WEBVTT NOTE Capital, Interest, and Profit 1 00:00:00.000 --> 00:00:04.560 We've said before that businessmen are aiming to maximize profit, but we haven't really 2 00:00:04.560 --> 00:00:09.160 gotten into the question of not so much what profit is or what explains it and therefore 3 00:00:09.160 --> 00:00:14.360 what justifies it. Where does profit come from? Why is there profit? What are the economic 4 00:00:14.360 --> 00:00:21.160 functions that it performs, etc.? First, profit is defined as total revenue minus total cost, 5 00:00:21.160 --> 00:00:27.240 and then if we're interested in the ratio, it's that over, say, total investment or 6 00:00:27.240 --> 00:00:37.440 The first thing to be done about profit is to separate profits into two very different 7 00:00:37.440 --> 00:00:42.320 kinds of returns, both of which are amalgamated into the accounting concept of profit. 8 00:00:42.320 --> 00:00:48.840 In other words, what is profit on the books of a firm really includes two very different 9 00:00:48.840 --> 00:00:55.080 kinds of returns, two very different kinds of reasons. 10 00:00:55.080 --> 00:01:03.600 The long-run profit does not mean it only appears in the long run, it means that long-run 11 00:01:03.600 --> 00:01:11.800 profit is sort of an underlying return which capital investment sees as a sort of a continuing 12 00:01:11.800 --> 00:01:14.200 vector in the day-to-day situation. 13 00:01:14.200 --> 00:01:19.520 So that's long-run profit, which as we'll see tends to be uniform throughout the system. 14 00:01:19.520 --> 00:01:24.880 That is not uniform, but tends to be uniformity, it's an important distinction. 15 00:01:24.880 --> 00:01:29.640 And the second category is short-run profit, which comes from completely different reasons 16 00:01:29.640 --> 00:01:33.760 and could well be and often is short-run losses. 17 00:01:33.760 --> 00:01:39.240 So we have what is called the profit and loss system in the economy, much more accurately 18 00:01:39.240 --> 00:01:42.480 than the so-called profit system, because of course there are many firms that do make 19 00:01:42.480 --> 00:01:43.480 losses. 20 00:01:43.480 --> 00:01:51.040 I think, for example, heroic entrepreneurs happen to be my uncles who were pharmacy store 21 00:01:51.040 --> 00:01:56.620 Capitalist entrepreneurs back in the thirties. They had a chain of, I think, two or three 22 00:01:56.620 --> 00:02:02.720 drug stores at the height of their entrepreneurial career. They quickly went bankrupt, not just 23 00:02:02.720 --> 00:02:05.920 because of the depression, but because there were many other forms of the door that did 24 00:02:05.920 --> 00:02:10.400 not go bankrupt. At any rate, they went bankrupt, revealing themselves and themselves into the 25 00:02:10.400 --> 00:02:15.400 world at large, those who were interested, as lousy entrepreneurs, after which they entered 26 00:02:15.400 --> 00:02:20.640 the ranks of the proletariat, in quotes, in other words, became wage earners. 27 00:02:20.640 --> 00:02:27.440 So, entrepreneurs often do suffer losses. This can easily be seen in one form of entrepreneurship, 28 00:02:27.440 --> 00:02:36.560 it's quite obvious, namely, purchase of stocks and commodities, where, again, some people 29 00:02:36.560 --> 00:02:40.680 are good entrepreneurs, some people are bad ones, and we'll see in a minute what accounts 30 00:02:40.680 --> 00:02:47.200 for this. The short-run profit, the whole realm of short-run profit and loss was unknown 31 00:02:47.200 --> 00:02:50.880 Welcome to 19th century economics, and there are many things, when I say that I mean all 32 00:02:50.880 --> 00:02:57.640 19th century economists, both Ricardo and Marx and also the Austrians, my particular 33 00:02:57.640 --> 00:03:02.600 favorites, they did not analyze, they did not explore the realm of short run profit 34 00:03:02.600 --> 00:03:04.400 and short run losses. 35 00:03:04.400 --> 00:03:11.360 Their eyes were fixed largely on long run considerations on so-called equilibrium situations. 36 00:03:11.360 --> 00:03:15.240 By equilibrium again, I don't mean day to day equilibrium, but long run equilibrium, 37 00:03:15.240 --> 00:03:20.040 and also called evenly rotating economy or final equilibrium, and so they're interested 38 00:03:20.040 --> 00:03:25.600 having their eyes on a longer or larger picture, they tended to ignore short run considerations, 39 00:03:25.600 --> 00:03:29.480 they figured that will all wash out in the long run, but of course the short run doesn't 40 00:03:29.480 --> 00:03:33.640 wash out because there's always a series of short runs as we'll see as we go along, the 41 00:03:33.640 --> 00:03:39.400 short run is always with us, it's always dominant, but the 19th century economics left this out 42 00:03:39.400 --> 00:03:45.180 of the Picture, and therefore left a very essential part of the explanation of profits 43 00:03:45.180 --> 00:03:51.320 out of their analysis. It was Frank Knight, who was the founder of what we can call the 44 00:03:51.320 --> 00:03:57.040 older Chicago School, the economist at the University of Chicago, who wrote a famous 45 00:03:57.040 --> 00:04:02.300 and brilliant PhD thesis, one of the top two or three PhD theses in the history of economic 46 00:04:02.300 --> 00:04:08.860 thought, Risk Uncertainty and Profit, which came out in 1921, where Knight single-handedly 47 00:04:08.860 --> 00:04:13.300 He brought the analysis of short-run profits into the picture and came up with the correct 48 00:04:13.300 --> 00:04:14.300 solution. 