WEBVTT NOTE On the Structure of Production 1 00:00:00.000 --> 00:00:07.000 It's not that I'm a techno-phobe, but I have a jet lag, so it takes me about three times as much to do the things that I usually do. 2 00:00:07.000 --> 00:00:10.000 And therefore my lecture will last now 45 minutes. 3 00:00:10.000 --> 00:00:16.000 And that's how we will end the day. 4 00:00:16.000 --> 00:00:21.000 Well, I changed the title of my presentation in the meantime. 5 00:00:21.000 --> 00:00:28.000 As modeling the time structure of production, it's an offshoot of a current writing project, 6 00:00:28.000 --> 00:00:35.320 A project in which I am engaged which concerns revision of capital theory and one of the 7 00:00:35.320 --> 00:00:40.000 elements that seem to be important is the representation, the graphical representation 8 00:00:40.000 --> 00:00:46.960 of the time structure of production. 9 00:00:46.960 --> 00:00:53.560 In order to explain the problem in various ways and I will start from the point of view 10 00:00:53.560 --> 00:01:02.560 This is a preview of a recent paper that I published in 2008, namely the demand for present goods and the relationship between the demand of present goods and the time market. 11 00:01:02.560 --> 00:01:22.560 And then, in the light of these considerations, we'll talk about typical Austrian illustrations of the time market, namely triangles, which is the main one, Hayekian triangles or Javanese triangles, and then trapezoids, which have been introduced by Murray Rothbard. 12 00:01:22.560 --> 00:01:34.560 And then we'll turn to the proper interpretation of what I consider to be the proper interpretation of triangles and then turn lastly to the advantages of trapezoids. 13 00:01:34.560 --> 00:01:40.560 So rather than modeling the time structure of production, my talk could have been the case for trapezoids. 14 00:01:40.560 --> 00:01:47.560 So this is work in progress. I've published so far two papers on this. 15 00:01:47.560 --> 00:01:53.560 The first one is the time preference and investment expenditure in Profesos de Mercado three years ago. 16 00:01:53.560 --> 00:01:57.560 Then two years ago, the demand for money in the time structure of production. 17 00:01:57.560 --> 00:02:04.560 And then this paper, the time structure of production reconsidered, which is on my website. 18 00:02:04.560 --> 00:02:10.560 So for those of you who are interested in having a look at this, it does not contain my present presentation. 19 00:02:10.560 --> 00:02:16.560 Okay, so let's start with the relationship between the demand for present goods and the time market. 20 00:02:16.560 --> 00:02:26.560 In the traditional Austrian literature, we have the most detailed discussion in Murray Rothbard's Man Economy and State, 21 00:02:26.560 --> 00:02:33.560 and here Rothbard gives us an analysis of the factors determining the demand for present goods. 22 00:02:33.560 --> 00:02:57.560 First of all, a definition, so present goods are goods that can be used immediately, that do not require any further transformation, which distinguishes them from future goods, which do require further transformation in order to be turned into final goods that can be finally used, so consumer goods in particular, and tools. 23 00:02:57.560 --> 00:03:03.560 And then Rothbard answers two questions, namely, what determines the demand for present goods? 24 00:03:03.560 --> 00:03:09.560 And he gives the answer, the ultimate factor determining this demand is time preference. 25 00:03:09.560 --> 00:03:17.560 So one particularity of Rothbard's theory is not particular as compared to previous authors such as Mises or Fetter, 26 00:03:17.560 --> 00:03:22.560 is that both sides of what he calls the time market, that is the market for monetary capital, 27 00:03:22.560 --> 00:03:28.560 are determined exclusively by time preference, both the supply and the demand for present goods. 28 00:03:28.560 --> 00:03:35.560 Who demands present goods? So we have three, four major groups. 29 00:03:35.560 --> 00:03:41.560 The owners of original factors of production, that is laborers. 30 00:03:41.560 --> 00:03:45.560 The owners of raw materials. 31 00:03:45.560 --> 00:03:53.060 Third, we have the owners of produced factors of production, that is, intermediate goods, tools, capital goods, and so on. 32 00:03:53.060 --> 00:03:58.060 And fourth, we have people, consumers, who want to obtain consumer credit. 33 00:03:58.060 --> 00:04:02.060 So these are the four main groups who ask for present goods. 34 00:04:02.060 --> 00:04:09.560 So based on this theory, we can easily derive an explanation of the changes of the demand for present goods. 35 00:04:09.560 --> 00:04:22.560 These changes must result if one of those factors that determine the demand for present goods among the typical groups change. 36 00:04:22.560 --> 00:04:29.560 So we have here particular changes in time preference which can express itself in a greater willingness to work. 37 00:04:29.560 --> 00:04:34.560 We have the discoveries of new raw materials and immigration, 38 00:04:34.560 --> 00:04:40.320 So new original factors or additional quantities of original factors of production become available 39 00:04:40.320 --> 00:04:43.000 and we have new technology. 