A price shock has the opposite effect of technological change. If an essential resource becomes more expensive, people have less money to spend on other items. Businesses will need to reduce investments to cope with the reduction in consumer spending so consumer spending, investment and economic growth will decrease. An example is the recession of 1973-1975 that was partially caused by an increase in oil prices.
During good economic times, businesses and individuals are confident and credit is readily available, so they tend to increase their leverage. Future income projections of businesses and individuals are often the basis for banks to lend money. When the economy slows down and their income reduces, they can get into trouble. People would have more disposable income when they were out of debt and did not have to pay interest. Similarly, businesses can go bankrupt even when they are profitable overall because of interest charges.
For example, a business expects a return on investment of 8% and it can borrow at 6%. It makes sense use leverage and the business may have a financial capital of two thirds of total capital. If the return on capital turns out to be 3%, the business operates at a loss because of interest payments. If there was no leverage then the business would still operate at a profit. Leverage can add to economic instability as it fuels the boom as well as the bust.
Often businesses are not liquidated but taken over at a lower price. In that case competitors that are more conservatively financed suffer as the overinvestment has created a new competitor with a lower cost base. Some of those more conservatively financed competitors can go bankrupt as a consequence. Leverage can be an accelerator of economic change as it destroys the capital of the leveraged business as well as the capital of the more conservatively financed businesses.
Banks create money by issuing bank credit that can be redeemed for money. From time to time a bank cannot meet the demand for money of its depositors and then the bank goes bankrupt. Because banks hold deposits at other banks, one bank's financial troubles can cascade through the banking system. People can lose their confidence in the banking system and bank runs may ensue. Banks may stop lending money because they want to meet the demand from depositors for money.
This can cause a depression because a reduction in lending causes a reduction in spending and investments. During a depression business incomes drop in money terms so many businesses and people experience difficulty to repay their debts. This causes more businesses to go bankrupt and more people to become unemployed. More loans will then not be repaid and consequently more banks get into trouble. In this way a credit cycle can reinforce itself.
Technological developments often make older technologies obsolete and previous investments in those technologies worthless. In many cases those changes are accompanied by changes in the demanded quality and quantity of labour. Also the business cycle destroys existing capital in a similar way by creating businesses during a boom and destroying them during a slump.
Some Marxist theories state that existing wealth must be destroyed by war or economic crises in order to clear the ground for the creation of new wealth .
Related to the Marxist theories is the theory of creative destruction. It states that innovative entry by entrepreneurs is a disruptive force that sustains economic growth, even as it destroys the value of established companies and the skills of labourers that dominate the market because of previous technological, organisational, regulatory, and economic developments .
Usury and debt slavery
Ancient societies observed the adverse consequences of interest. Interest contributed to the concentration of money in the hands of a few people, while on the other hand many people were in debt or had become serfs of the money lenders. For that reason debts were forgiven from time to time . The Bible has provisions to forgive debts such as the Jubilee Year. Compound interest is infinite in the long run. This is only a problem when the money lenders do not spend the interest on their money but accumulate it.
When money became concentrated into the hands of a few, less money remained in circulation. It became more difficult to repay debts with interest because the debts and interest were fixed in money terms, while prices dropped and interest payments further reduced the available money in the hands of the public. The money lenders could take possession of the belongings of the borrowers and demand their labour as repayment. In this way many people became serfs of the money lenders. This phenomenon is called debt slavery.
Much of the study of economics involves the implications of government policies on the economy. Macro economic policies are the manipulation of taxes, expenses and money supply to achieve goals concerning economic activity, employment and price levels. Stated policy goals are often high economic activity, low unemployment and stable prices.