49 00:04:14.300 --> 00:04:20.580 He also messed up completely the theory of competition, but that we get to another time. 50 00:04:20.580 --> 00:04:25.780 In the theory of profits, however, Knight came up with the definitive formulation that 51 00:04:25.780 --> 00:04:27.980 he didn't deal with long-run profits at all. 52 00:04:27.980 --> 00:04:33.380 He dealt with it unsatisfactorily, but really not much at all. 53 00:04:33.380 --> 00:04:37.220 He dealt with a short-run and close situation. 54 00:04:37.220 --> 00:04:42.260 What he said was that profits, in the short-run sense, arise from uncertainty, the fact that 55 00:04:42.260 --> 00:04:43.260 the world was uncertain. 56 00:04:43.260 --> 00:04:47.740 See, the problem is that most economists in the past tended to think of the world as more 57 00:04:47.740 --> 00:04:48.740 or lessividely certain. 58 00:04:48.740 --> 00:04:52.520 In other words, you look at the situation, you say, well, we more or less know what the 59 00:04:52.520 --> 00:04:58.680 future is going to hold as far as demand goes and costs and so forth, which of course leaves 60 00:04:58.680 --> 00:05:03.420 out an essential part of the picture, which is that the world is uncertain, that supplies 61 00:05:33.420 --> 00:05:38.420 and then they go up and other people buy stocks and then they go down. 62 00:05:38.420 --> 00:05:45.420 This is not, however, a scientific, which we'll return to, it's not a scientific, it's not an applied science of forecasting. 63 00:05:45.420 --> 00:05:50.420 If it were, it would be like forecasting the comets and sort of thing. 64 00:05:50.420 --> 00:05:54.420 Instead, it's a high art because it involves not only your knowledge, general knowledge, 65 00:05:54.420 --> 00:05:59.420 it also involves detailed insight into the market and what's going on, 66 00:05:59.420 --> 00:06:12.420 and your specific knowledge of concrete events, which often keep changing, so you have to sort of also involve punches and involves personal entrepreneurship or personal artistry, which some people have and some people don't. 67 00:06:12.420 --> 00:06:22.420 What it involves again is seeing gaps in the market. In other words, what you have really, in the long run, touching on long run profits, in the long run, profits will tend to be the same. 68 00:06:22.420 --> 00:06:52.420 In other words, posing the Angel Gabriel came down and says to the earth, I'm going to turn to Angel Gabriel later on as a convenient hypothesis, Angel Gabriel comes to the earth and freezes everything, in other words, he declares a freeze, much more expensive than the Nixon freeze of Orga 71, he freezes all value scales, everybody from now on will have the same value scale, all resources are frozen, so that any copper taken out of the ground will sort of magically be restored, all technology is frozen. Given that, given the 69 00:06:52.420 --> 00:06:56.220 The freezing of all consumer demands, the consumer value scale, given the freezing of 70 00:06:56.220 --> 00:07:02.220 supply, so that an old stonemason dies, he's magically replaced by a young stonemason, 71 00:07:02.220 --> 00:07:03.220 so forth and so on. 72 00:07:03.220 --> 00:07:09.180 Given this kind of model, then in a few years, which would have the following situation, 73 00:07:09.180 --> 00:07:14.780 you would have, for example, certain industries that are making 30% profits, others are making 74 00:07:14.780 --> 00:07:15.780 suffering losses. 75 00:07:15.780 --> 00:07:20.340 This means that capitalists will enter the profitable industries and get out of the losing 76 00:07:20.340 --> 00:07:21.340 industry. 77 00:07:21.340 --> 00:07:25.340 The point is, when you freeze everything, you see the conclusion of all this. 78 00:07:25.340 --> 00:07:28.340 They'll flood into the superior, the profit-making industries. 79 00:07:28.340 --> 00:07:39.340 As they flood into the high-profit industries, production increases, supply curve shifts to the right, the price falls, costs are bid up, wage rates, raw materials, et cetera, in that industry. 80 00:07:39.340 --> 00:07:44.340 And you wind up, eventually, in a couple of years, let's say, with a uniform profit rate. 81 00:07:44.340 --> 00:07:47.340 What the uniform profit rate is, what it comes from, we'll get to later on. 82 00:07:47.340 --> 00:07:50.340 Let's say it's 8%, just for the heck of it. 83 00:07:50.340 --> 00:08:20.340 So we'll get to the uniform 8% and stop. In the meantime, those firms that are now in the capitalist, investing in the losing industry, say the hula hoop industry, now the hula hoops are more or less defunct, we'll get out of there, stop making losses, move into other profitable industries, and whatever hula hoop firms exist, if any do exist, we'll also be making 8%. There's still a couple of horse and buggy manufacturers. They're not very big. They make, say, horse and buggies for Central Park horse and buggy market. 