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Virtuous circle and vicious circle

    In many parts of economics there is an assumption that a complex system of determinants will tend to lead to a state of equilibrium When this tendency is absent we use terms like '''virtuous circle''' and '''vicious circle''' (or virtuous cycle and vicious cycle) to describe these unstable pattern of events Both circles are complexes of events with no tendency towards equilibrium (at least in the short run) Both systems of events have feedback loops in which each iteration of the cycle reinforces the first (positive feedback) The difference between the two is that a virtuous cycle has favorable results and a vicious cycle has deleterious results These cycles will continue in the direction of their momentum until an exogenous factor intervenes and stops the cycle The prefix “hyper” is sometimes used to describe these cycles The most well known vicious circle is hyperinflation

    Example of a vicious circle in macroeconomics


    Vicious Circle

    Hyperinflation is where a spiral of inflation causes still more inflation in the future The initial exogenous event might be a sudden large increase in international interest rates or a massive increase in government debt due to the funding of a mega-project Whatever the cause the government could pay down some of its debt by printing more money (called monetarizing the debt) This increase in the money supply could increase the level of inflation In an inflationary environment people tend to spend their money quickly because they expect its value to decrease further in the future They convert their financial assets into physical assets while their money still has some purchasing power Often they will purchase on credit Because of this the level of savings in the country is very low and the government could have problems refinancing its debt It’s solution could be to print still more money starting another iteration of the vicious cycle


    Example of a virtuous circle in macroeconomics


    Virtuous Circle

    Economic growth can be seen as a virtuous circle It might start with an exogenous factor like technological innovation As people get familiar with the new technology there could be learning curve effects and economies of scale This could lead to reduced costs and improved production efficiencies In a competitive structure] this will likely result in lower average prices As prices decrease consumption could increase and aggregate output also Increased levels of output leads to more learning and scale effects and a new cycle starts


    Example of a virtuous circle in management


    Virtuous Circle

    An investment in your employees’ ability to provide superior service to customers can be seen as a virtuous circle Effort spent in selecting and training employees and creating a corporate culture in which they are empowered can lead to increased employee satisfaction and employee competence This will likely result in superior service delivery and customer satisfaction This in turn will create customer loyalty improved sales levels and higher profit margins Some of these profits can be reinvested in employee development thereby initiating another iteration of a virtuous cycle

    Example of a vicious circle in management

    A harvesting strategy can be an example of a vicious circle Rather than reinvesting in employee development new product development and marketing research management could decide to harvest their investment by reducing costs then increasing dividends or increasing executive compensation The consequence of this could be reduced employee wages minimal training an outdated product line and a failure to understand the needs of the customer This will likely result in employee dissatisfaction employee incompetence and high employee turnover This could cause poor service delivery customer dissatisfaction high customer turnover and loss of market share Reduced sales and lower profit margins may require a further reduction in investment thereby initiating another iteration of the vicious cycle

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    External sources

    • Schlesinger L. and Heskett J. (1991) Breaking the cycle of failure in services Sloan Management Review vol 31, spring 1991 pp17 - 28
    • http://william-kingwwwdrexeledu/top/prin/txt/gro/gro21bhtml - An introduction to 20th century virtuous circle theory

    External sources : Virtue in economics