Department of Economics Working Papers,
Vienna University of Economics and Business, Department of Economics

Abstract: Boom and bust cycles are widely documented in the literature on industry dynamics. Rigidities and delays in capacity adjustment in combination with bounded rational behavior have been identified as central driving forces. We construct a model that features only these two elements and we show that this is indeed sufficient to reproduce some stylized facts of a boom and bust cycle. The bifurcation diagrams summarizing the dynamic behavior reveal complex cycles and in particular also abrupt changes in the nature of these cycles. We apply new insights from the mathematical theory of piecewise smooth dynamic systems - in particular, results from the theory of border collision bifurcations - and show that the very existence of borders such as capacity constraints or nonnegativity constraints may lie behind abrupt changes in the dynamic behavior of economic variables.

Keywords: Boom and bust cycle, cobweb dynamics, piecewise smooth system, border collision bifurcation.

JEL-codes: B52; C61; C62; C63; D41 March 2012

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