84 00:08:20.340 --> 00:08:23.820 Presumably they're making the usual uniform rate of profit. 85 00:08:23.820 --> 00:08:29.500 So you wind up then, if you freeze everything, if you have this magic permanent freeze, you 86 00:08:29.500 --> 00:08:32.700 wind up with a uniform profit rate throughout the whole system. 87 00:08:32.700 --> 00:08:36.340 Every firm, every industry is making this long-run normal rate of profit. 88 00:08:36.340 --> 00:08:41.260 And I say, we'll get to later what determines long-run normal rate of profit, why it exists 89 00:08:41.260 --> 00:08:42.800 in the first place, etc., etc. 90 00:08:42.800 --> 00:08:47.900 Right now we're focusing on the fact that short-run profits tend to disappear given 91 00:08:47.900 --> 00:08:49.380 a freeze, in other words, given certainty. 92 00:08:49.380 --> 00:08:53.060 If you know that there's a freeze, if you know that the freeze will persist forever, 93 00:08:53.060 --> 00:08:58.380 then you have certainly what the future will lie, you know with certainty what future consumer 94 00:08:58.380 --> 00:09:03.340 demands will be, what future costs will be, etc., and then you make your changes and you 95 00:09:03.340 --> 00:09:09.540 wind up, after six months, two years, whatever the time period, after this time period, you 96 00:09:09.540 --> 00:09:13.540 wind up with an evenly rotating economy where everybody's making, every firm is making 97 00:09:13.540 --> 00:09:18.500 up 8% or 6%, whatever the uniform rate is. In other words, short-run profits and short-run 98 00:09:18.500 --> 00:09:25.300 Profits and losses are wiped out. Obviously, the reason we have persisting short-run profits 99 00:09:25.300 --> 00:09:28.940 and losses and why they keep changing all the time, fluctuating, appearing, popping 100 00:09:28.940 --> 00:09:33.640 up here and there, is because we don't have certainty, we have uncertainty, we have changes 101 00:09:33.640 --> 00:09:39.100 all the time, and all of these factors, changes in consumer values, changes in resources, 102 00:09:39.100 --> 00:09:45.100 changes in technology, etc. So what the function then, the profit maker, is engaged in a forecasting 103 00:09:45.100 --> 00:09:46.100 and Function. 104 00:09:46.100 --> 00:09:47.100 It's forecasting plus investment. 105 00:09:47.100 --> 00:09:49.420 I mean, forecasting with a bite, so to speak. 106 00:09:49.420 --> 00:09:52.540 It's not just forecasting as an abstract sociologist. 107 00:09:52.540 --> 00:09:55.380 It's forecasting with a pocketbook. 108 00:09:55.380 --> 00:10:00.120 He's investing money, and by doing this, he's forecasting where he thinks he will make a 109 00:10:00.120 --> 00:10:01.380 profit and not make a loss. 110 00:10:01.380 --> 00:10:02.900 This is not determined in advance. 111 00:10:02.900 --> 00:10:05.340 There's no guarantee that he's not going to make losses. 112 00:10:05.340 --> 00:10:07.860 There's no guarantee he'll make high profits. 113 00:10:07.860 --> 00:10:13.220 It all depends on his superior forecasting, in other words, forecasting better than his 114 00:10:13.220 --> 00:10:14.220 competitors. 115 00:10:14.220 --> 00:10:17.900 In the stock market, where it's clear this is what happens, the superior forecasters make 116 00:10:17.900 --> 00:10:22.980 heavy profits, the mediocre forecasters sort of peg along, break even, the lousy forecasters 117 00:10:22.980 --> 00:10:26.180 go out of business eventually and make severe losses. 118 00:10:26.180 --> 00:10:30.420 What you have then is the entrepreneur, in quotes, in other words, the capitalist as 119 00:10:30.420 --> 00:10:35.740 entrepreneur, as undertaker, so to speak, as risk taker, as uncertainty bearer, gains 120 00:10:35.740 --> 00:10:40.900 profits from superior forecasting. Superior forecasting for what? Superior forecasting 121 00:10:40.900 --> 00:10:45.720 and the best ways of meeting the most urgent consumer demand. In other words, the superior 122 00:10:45.720 --> 00:10:49.680 forecasters, he looks at the market and he sees, aha, there's not enough, whatever it 123 00:10:49.680 --> 00:10:53.700 is, tungsten production, let's say. If I go into the tungsten business and I open up a 124 00:10:53.700 --> 00:10:57.400 new tungsten mine or produce more tungsten or whatever, I'll be able to make high profits 125 00:10:57.400 --> 00:11:02.900 because they're not making enough now to satisfy consumer demands. He might think of a better 126 00:11:02.900 --> 00:11:08.660 way of producing tungsten. He might invent a new process or his brother-in-law might 127 00:11:08.660 --> 00:11:14.900 of a New Process, finances, or whatever. Again, he sees better than the other people, better 128 00:11:14.900 --> 00:11:18.980 than his competitors, where there are gaps in the market, where there are profit opportunities 129 00:11:18.980 --> 00:11:24.140 to be made, and then nips in to fill them. By filling these profit opportunities, he 130 00:11:24.140 --> 00:11:29.260 is increasing consumer welfare, because