureates Finn E. Kydland and Edward C. Prescott (Kydland – Prescott
1982). The main factor causing such fluctuations is assumed to be technological
shocks leading to random fluctuations in productivity which shifts growth rate
up or down. Example of such shocks may include things like innovation, natural
disasters, weather, commodity price shocks, and several other exogenous factors.
These shocks are real as opposed to nominal, so there is no role for money or
nominal variables in RBC models.
Neglecting the financing aspects in RBC approaches, or in general by the dy-
namic structural general equilibrium (DSGE) models had its cost as it was shock-
ingly exposed by the events of the 2007-08 global financial crisis. The attention
was immediately attracted to the other main school of business cycle theories
which is most prominently represented by the Hyman Minsky’s financial insta-
bility hypothesis. “The financial instability hypothesis is a model of a capitalist
economy which does not rely upon exogenous shocks to generate business cycles
of varying severity. The hypothesis holds that business cycles of history are com-
pounded out of (i) internal dynamics of capitalist economies, and (ii) the system
of interventions and regulations that are designed to keep the economy operating
within reasonable bounds.” (Minsky 1992: 8).
Minsky (1986) emphasized the role of debt (a stock variable2) and financial
instability linked to flows and behavioral characteristics of speculative finance,
and proved that the linkages between finance and economic activity are major
components of the modern explanation for economic fluctuations.
Bródy’s theory of economic cycles combines some aspects of the two main ap-
proaches as it is based on real technological interrelationships depicted by input-
output matrices, but also introduces some behavioral aspects of market adjust-
ments in prices3 driven by the profit motive.
The framework we propose in this paper is less complex than Bródy’s, easier
to handle and illustrates its mathematical properties, still capable to cover several
distinct areas of Bródy’s economics. We will use two types of equations. The first
one describes the technological or accounting properties of firm level activity.
These economic relationships are represented in the company balance sheets as

2
An important contribution of Bródy to dynamic input-output economics is the integrated
handling of stocks (capital) and flows (inputs) in the theory of economic motion (see
Bródy1974; 2000). Raa (2010) demonstarted that the distinction between flows and stocks in
dynamic input-output analysis must be consistent with Bródy’s capital equation.
3
Prices in the model represent nominal valuation variables.

Society and Economy 40 (2018)

172 IMRE DOBOS – ISTVÁN ÁBEL

the opening and closing balances. Adding the revaluation of assets and the profits
(nominal variables) from production to the opening balance yields the closing
balance. The other equations are used to describe how demand and supply rela-
tions determine price changes in the market.
First we present the model in the next section by using these differential equa-
tions. Behavioral characteristics of this model are illustrated in the following sec-
tions by using numeric examples for solving the model. In the fourth section we
detail the effects of technological change on the cyclical patterns. Technological
change is represented by increased efficiency in terms of cost savings. The effect
of an increase in capital intensity is also examined in a multi sector propagation
process.

3. THE MODEL

The model in a traditional input-output framework using the following nota-

tions:
n number of firms,
A matrix of input coefficients of current expenditures (outlays) of firms, n×n
quadratic,
B matrix of capital (stocks) coefficients of firms, n x n quadratic,
ai input coefficients of current expenditures (outlays) of firm i, (i=1,…,n),
(column vector of matrix A),
bi capital (stocks) coefficients of firm i, (i=1,…,n), (column vector of matrix
B),
aTj output coefficients of market j, (j=1,…,n), (row vector of matrix A and
index T transpose),
bTj coefficients of output used as capital by firms on market j, (j=1,…,n), (row
vector of matrix B and index T transpose),
xi(t) output of firm i at time t, (i=1,…,n), scalar function,
x(t) vector of output at time t (non-negative),
pj(t) price of product j at time t (non-negative), (j=1,…,n), scalar function,
p(t) price vector at time t (non-negative),
T time horizon, t  0, T .