40 00:04:43.000 --> 00:04:48.720 And that is simply because Rothbard was reasoning so the equilibrium on the time market is being 41 00:04:48.720 --> 00:04:54.880 derived in a framework of general equilibrium or otherwise set in an evenly rotating economy 42 00:04:54.880 --> 00:05:00.240 and such an evenly rotating economy is constructed under the hypothesis that factor endowments 43 00:05:00.240 --> 00:05:12.240 So if one of those things changes, then we can get a variation in the demand for present goods. 44 00:05:12.240 --> 00:05:16.240 So how does this look then on the time market? 45 00:05:16.240 --> 00:05:27.240 And here then my contribution in this 2008 paper was to show that the consequence is different from the one that is typically envisioned in the Austrian literature. 46 00:05:27.240 --> 00:05:39.240 and literature, namely a general rise of time preference brings about an increase of the demand for money and a simultaneous reduction in the supply of present goods. 47 00:05:39.240 --> 00:05:49.240 So when we get into the inverse case, we have here, you see, why does the red dot disappear? 48 00:05:49.240 --> 00:06:00.240 So this is the old equilibrium here, this is the new equilibrium, so of course we can read it also the other way around, then we get the typical Austrian scenario. 49 00:06:00.240 --> 00:06:13.240 Let's suppose that this is the new equilibrium, the old equilibrium, and then from there we get an increased supply of present goods, so the supply curve shifts from here to here as one. 50 00:06:13.240 --> 00:06:25.240 Then we would get a new equilibrium at this point, but this would not represent a general decrease in time preference, 51 00:06:25.240 --> 00:06:33.240 but it would only represent an increase of the supply of present goods while the demand for present goods stays the same. 52 00:06:33.240 --> 00:06:39.240 That is, we suppose implicitly that the reduction of time preference concerns only the suppliers of present goods, 53 00:06:39.240 --> 00:06:45.240 of Present Goods, not the demanders of present goods, which is not a general decrease of time preference. 54 00:06:45.240 --> 00:06:51.240 So if we get a general decrease of time preference, we move from this equilibrium to this one, and the other way around. 55 00:06:51.240 --> 00:06:56.240 If the time preference generally decreases, we move from here to this point here. 56 00:06:56.240 --> 00:07:04.240 Oh, I'm trembling. It's time that I get a drink or something. 57 00:07:04.240 --> 00:07:07.240 And then we can consider various other circumstances. 58 00:07:07.240 --> 00:07:10.240 I'll just give you one other example here. 59 00:07:10.240 --> 00:07:15.240 A simultaneous increase of the supply of present goods and of the demand for present goods 60 00:07:15.240 --> 00:07:20.240 and then the equilibrium shifts out from this point to this point 61 00:07:20.240 --> 00:07:25.240 so we get a higher exchange, a higher volume of gross savings 62 00:07:25.240 --> 00:07:29.240 on the time market being exchanged at by and large the same interest rate. 63 00:07:29.240 --> 00:07:32.240 So there's no systematic impact on the interest rate. 64 00:07:32.240 --> 00:07:45.240 Now, of course, demand and supply do not necessarily have to change in the same direction and this implies a very important implication, namely that on the time market any combination of changes is possible. 65 00:07:45.240 --> 00:07:59.240 That is, we do not only have the combination that we typically underline in Austrian reasoning and Austrian literature, namely a higher savings rate and a lower pure rate of interest, 66 00:07:59.240 --> 00:08:10.240 But we get also a higher savings rate and a higher pure rate of interest or higher savings rate at a constant pure rate of interest or a higher and a lower pure rate of interest at a constant savings rate. 67 00:08:10.240 --> 00:08:18.240 I will focus later on in particular on this case here, the higher savings rate and a higher pure rate of interest. 68 00:08:18.240 --> 00:08:31.240 Now, from here then, the problem of my present talk is then how do we translate this into a graphical representation of the time structure of production. 69 00:08:31.240 --> 00:08:41.240 And the usual, the most commonly used graphical representation is the triangular representation according to Jevons and Hayek. 70 00:08:41.240 --> 00:09:11.240 So Jevons in 1871 and then Hayek in his Prices of Production in 1933 introduces and most, virtually all other Austrian authors have used the triangular form as well and so what we see here is that at some point, this needs to be read from left to right, the production process starts at some point of time removed from final consumption which is here and then produces 71 00:09:11.240 --> 00:09:27.240 First, intermediate goods, and then finally, so intermediate goods are transformed, increase in monetary value, and finally are transformed into consumer goods, which are sold at this exchange value, this payment. 72 00:09:27.240 --> 00:09:35.040 Now, in Rothbard, we get to find a trapezoid representation of the time structure, which 73 00:09:35.040 --> 00:09:36.480 is therefore somewhat different. 