what he's doing is he's filling these gaps. In 131 00:11:29.260 --> 00:11:34.020 other words, he's kind of zipping in there to take advantage of these high profit opportunities, 132 00:11:34.020 --> 00:11:40.860 by directing production into those areas where consumers most urgently demand further resources, 133 00:11:40.860 --> 00:11:47.860 further production. So in other words, higher profits are an indicator of a superior, not 134 00:11:47.860 --> 00:11:52.860 only forecasting ability, but a superior ability in satisfying consumer, urgent consumer needs 135 00:11:52.860 --> 00:11:58.780 as quickly and as efficiently as possible. Low profits or losses are an indicator of 136 00:11:58.780 --> 00:12:04.780 for having wasted resources, being a lousy forecaster, have invested in areas where consumers 137 00:12:04.780 --> 00:12:09.540 either did not want the product too much, or there was a low demand for it, or invested 138 00:12:09.540 --> 00:12:10.940 in an inefficient manner. 139 00:12:10.940 --> 00:12:15.740 For example, this is only what the government can do because the government has no compunction 140 00:12:15.740 --> 00:12:20.180 as not to suffer losses because the taxpayer picks up the tab, is forced to pick up the 141 00:12:20.180 --> 00:12:21.180 tab. 142 00:12:21.180 --> 00:12:24.780 There's the famous British groundnut scheme in West Africa about 20 years ago or so when 143 00:12:24.780 --> 00:12:30.780 The British government invested or caused to invest in an enormous acreage of peanuts, 144 00:12:30.780 --> 00:12:36.080 known in England as groundnuts. Some joker had the idea that the West African soil, whatever 145 00:12:36.080 --> 00:12:41.340 is suitable for peanuts, is an enormous investment, all of which went down to two. Usually private 146 00:12:41.340 --> 00:12:45.240 entrepreneurs don't do this because they have to be very cautious about investing correctly, 147 00:12:45.240 --> 00:12:50.380 which governments don't. In other words, there's all sorts of losses or embodiment 148 00:12:50.380 --> 00:12:54.880 of Malinvestment. In other words, the embodiment of the fact that the guy has wasted resources. 149 00:12:54.880 --> 00:12:59.120 So we have a very peculiar situation. And another thing I should say is that the high 150 00:12:59.120 --> 00:13:04.340 profit person, the firm that earns high profits, is pointing the way toward other firms to 151 00:13:04.340 --> 00:13:08.300 get into this industry. In other words, if let's say there's a firm invested in Tungsten 152 00:13:08.300 --> 00:13:12.660 and has a high profit in there, he's sort of pointing the road and saying, look, here's 153 00:13:12.660 --> 00:13:17.060 an area with a big gap in the market, big gap in filling consumer demand, and this is 154 00:13:17.060 --> 00:13:26.980 In the other hand, of course, the guy who loses money in peanuts is an indicator in 155 00:13:26.980 --> 00:13:31.900 a beacon light to other capitalists, stay out of peanuts, this is not the place to invest. 156 00:13:31.900 --> 00:13:39.220 So therefore, the profit maker of a capitalist who earns these profits from superior forecasting 157 00:13:39.220 --> 00:13:43.900 etc. is performing an enormous social service to the consumer, in addition to making profits 158 00:13:43.900 --> 00:13:49.180 And yet we have a peculiar situation in the current culture where the profit-maker is 159 00:13:49.180 --> 00:13:56.380 bitterly attacked and the loss-maker is slobbered over by writers and lecturers, etc. 160 00:13:56.380 --> 00:14:00.340 So in other words, in the current energy crisis, the oil companies are bitterly attacked for 161 00:14:00.340 --> 00:14:01.340 earning high profits. 162 00:14:01.340 --> 00:14:05.260 Instead of saying, hey, this is a great thing that you're earning high profits, an indication 163 00:14:05.260 --> 00:14:10.740 of being in an area where consumers need more stuff and we hope that other people will join 164 00:14:10.740 --> 00:14:15.380 in this great endeavor, producing more oil. Instead of that, we're attacking oil companies 165 00:14:15.380 --> 00:14:19.620 for the fact that they're making profits as a sign that somehow they're evil. On the other 166 00:14:19.620 --> 00:14:24.860 hand, we have other companies which are suffering losses chronically, say Lockheed or Penn Central, 167 00:14:24.860 --> 00:14:28.500 and the government and intellectuals feel compelled to rush to their defense, to subsidize 168 00:14:28.500 --> 00:14:32.940 them, to keep them floating forever, and thereby, of course, subsidizing their constant waste 169 00:14:32.940 --> 00:14:36.500 of resources, waste of land, labor, and capital, which would be better used, let's say, in 170 00:14:36.500 --> 00:14:39.380 and Oil, or some other profitable industry. 171 00:14:39.380 --> 00:14:43.860 So we have this peculiar situation where the people who make losses are weeped over and 172 00:14:43.860 --> 00:14:49.660 subsidized, whereas the people who make profits are culminated and profits taxed away or they're 173 00:14:49.660 --> 00:14:56.060 hobbled in all sorts of ways, thus of course penalizing efficient service of the consumer 174 00:14:56.060 --> 00:15:01.420 demands, consumer needs, and subsidizing inefficient and crummy service of consumer needs. 