Capital covers all stock variables, including buildings, machinery, inventories

and other forms of capital. Current outlays include all kind of flow variables. As-
suming that each product is produced by only one firm (activity) we can construct
a dynamic Leontief model with these notations. To simplify matters we also as-
sume that each product has a market where the supply and the firm’s demand de-

Society and Economy 40 (2018)

 A THEORY OF ECONOMIC CYCLE 173

termine its price. Implicitly this also means that the supplying firm covers not just
the production of the good but all other activities related to its distribution and
sale. The model says nothing about how these auxiliary activities are organized,
what behavioral rules are followed. It can be a free market type, competitive and
open form, but it can be a closed monopolistic or mechanical routine.
In this form the model is a one-product-one technology input-output economy.
Each firm i uses ai  xi (t ) products or services, where i=1, …,n, to produce xi (t )
output. A firm to change its output needs to change its capacity by acquiring
bi  xi (t ) (i=1,…,n), where function xi (t ) is the time derivate of output of firm i.
The price of goods is determined on the market. The price vector p(t) is deter-
mined by the model. The mechanism of price determination is open to various
interpretations and could be consistent with alternative behavioral or organiza-
tional assumptions. The model only determines the changes in prices in response
to imbalances in supply and demand described below.
The capital4 of firm i is given by the total value of its assets p (t )  bi  xi (t ) . We
use two approaches to the valuation in this system. The first approach evaluates
the outlays (costs) and profits of the firm. The other approach is the valuation of
the product determined by supply and demand. As each product is produced by
only one firm and each firm produces only one product, these two valuations are
in dual relationships.

3.1. Evaluation of the activity by profits and outlays

The change in the value of the assets of the firm is a result of the productive activ-
ity. The final product becomes an inventory, a property of the firm, consequently
increases its assets by pi (t )  xi (t ) , while the materials used in the production
process become part of the product and the inventory is reduced accordingly by
p (t )  ai  xi (t ) . These two changes in the total value of assets determine the profit
of the firm: pi (t )  xi (t )  p (t )  ai  xi (t ) .
At the same time prices also may change resulting in revaluation of the assets
and altering the profit of the firm by p (t )  bi  xi (t ) , where vector function p (t )
is the time derivate of prices of products.
These two components of the change in the value of the firm gives the follow-
ing equation for each product or technology
d
 p(t )  bi  xi (t )   pi (t )  xi (t )  p(t )  ai  xi (t ) p (t )  bi  xi (t ) (i=1,2,…,n).
dt

4
Thijs ten Raa (2010) gives a good exposition of Bródy’s distinction between flows and stocks
in dynamic input-output analysis discussing Bródy’s capital equation .
Society and Economy 40 (2018)
174 IMRE DOBOS – ISTVÁN ÁBEL

Rearranging this form we get

p (t )  bi  xi (t )  pi (t )  xi (t )  p (t )  ai  xi (t ) , (i=1,2,…,n).
or written in the following form
pi (t )  p (t )  ai
xi (t )   xi (t ) , (i=1,2,…,n). (1)
p (t )  bi
The differential equation (1) describes the dynamic adjustment process of the
supply in response to profitability. The growth rate of product xi(t) at time t is
p (t )  p (t )  ai
proportional to the rate of profit i , i.e. the profit in percent of the
p (t )  bi
assets of the firm valued at current prices. In this evaluation prices are exog-
enously given.

3.2. Evaluation of the product according to supply and demand

Profits and outlays are categories of the business activity and are measured at the
enterprise level. Demand and supply are product related categories revealed on
the market. Prices are determined on the market and we assume the following
dynamics.
Total demand for the good j has three components, namely the product is used
for replenishing stocks, for increasing capacity, and for inputs. Stocks will ab-
sorb p j (t )  b j  x(t ) amounts while current production will use p j (t )  a j  x(t )
T T

amount from product j as inputs. In addition we would need p j (t )  b j  x (t ) of