74 00:09:36.480 --> 00:09:44.760 We see, of course, in the trapezoid form, this line, which represents the progressing 75 00:09:44.760 --> 00:09:49.960 exchange value of the intermediate goods and of the final goods, does not cross the 76 00:09:49.960 --> 00:10:01.960 The structure of production starts at some positive value, which is not zero, and this is significant and important, and helpful, especially. 77 00:10:01.960 --> 00:10:16.960 So the point is now to explain why this is helpful, and in order to do this we will first have a look at, well first of all to show that the traditional scenario can be illustrated with both representations. 78 00:10:16.960 --> 00:10:42.960 The adjustment of the structure of production in the tradition Hayekian scheme works like this, so we start off with this structure of production here in blue and then we get on the time market an increase of the supply of present goods at a constant demand which entails a greater volume exchange, so greater savings rate at a lower price that is at a lower interest rate. 79 00:10:42.960 --> 00:10:54.960 Now this entails, therefore, because the savings rate increases, the final consumer expenditure diminishes and because the interest rate diminishes, the curve becomes flatter. 80 00:10:54.960 --> 00:11:01.960 So this is the traditional way of illustrating this and we can do the same thing with Rothbard's trapezoid diagram. 81 00:11:01.960 --> 00:11:10.960 We start here from the curve A and then on the time market there's an increased supply of present goods. 82 00:11:10.960 --> 00:11:11.960 Present Goods 83 00:11:11.960 --> 00:11:21.120 So the curve becomes flatter and the structure becomes longer. 84 00:11:21.120 --> 00:11:29.000 Now if we turn to another case we will see that we, the case that we discussed before 85 00:11:29.000 --> 00:11:33.200 namely higher savings rate and a higher interest rate so we suppose here that the supply of 86 00:11:33.200 --> 00:11:37.080 present goods remains the same but there is an increase of the demand for present goods 87 00:11:37.080 --> 00:11:41.560 for whatever reason, one of the changes that we considered before, and we ask ourselves 88 00:11:41.560 --> 00:11:47.520 how can this be represented, the corresponding changes in the time structure, how can these 89 00:11:47.520 --> 00:11:52.440 be represented graphically, well the answer is they cannot be represented graphically 90 00:11:52.440 --> 00:12:00.140 with a traditional triangle, and the reason is that in a triangle the curve would have 91 00:12:00.140 --> 00:12:05.520 to become steeper and at the same time the volume that is under the curve would have 92 00:12:05.520 --> 00:12:25.520 If the curve becomes steeper and starts at the same point, or even at a lower point because the savings rate increases, then the volume under the curve of the surface becomes smaller, so the savings rate would have to necessarily diminish. 93 00:12:25.520 --> 00:12:34.520 So this constellation that we find here on the time market, increasing pure interest rate and a higher savings volume could not be represented with a triangle. 94 00:12:34.520 --> 00:13:04.520 But it can be illustrated with a trapezoid, so we have one first advantage, and what we see is the following, the savings rate increases, so consumer expenditure diminishes, and the curve becomes steeper, so you see they move out from one another, and the volume under this curve is, well here it's not very beautifully, but you can construct such cases more and more clearly, in which the volume under this curve, the surface under this curve, is bigger than the surface under the blue curve. 95 00:13:04.520 --> 00:13:09.520 So what then is the proper interpretation of triangles? 96 00:13:09.520 --> 00:13:13.520 What are the premises that we have to make? 97 00:13:13.520 --> 00:13:19.520 The first one is we have unchanging monetary conditions in an evenly rotating economy. 98 00:13:19.520 --> 00:13:22.520 The question is do we have any money at all in an evenly rotating economy? 99 00:13:22.520 --> 00:13:26.520 It's a different question, so I assume we have unchanging monetary conditions. 100 00:13:26.520 --> 00:13:33.520 And then in the evenly rotating economy we have these three or four mentioned premises, conditions 101 00:13:33.520 --> 00:13:36.520 that we find also in the Austrian literature. 102 00:13:36.520 --> 00:13:40.520 Rothbard stresses that we always assume unit services, 103 00:13:40.520 --> 00:13:44.520 otherwise we couldn't get a progression of value across time. 104 00:13:44.520 --> 00:13:50.520 But then, and these are the two additional premises that I wish to stress now, 105 00:13:50.520 --> 00:13:53.520 there are in fact no purchases of factors of production. 106 00:13:53.520 --> 00:13:59.520 And the product here that matures from intermediate products into a final good 107 00:13:59.520 --> 00:14:02.520 is only sold from one capitalist to another. 108 00:14:02.520 --> 00:14:10.520 There is never any sale of a factor of production from the owner of an original factor to a capitalist. 109 00:14:10.520 --> 00:14:15.520 Otherwise said, all owners of original factors of production are capitalists. 