175 00:15:01.420 --> 00:15:05.300 It doesn't make too much sense, except of course if you want to smash the system altogether. 176 00:15:05.300 --> 00:15:12.340 Okay, so this is the function of the so-called short-run profit. 177 00:15:12.340 --> 00:15:20.420 As a marvelous illustration of the function of the entrepreneur and what the entrepreneur 178 00:15:20.420 --> 00:15:25.900 does in one of the great Somerset and More movies that appeared about 25, 30 years ago, 179 00:15:25.900 --> 00:15:30.060 I forget whether it was Trio or Quartet, one of these short subject things. 180 00:15:30.060 --> 00:15:33.980 And one of them was Morem's great short story called The Verger, and it's a charming story 181 00:15:33.980 --> 00:15:42.980 I want to tell you about this fairly elderly fellow who was a verger, in other words, a deacon, no, a sexton, I guess, at the St. Paul's Church, a small church in London. 182 00:15:42.980 --> 00:15:51.980 A new pastor comes in and wants to make the place efficient and rev it up. He finds with horror the sweet old verger performing his duties with great diligence, etc. 183 00:15:51.980 --> 00:15:55.980 He finds out this guy can't read. He says, this is a terrible thing. You're illiterate. 184 00:15:55.980 --> 00:16:00.980 What a shame this is for the community to have a verger of this great church that can't read. 185 00:16:00.980 --> 00:16:07.980 So he tries to force him to learn how to read and write, and the guy says, yes sir, I'll try to learn, but he can't do it, he can't read or write. Sorry sir, I'm too old. 186 00:16:07.980 --> 00:16:18.980 And so the pastor kicks him out, gives him a terminal leave, and he's walking the streets, very disconsolate, and here he is in fire, and he's 55 years old, whatever he was. 187 00:16:18.980 --> 00:16:25.980 He's walking the streets, he feels the need for a cigarette, he's pacing, he's walking down the streets of the neighborhood, looking for a tobacco in his shop, can't find one. 188 00:16:55.980 --> 00:16:59.480 He tells me you should go to open up a bank account, let them invest for you, etc. 189 00:16:59.480 --> 00:17:05.480 So he goes to this bank, he plops all his money on the desk, there's almost no money on the desk. 190 00:17:05.480 --> 00:17:07.480 And he says, I'd like to open a bank account, etc. 191 00:17:07.480 --> 00:17:09.480 He says, yes, yes, sir, of course. 192 00:17:09.480 --> 00:17:12.480 And the bank manager gives him the forms to fill out. 193 00:17:12.480 --> 00:17:14.480 And he says, well, just sign your name on this form. 194 00:17:14.480 --> 00:17:16.480 He says, sorry, I'm going to make an X. 195 00:17:16.480 --> 00:17:19.480 Why are you making an X? Because I can't read or write. 196 00:17:19.480 --> 00:17:22.480 The bank manager looks at him, astonished me, he says, 197 00:17:22.480 --> 00:17:26.480 My God, man, where would you be today if you only knew how to read or write? 198 00:17:26.480 --> 00:17:29.480 If I know where I'd be, I'd be the verger at St. Paul. 199 00:17:35.480 --> 00:17:39.480 This not only shows the entrepreneurship filling the gap of the market, 200 00:17:39.480 --> 00:17:42.480 it also shows that reading and writing, or a Ph.D., or whatever, 201 00:17:42.480 --> 00:17:45.480 is not necessarily a royal road to successful entrepreneurship. 202 00:17:45.480 --> 00:17:53.740 There are indeed lots of illiterate millionaires still roaming around who do very well, Lebanese 203 00:17:53.740 --> 00:17:58.360 importers and that sort of thing, who do very well even though they can't be here right. 204 00:17:58.360 --> 00:18:03.160 Again this indicates that successful entrepreneurship is an art rather than some kind of an educative 205 00:18:03.160 --> 00:18:06.120 science which you can go to school and learn. 206 00:18:06.120 --> 00:18:12.920 Okay, so I think we can see the profit and loss element in profits, that the short run 207 00:18:12.920 --> 00:18:17.480 Long-run profits and short-run losses see the social function that they perform. 208 00:18:17.480 --> 00:18:18.480 What about long-run profits? 209 00:18:18.480 --> 00:18:23.000 Now long-run profits, they were the things that were focused on in the 19th century. 210 00:18:23.000 --> 00:18:28.040 Long-run profit, for reasons which we will come to, can also be called a rate of interest. 211 00:18:28.040 --> 00:18:31.620 Capital earning a rate of interest in the long run. 212 00:18:31.620 --> 00:18:32.620 Why is there such? 213 00:18:32.620 --> 00:18:34.480 First of all, would there be long-run profits? 