T

product j as investments needed to expand the output. This amount can be nega-
tive in case of declining output. Total supply of good j is p j (t )  x j (t ) . Any dis-
crepancy between supply and demand will force prices to adjust, prices will in-
crease in case of excess demand:
d
 p j (t )  bTj  x(t )   p j (t )  aTj  x(t )  p j (t )  bTj  x (t )  p j (t )  x j (t ) , (j=1,2,…,n).
dt 
after rearranging this form we get
p j (t )  bTj  x(t )   p j (t )  x j (t )  p j (t )  aTj  x(t ) , (j=1,2,…,n)
or the following differential equation for the price adjustment:
x j (t )  aTj  x(t )
p j (t )    p j (t ) , (j=1,2,…,n). (2)
bTj  x(t )

Society and Economy 40 (2018)

 A THEORY OF ECONOMIC CYCLE 175

The price will decline in proportion to the ratio of excess supply to the stocks
(capital).
x j (t )  aTj  x(t )

bTj  x(t )

Economic motion in Bródy’s economy is driven by the forces described by equa-

tions (1)-(2). Incomes and costs at market determined (given) prices shape activi-
ties at the company level by (1), and the prices are formed by supply and demand
on the market as described by (2). This formulation gives a framework for the
cyclical motion of the economy in Bródy (1980), which is in close similarity with
the Goodwin model (Goodwin 1967).

4. Bródy’s model

A special case of equations (1)-(2) takes the form of Bródy’s well-known model
which is equivalent to the following eigenvalue problem:
x  A  x  λ  B  x, (3)
and
p  p  A  λ  p  B, (4)
where A is the input flow coefficient matrix and B is the matrix of input stock co-
efficients. Bródy (1974), examined the solutions of eigenvalue problems of form
(3) and (4). Dobos (2007) showed the existence of a solution even if B would be
singular. Let us denote the solution of (3)-(4) by the positive vector (λ0, x0, p0).
The existence of such a solution is granted if the Leontief inverse of A exists. In
this case, the eigenvalue-eigenvector problem takes the following form:
1
x  I  A   B  x
1

λ
The existence of a non-negative eigenvector and eigenvalue solution to the
problem is granted by the Perron-Frobenius-theorem (Gantmacher 1959).
This also means that the Bródy model given in (3)-(4) is a special case of the
model given by the differential equations (1)-(2), namely the solution determined
by the Neumann ray when the economy is in equilibrium and growth is con-
stant.

Society and Economy 40 (2018)

176 IMRE DOBOS – ISTVÁN ÁBEL

5. DYNAMIC PROPERTIES OF THE MODEL

There is no closed form analytic general solution of the model described in equa-
tions (1)-(2), but we can calculate numerically the solutions and examine their
properties. First, we will look at the trivial solution.
Property 1: x(t )  e λ0 t  x0 and p(t )  e λ0 t  p0 are non  negative solutions.
A non-negative solution of the model takes the following form: x(t )  e λ0 t  x0
 λ t
and p (t )  e 0  p0 , given that the initial condition of the differential equations
(3)-(4) is chosen as
 x(0)   x0 
 p (0)    p  .
   0
To check this assertion we substitute this solution in the system (1)-(2). Sim-
plifying with the exponential terms we get the forms (3)-(4).
This property indicates that in this special case the solution of the differential
equations (1)-(2) is equivalent with the solution of the following linear form:
x(t )  A  x(t )  B  x (t ) (5)
and
p (t )  p (t )  A  p (t )  B (6)
The system (1)-(2) this way gives the dynamic Leontief-model. This model is
well known. So is the following property of the solution:

Property 2: The solutions of (1)-(2) are positive if the initial conditions for
prices and quantities are positive.

We demonstrate the importance of positive initial conditions below. To see this

take equation (1) for the quantity adjustment of product i:
xi (t ) pi (t )  p (t )  ai
 .
xi (t ) p (t )  bi
To solve this we use the following notation
d p (t )  p (t )  ai
ln x(t )   i ,
dt p (t )  bi
which brings us to the form below
t
pi ( τ )  p ( τ )ai
 p ( τ )bi
dτ
xi (t )  xi (0)  e 0
.

