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New Earth Mining

In: Business and Management

Submitted By james940
Words 1024
Pages 5
Assignment 3
Question 1
According to Irving Fisher, “money illusion” caused business cycles. Briefly explain.
Fisher’s usage of the term money illusion is used to differentiate the real interest rates to nominal interest rates. This term basically defines consumer’s inability to realize the difference in a nominal term of a dollar to a purchasing power of a dollar, which takes into account of the inflation rate. In other words, people did not realize about the effects of inflation on their standard of living and purchasing power. For example, people were just happy with nominal increase of their wages, even though they were losing out due to bigger inflation rate. This could have been due to lack of financial education and price stickiness spotted from goods and services.
Fisher believed that money illusion is somewhat the cause of business cycles. Whenever the economy is in a state of booming there follows high inflation. This causes the nominal interest rates to rise, and hence make businesses to feel that the real interest rates are also high, leading to less borrowing and investments. This however, pulls the economy down and gradually slows the economy leading to a vicious cycle. This pattern is the same for the vice versa situation. Expansions and contractions in an economy create money illusion in the process and stop each stage and reverse the economic activities. With expansionary and contractionary phases, banks have to make corresponding judgment and alter their nominal interest rates, followed by real interest rates. And, this kind of phenomenon is thought as the cause of the business cycle, by Fisher.

Question 2
What were the causes of business cycles found by Schumpeter?
Schumpeter is an economist who first researched the business cycles and the fluctuations. He identified 3 different phases of the business cycle.
First phase was known as the...

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