214 00:18:34.480 --> 00:18:36.760 Some economists have denied this. 215 00:18:36.760 --> 00:18:42.120 Some economists claim that in the evenly rotating economy, in this long-run equilibrium situation, 216 00:18:42.120 --> 00:18:46.000 Profits and losses would both be zero. Obviously losses would be zero because nobody is going 217 00:18:46.000 --> 00:18:50.080 to invest. They knew they were going to make losses. That's pretty clear. So if you had 218 00:18:50.080 --> 00:18:54.640 a world of certainty and you had this equilibrium situation, nobody would make losses. But the 219 00:18:54.640 --> 00:19:00.360 contention of many economists is profits would be zero also. I deny this and also I think 220 00:19:00.360 --> 00:19:04.600 many other economists do too. There's another thing to be explained here. Can't just use 221 00:19:04.600 --> 00:19:11.040 a nice explanation of entrepreneurship and short-run profits and losses and uncertainty. 222 00:19:11.040 --> 00:19:18.440 has also other stratum of 6%, 8%, 4%, whatever the percentage happens to be, which will tend 223 00:19:18.440 --> 00:19:22.840 to exist even in a world of certainty, even when there is no list to take, even when you 224 00:19:22.840 --> 00:19:26.280 know what the demands and costs will be forever and the technology forever and ever. 225 00:19:26.280 --> 00:19:29.960 Now the reason, of course, we're interested in this long-run equilibrium model, although 226 00:19:29.960 --> 00:19:35.080 most microeconomics is only interested in that, the reason why I am interested in other 227 00:19:35.080 --> 00:19:39.080 so-called Austrian economists who are interested in this equilibrium model is as a method of 228 00:19:39.080 --> 00:19:43.160 separating long-run and short-run and trying to figure out the explanations of both of 229 00:19:43.160 --> 00:19:48.040 them and also to see where the economy is tending because even if things are not frozen, 230 00:19:48.040 --> 00:19:52.580 of course they are not, we can say that while the economy is always tending in the direction 231 00:19:52.580 --> 00:19:55.920 of this equilibrium, even though it will never reach it, and it's not a great thing if it 232 00:19:55.920 --> 00:19:59.760 could reach it, it would be pretty miserable, that it will never reach it, it's a way of 233 00:19:59.760 --> 00:20:03.040 explaining direction and tendencies in the system. 234 00:20:03.040 --> 00:20:07.000 I like to think of the analogy I like to use as a dog chasing a mechanical rabbit, an economy 235 00:20:07.000 --> 00:20:10.640 The economy is a dog, long-run equilibrium, a uniform rate of profit throughout the system 236 00:20:10.640 --> 00:20:13.920 is a mechanical rabbit, and the mechanical rabbit is always changing direction in a sort 237 00:20:13.920 --> 00:20:18.480 of unpredictable manner, and the economy tries to, the dog tries to follow it. 238 00:20:18.480 --> 00:20:23.760 It sort of, it leads you to be able to explain the tendencies in which the economy is going, 239 00:20:23.760 --> 00:20:27.600 but it will never reach because the angel Gabriel has not come down to freeze values, 240 00:20:27.600 --> 00:20:29.040 resources, and technology. 241 00:20:29.040 --> 00:20:33.020 If the angel Gabriel did come down and freeze it, then we would after a couple of years 242 00:20:33.020 --> 00:20:37.820 wind up in this kind of evenly rotating and long-run equilibrium system. 243 00:20:37.820 --> 00:20:45.820 Okay, so among one of the components then, we talked about short-run profits and short-run losses, forecasting and uncertainty. 244 00:20:45.820 --> 00:20:51.820 What about this other vector, this other long-run profit? Where does that come from? What's the explanation for it, etc.? 245 00:20:51.820 --> 00:20:59.820 It's that profit, the long-run profit, for example, that Karl Marx was attacking as surplus value is illegitimate, 246 00:20:59.820 --> 00:21:03.820 is extracted from workers' wages and so forth. 247 00:21:03.820 --> 00:21:09.820 To be more specific, in the long run, labor earns wages, and wages are determined by the marginal productivity, 248 00:21:09.820 --> 00:21:13.820 the marginal revenue products we've seen of workers. 249 00:21:13.820 --> 00:21:17.820 Land earns rent, which is also determined by the marginal revenue products. 250 00:21:17.820 --> 00:21:19.820 We can see how that happens. 251 00:21:19.820 --> 00:21:21.820 What about capital? Where does profits come in? 252 00:21:21.820 --> 00:21:23.820 Or where does the long run profit or interest come in? 253 00:21:23.820 --> 00:21:27.820 We'll see a little later why it's called interest. 254 00:21:27.820 --> 00:21:39.820 The easy answer for this, and the answer to the so-called productivity theory, probably invented by a nationalist senior, the great English 19th century classical economist, which is still in the textbooks, by the way, 255 00:21:39.820 --> 00:21:46.820 the easy answer goes as follows, and it comes from this triad, which is really a legitimate triad, of land, labor, and capital. 256 00:21:46.820 --> 00:21:56.820 Three kinds of factors of production, labor earns wages in accordance with the marginal productivity, land earns rent in accordance with marginal productivity, and capital, in quotes, 257 00:21:56.820 --> 00:22:03.540 machines, equipment, buildings, all these man-made factors of production, earn profits, 258 00:22:03.540 --> 00:22:06.840 earn rate of interest, because of its productivity. 