Society and Economy 40 (2018)

 A THEORY OF ECONOMIC CYCLE 177

As the exponential function is always positive, this form must be positive be-
cause of the positivity of the initial value xi(0).
Using the MathCad 8.0 package, we analyze the behavior of the model using
numerical methods. We depart from the analytical solution but we also depart
from the assumption of starting from the equilibrium (we leave the Neumann-ray
now).
In these calculations we use the following numerical 3x3 matrix representa-
tion5 for the input coefficient matrix A and for the stock coefficient matrix B:

 0.1 0.3 0.2   0.01 0.03 0.02 

A   0.5 0.2 0.4  , B   0.05 0.02 0.04 
 
0.2 0.4 0.5 0.07 0.06 0.01

The initial values of the output and prices are:

0.1 0.1
x(0)  0.1 , p (0)  0.1
  (7)
0.1 0.1

These initial values are not equilibrium values as the equilibrium Neumann
ray would be
 0.375  0.493
 
x (t )  0.612   e
N 0,404t
, p (t )  0.554   e 404t
N

0.696   0.671

with and equilibrium growth rate of λ0 = 0.404, and the equilibrium output and
price vectors (the solutions of (3)-(4) with the chosen matrices):

 0.375  0.493
x0  0.612  , p0  0.554 
 
0.696   0.671

Solving (1)-(2) numerically with the initial condition (7) we get a path for the
output and price variables. This path for the first sector can be seen in Figures
1 and 2 in a continuous line, but for the other sectors the picture would be very
similar. (Note that in all of the following Figures we use logarithmic scale.)

5
This representation serves only illustrative purposes. The numbers are arbitrarily chosen.

Society and Economy 40 (2018)

178 IMRE DOBOS – ISTVÁN ÁBEL

The dashed line gives the path determined by the dynamic Leontief model of
form (5) with initial conditions given by (7).

Property 3: Starting from non-equilibrium initial conditions, prices and quanti-

ties follow a cyclical motion not centered around the Neumann-ray.

ln x1
t

ln y1
t

t
Figure 1. Output level in the model and the Neumann ray for the first product

Source: authors

ln p1
t

ln q1
t

Figure 2. Movement of the price in the model and the Neumann ray
Source: authors

Society and Economy 40 (2018)

 A THEORY OF ECONOMIC CYCLE 179

The cyclical motion of the economy has no stable equilibrium properties; it is

not converging to such a state. The trend of the prices is declining, so eventually
it may converge to zero ad infinitum, but the output is increasing in a cyclical
pattern. This divergence raises other questions. Do prices and quantities oscillate
with the same frequencies? Is there any co-movement between different sectors?
Figure 3 helps to decide on the first question, as it indicates the interference
between the oscillation of price and output. There is a lag, output follows price
changes with a delay. The speed of price increase start to diminish when output
reaches a local minimum and speed of price reduction start to fall when output is
at its local maximum. But we equally could say the same thing for changes in the
speed of output growth and local minimum and maximum of prices. These two
move in relation to each other but causality could run both ways.
Figure 4 gives some hint to answer the second question, indicating that the dif-
ferent sectors may have completely different cycles with different amplitude and
frequency. It could be the case that two sectors move with similar frequencies in
opposite direction while a third one follows a path alternating between the two
other sectors. This leads us to the fourth property.

Property 4: Output cycles follow price cycles with a delay. Different sectors may
follow rather different cyclical movements.

ln x1
t

ln p1
t

t
Figure 3. Comparison of output level and price

Source: authors

Society and Economy 40 (2018)

180 IMRE DOBOS – ISTVÁN ÁBEL

ln x1
t

ln x2
t

ln x3
t

Figure 4. Comparison of the otput levels of the economy

Source: authors

6. TECHNOLOGICAL CHANGE

What are the effects of changes in the input coefficients or changes in the coef-
ficients of stocks which could occur as a result of technological change? How
would this change the cyclical pattern?
First we will look at innovation which reduces the cost by reducing an input
coefficient: aij > a’ij,
For the numerical illustration we changed a12 in the input matrix A so we will
use the new A’ matrix in the computation:
 0.1 0.3  0.05 0.2 
A   0.5 0.2 0.4  ,
0.2 0.4 0.5

For illustration it is sufficient to take the result for the first product which is in
Figures 5 and 6, where y stands for the new output and q is the new price resulting
after the change in the input coefficient (aij > a’ij).
In Figure 5, the dashed line gives the path of the output after innovation. A re-
duction in the input coefficient leads to an increase in output which follows a
similar cyclical pattern as before innovation, although peaks and through are a
bit delayed also.

