If you have ever sat in a microeconomics course, then you are probably aware of the law of supply and demand. The law of supply states that the quantity of a good supplied rises as the market price rises, and falls as the price falls. Conversely, the law of demand says that the quantity of a good demanded falls as the price rises, and vice versa.
This article is based on findings of the Swiss historian Jean-Charles Sismondi who was the first to identify the occurrence of periodic economic crises and the work of the Frenchman Charles Dunoyer. Obviously this article is a big generalization of how the market works, but so is the theory of macroeconomy. We’ll try to explain why the economy supposedly works like a yo-yo in 4 steps.
1. During boom times when companies are receiving high returns on their investments and the profits keep increasing, it is very likely that the companies will increase production even more to satisfy the demand for these goods. The next logical step is that other companies see the market potential and try to take a stake of the profits as well by getting into the market. This leads to excess supply and market saturation.
2. Now that the market is saturated, the companies begin to cut prices to compete for customers and to stay at the top.
3. This leads to lower profits, lay-offs, and eventually into an economic depression.
4. However, companies begin to recover once prices become cheap enough to stimulate demand and credit becomes more available, which leads to an increase in demand and profits may go back up, delivering the yo-yo effect.
An early crisis that confirmed the yo-yo effect was the stock-market crash of 1825, which was one of the first documented crises caused solely by international economic events. Please note that the while the economy may work like a yo-yo doesn’t imply that the GDP stays the same after the up and downs, eventually there may be a strong tendency in the long-term process which may lead the GDP upwards or downwards in the big scheme of things.