259 00:22:06.840 --> 00:22:12.600 And usually this sort of productivity explanation is, well, after all, since capital machines 260 00:22:12.600 --> 00:22:16.600 are very productive, they're very important in production, therefore, machines have to 261 00:22:16.600 --> 00:22:22.100 earn something too, so therefore, that machines get this rate of profit. 262 00:22:22.100 --> 00:22:26.800 And you'll see, for example, in most textbooks, this sort of diagram, the economists will 263 00:22:26.800 --> 00:22:31.600 We'll start with the marginal product productivity theory, wind up with this sort of thing, usually 264 00:22:31.600 --> 00:22:32.600 in the labor market. 265 00:22:32.600 --> 00:22:38.760 Say, okay, in the y-axis there's wage rates, in the x-axis there's purchase of labor, purchase 266 00:22:38.760 --> 00:22:41.640 of the factor, hiring. 267 00:22:41.640 --> 00:22:46.560 And the demand for, and there's a supply curve and demand curve, the demand curve for labor 268 00:22:46.560 --> 00:22:49.920 is equal to the marginal revenue product, marginal productivity. 269 00:22:49.920 --> 00:22:56.280 Then the next chapter or the next diagram, the author says, okay, in the same way capital 270 00:22:56.280 --> 00:22:59.840 Capital earns interest. Instead of having wage rates on the y-axis, you have interest 271 00:22:59.840 --> 00:23:06.040 suddenly pops up and then you have capital hired or purchased and then you have a demand 272 00:23:06.040 --> 00:23:10.280 curve for capital or a demand curve for machines or whatever, which is supposedly equal to 273 00:23:10.280 --> 00:23:15.160 the marginal revenue product, which then determines the interest rate. There's lots of problems 274 00:23:15.160 --> 00:23:18.640 with this. The first place is a tremendous equivocation of the word capital. There's 275 00:23:18.640 --> 00:23:25.120 two different uses of the word capital. As capital as a fund is available for investment 276 00:23:25.120 --> 00:23:30.120 Capital Goods, Machines, Tools, Buildings, Trucks, etc., etc. 277 00:23:30.120 --> 00:23:32.120 The problem with this is, it looks pretty easy. 278 00:23:32.120 --> 00:23:37.120 The economist then wraps the whole thing up, and that explains profit, and you go on to something else. 279 00:23:37.120 --> 00:23:40.120 The problem here is that interest has nothing to do with wage rates. 280 00:23:40.120 --> 00:23:42.120 It's not analogous at all. 281 00:23:42.120 --> 00:23:47.120 The analogous thing for capital is the price of the machine, or the price of a building, or whatever. 282 00:23:47.120 --> 00:23:49.120 So where does interest come in? 283 00:23:49.120 --> 00:23:53.120 In other words, the genius also earns its marginal revenue product, gives it a price. 284 00:23:53.120 --> 00:23:57.240 If the marginal revenue product of a machine is, let's say, $10,000 a year, let's assume 285 00:23:57.240 --> 00:24:01.840 for a while, for various, to simplify matters, that nobody buys a machine, I'll get back 286 00:24:01.840 --> 00:24:06.000 to buying machines later, let's assume everybody rents a machine, there's machine producers, 287 00:24:06.000 --> 00:24:10.120 there are capitalists who produce, and then other people who rent the machine out, assume 288 00:24:10.120 --> 00:24:13.440 they're all rented, and then the marginal revenue product of the machine, let's say, 289 00:24:13.440 --> 00:24:19.160 is $10,000 a year, the question then is, why is it not that the capitalist who rents the 290 00:24:19.160 --> 00:24:23.160 Why doesn't he have to pay $10,000 for it? 291 00:24:23.160 --> 00:24:27.160 In other words, this should be $10,000 here on the intersection point. 292 00:24:27.160 --> 00:24:30.160 We should wind up with the price of the machine being $10,000. 293 00:24:30.160 --> 00:24:32.160 In fact, it isn't. 294 00:24:32.160 --> 00:24:34.160 The point is, in fact, that it's lower than $10,000. 295 00:24:34.160 --> 00:24:36.160 The price of the machine is, let's say, $9,000, 296 00:24:36.160 --> 00:24:38.160 which means that the guy who rents the machine, 297 00:24:38.160 --> 00:24:41.160 the capitalist who rents the machine from the producer, 298 00:24:41.160 --> 00:24:43.160 earns a 10%, let's say, interest rate. 299 00:24:43.160 --> 00:24:44.160 It's usually less than that. 300 00:24:44.160 --> 00:24:45.160 Let's say it's 10%. 301 00:24:45.160 --> 00:24:46.160 That's it. Simple. 302 00:24:46.160 --> 00:24:48.160 Something like 10%. 303 00:24:48.160 --> 00:24:56.160 The question then to be discovered, you see, in other words, the modular productivity theory doesn't explain interest, the existence of interest or long-run profits at all. 304 00:24:56.160 --> 00:25:02.160 What it explains is the existence of a price for a machine that you have to pay a certain amount. 305 00:25:02.160 --> 00:25:05.160 So where does interest come in? The answer is it doesn't come in yet. 306 00:25:05.160 --> 00:25:11.160 So the productivity theory is not an explanation at all of the interest rate. 307 00:25:11.160 --> 00:25:16.160 So then the thing to be explained is why is there, why is it not the price bid up to 10,000? 308 00:25:16.160 --> 00:25:27.920 In the same way, wages and land rents are also discounted in a very similar way, so 309 00:25:27.920 --> 00:25:33.960 that we wind up with wages and land rents all discounted by an interest rate, by let's 310 00:25:33.960 --> 00:25:34.960 say 10%. 