Society and Economy 40 (2018)

 A THEORY OF ECONOMIC CYCLE 181

ln x1
t

ln y1
t

t
Figure 5. Output levels before (x) and after (y) innovation

Source: authors

The result for the price is given in Figure 6 by the dashed line, the new price is
lower than before innovation and its cycle is also a bit delayed.

Property 5: Cost saving innovations resulting in lower input coefficients lead to

increased output level and lower prices. The new output and price follows the
same cyclical pattern as before, although with some delay.

ln p1
t

ln q1
t

t
Figure 6. Prices before (p) and after (q) innovation

Source: authors

Society and Economy 40 (2018)

182 IMRE DOBOS – ISTVÁN ÁBEL

Turning to the impact of innovation which in this example increases capital

intensity, i.e. innovation increases the stock coefficient: bij < b’ij, and the new
matrix is:
 0.01 0.03  0.01 0.02 
B   0.05 0.02 0.04  .
0.07 0.06 0.01

The resulting change for the output is illustrated in Figure 7. The new output
(dashed line) y indicates that innovations increasing capital intensity do not re-
sult in marked change in output levels but they significantly change the cyclical
pattern of outputs, reduce its frequency and the cycle is lengthened. This is not
surprising as in this case the turnover of capital is lengthened.
The same innovation will have a similar impact on prices (Figure 8) which will
move with outputs following a lengthened cyclical pattern.

Property 6: Innovation increasing capital intensity leads to lengthened cycles

with some delay.

ln x1
t

ln y1
t

t
Figure 7. Fluctuation of output levels in case of increased capital intensity

Source: authors

Society and Economy 40 (2018)

 A THEORY OF ECONOMIC CYCLE 183

ln p1
t

ln q1
t

t
Figure 8. Fluctuation of the prices in case of increased capital intensity

Source: authors

7. SUMMING UP

A simple framework of the non-equilibrium generalized Leontief-economy where

the sectors are identified with firms gives a transparent description of Bródy’s
theory of economic cycles. Using this framework, analytical solutions of the
models are not accessible, but numerical computations offer efficient means to
analyze and illustrate the cyclical patterns on the prices and quantities.
With appropriate (equilibrium) choice of initial conditions as a special case the
model’s analytical solution gives the well-known Neumann path (Neumann-ray).
This special case is equivalent with the classic dynamic Leontief model.
Bródy’s extensive research centered around the dynamic Leontief model,
but his theory of economic cycles departed from it by giving up the assumption
that the initial conditions satisfy the equilibrium conditions, that they are on the
Neumann-ray. Bródy examined the dynamics of an economy which started from a
non-equilibrium state. Choosing such initial conditions as departure for research
are more realistic. Non-equilibrium initial conditions always lead to cyclical out-
put and price patterns. Interestingly the cycle seems to move around the Neu-
mann-ray, but typically the equilibrium solution represented by the Neumann-ray
is not in the center of the cycle. The sectors (firms) typically follow very different
cycles often in opposite direction to one another. The cycles of prices and outputs
are intertwined but not identical, inflexion points in one correspond to peaks or
through in the other. Cycles on prices feed output cycles and vice versa. There

Society and Economy 40 (2018)

 184 IMRE DOBOS – ISTVÁN ÁBEL

is no convergence and there is no equilibrium in the system at any point in time.

When any element of the system seems to be in equilibrium there are forces in
action moving it out of this state.
In this simple framework it is easy to examine the impact of cost savings and
increasing capital intensity. Cost savings increase output and reduce prices while
the cycle is a bit delayed. Changes in capital intensity change the frequency of
cycles, increasing capital intensity lengthens the cycle.

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