110 00:14:15.520 --> 00:14:19.520 All capitalists use factors of production that they own themselves. 111 00:14:19.520 --> 00:14:25.520 For example, their own labor and their own raw materials. These are never purchased. 112 00:14:25.520 --> 00:14:40.520 Translated in other terms, the typical Hayekian triangle representation of a time structure of production corresponds to an economy exclusively composed of producer cooperatives. 113 00:14:40.520 --> 00:14:48.520 And the last point is that we can only illustrate primitive structures. 114 00:14:48.520 --> 00:15:02.520 Now, by a primitive structure, I mean a structure of production that always starts without capital goods, that is, the value of the original factor is always zero at the beginning, or close to zero at the beginning. 115 00:15:02.520 --> 00:15:07.520 There is no use of capital goods in the highest stage of production. 116 00:15:07.520 --> 00:15:17.520 And this, of course, corresponds to the case discussed in Rothbard's textbook, which starts off with the example of a primitive, a cruiser type economy, 117 00:15:17.520 --> 00:15:29.520 But it does not correspond to the conditions that we find in a modern economy in which even those stages of production furthest removed from the production of final consumer goods operate with capital goods produced in later stages. 118 00:15:29.520 --> 00:15:46.520 So this would be an advanced economy. So we have these two. So it makes that the triangular representation is not wrong, but it corresponds to a very specific set of conditions that are not representative of our present day conditions. 119 00:15:46.520 --> 00:15:48.600 So what about trapezoids? 120 00:15:48.600 --> 00:15:53.000 Here we have to use the first three premises as well, 121 00:15:53.000 --> 00:15:54.800 but trapezoids give us the advantage 122 00:15:54.800 --> 00:15:57.600 that we can do without the last two premises. 123 00:15:57.600 --> 00:15:59.920 That is, we can here assume that there are purchases 124 00:15:59.920 --> 00:16:00.920 of factors of production, 125 00:16:00.920 --> 00:16:03.040 namely the factors of productions are purchased here. 126 00:16:03.040 --> 00:16:06.280 Here we have the purchase initially of, for example, 127 00:16:06.280 --> 00:16:08.560 original factors of production. 128 00:16:08.560 --> 00:16:13.200 And fifth, we can also represent advanced structures 129 00:16:13.200 --> 00:16:22.200 By introducing one additional element, namely that we have a reinterpretation of the structure. 130 00:16:22.200 --> 00:16:28.200 The structure needs to be interpreted as a forward-looking tool, not as a backward-looking tool. This is important. 131 00:16:28.200 --> 00:16:36.200 You see here on the abscess I put length of production in terms of planned numbers of stages. 132 00:16:36.200 --> 00:16:41.200 So we are looking from the point of time at which we are finding ourselves right now, 133 00:16:41.200 --> 00:16:50.200 And from this point of time, of course, all producers' goods that have been produced in the past and all intermediate goods are like original factors of production. They are there. 134 00:16:50.200 --> 00:16:57.200 So they can be interpreted exactly as original factors of production. So we get this type of structure. 135 00:16:57.200 --> 00:17:09.200 So this case that we have here, so I put it in blue, this surface in blue corresponds to the savings volume. 136 00:17:09.200 --> 00:17:23.200 This structure here corresponds to a case in which all factors that are being bought are bought only in the last stage of production, which is not the case in empirical practice, but this is useful for illustrative purposes. 137 00:17:23.200 --> 00:17:29.200 If you read my paper, you'll see I use this a lot because it simplifies numerical illustrations. 138 00:17:29.200 --> 00:17:39.200 and it can be changed very easily by adjusting the trapezoid representation with the case in which factors are purchased at each stage and then it would look something like this. 139 00:17:39.200 --> 00:17:49.200 So you see here we have the same interest rate at each stage, this and this, and then at each stage we have this capital or these capitalists operating in this stage here. 140 00:17:49.200 --> 00:17:56.200 They buy original factors of production here in this volume and because it's forward-looking they also buy produce factors of production 141 00:17:56.200 --> 00:18:04.200 and they produce factors of production from owners of the businesses in the stage before. 142 00:18:04.200 --> 00:18:06.200 So we have a great flexibility here. 143 00:18:06.200 --> 00:18:12.200 And so this gives us the following conclusions, namely three main conclusions. 144 00:18:12.200 --> 00:18:19.200 The conventional triangular illustration is suitable, but suitable only for a very limited set of circumstances. 145 00:18:19.200 --> 00:18:47.960 of Circumstances, and these are defined by the prevalence of producer cooperatives and primitive structures of production, whereas trapezoids can be used to illustrate all possible changes on the time market and therefore a more flexible tool to represent changes on the time market and on the time structure of production. Thank you for your attention!