311 00:25:34.960 --> 00:25:37.760 That could be 6%, and all the time what the interest rate happens to be. 312 00:25:37.760 --> 00:25:43.080 So then the question is, how come permeating the system, we have an interest return for 313 00:25:43.080 --> 00:25:44.080 for Capitalists. 314 00:25:44.080 --> 00:25:48.800 Totally apart from forecasting, from risk taking and all the rest of it, why is it wages 315 00:25:48.800 --> 00:25:54.800 and land rents and capital and machinery are not bid up to their full margin of revenue 316 00:25:54.800 --> 00:25:55.800 product? 317 00:25:55.800 --> 00:26:00.600 Put it another way, Karl Marx pointed out that the laborer had to pay a surplus, had 318 00:26:00.600 --> 00:26:04.000 to pay a profit rate to capitalists. 319 00:26:04.000 --> 00:26:08.140 One of the answers to this is, well yes that's true, on the other hand also land has to pay 320 00:26:08.140 --> 00:26:11.000 a profit rate and machines have to pay it. 321 00:26:11.000 --> 00:26:14.440 you wind up with this discount going all the way across the board 322 00:26:14.440 --> 00:26:16.640 then the question is why are they willing to pay it? 323 00:26:16.640 --> 00:26:19.560 because they obviously are, why is it that the market winds up 324 00:26:19.560 --> 00:26:22.840 and the free market winds up with this sort of payment being made 325 00:26:22.840 --> 00:26:26.440 this call of exploitation doesn't really answer the question obviously 326 00:26:26.440 --> 00:26:30.320 and also we find out that this productivity theory doesn't answer it either 327 00:26:30.320 --> 00:26:32.620 what we had is that the answers to the 328 00:26:32.620 --> 00:26:35.520 Marxian or the other taxon profit 329 00:26:35.520 --> 00:26:38.360 were not satisfactory throughout the nineteenth century 330 00:26:38.360 --> 00:26:40.200 the answer finally came 331 00:26:40.200 --> 00:26:42.780 was one of the greatest economists in the history of economic thought. 332 00:26:42.780 --> 00:26:47.640 Eugen von Boehm-Bawerk has a great work, Capital and Interest, which came in as a combination 333 00:26:47.640 --> 00:26:50.640 of the older Austrian school and the middle 1880s. 334 00:26:50.640 --> 00:26:54.560 But only Boehm-Bawerk really sort of copper riveted the explanation. 335 00:26:54.560 --> 00:26:59.760 It came up with the answer to this whole puzzling question of where long-run profits come from, 336 00:26:59.760 --> 00:27:01.920 or interest rates come from. 337 00:27:01.920 --> 00:27:07.200 One way of introducing this Boehm-Bawerkian solution is that you rent out a machine and 338 00:27:07.200 --> 00:27:12.840 When you produce it over a year and you earn the 10% or 6% or whatever, the key thing wrapped 339 00:27:12.840 --> 00:27:13.840 up in this whole thing is time. 340 00:27:13.840 --> 00:27:16.920 In other words, time is a key element in the earning of interest. 341 00:27:16.920 --> 00:27:22.760 Or, to put it another way, part of the Marxian critique, he said, well, it's true that capital 342 00:27:22.760 --> 00:27:25.120 goods are productive, they're very important. 343 00:27:25.120 --> 00:27:29.160 However, capital goods are themselves produced, they don't drop from the sky, they're themselves 344 00:27:29.160 --> 00:27:31.040 produced by land, labor, and capital. 345 00:27:31.040 --> 00:27:34.680 If you push the whole thing back, logically capital drops out and you're left with only 346 00:27:34.680 --> 00:27:36.400 labor and land. 347 00:27:36.400 --> 00:27:41.800 And what Marx said is that therefore labor should get the entire income, the entire product. 348 00:27:41.800 --> 00:27:46.040 Of course, if you add, since he ignored land, which you have to do first of all is add land 349 00:27:46.040 --> 00:27:48.680 into the picture and say labor and land should get the whole product. 350 00:27:48.680 --> 00:27:52.280 And then you have to say, well after all product takes a long time, so the time in some way 351 00:27:52.280 --> 00:27:53.280 enters then. 352 00:27:53.280 --> 00:27:57.080 You wind up instead of saying, as Marx does, the capital goods are frozen labor or embodiments, 353 00:27:57.080 --> 00:28:00.440 frozen embodiments of labor, which should modify that and say first place, okay, first 354 00:28:00.440 --> 00:28:05.800 place we have to include in labor management, entrepreneurship, decision making, entrepreneurship 355 00:28:05.800 --> 00:28:10.000 in the short run uncertainty. So in other words, the president of General Motors would 356 00:28:10.000 --> 00:28:15.200 also be a laborer. And second of all, aside from that, it's also frozen land and it's 357 00:28:15.200 --> 00:28:20.500 also frozen time. And then we'll see that the key to the long run rate of profit is 358 00:28:20.500 --> 00:28:25.220 precisely this whole time consideration, our so-called time preference. Before I get into 359 00:28:25.220 --> 00:28:31.320 more into that, I want to put on the board a great diagram which has dropped out of current 360 00:28:31.320 --> 00:28:38.320 The so-called structure of production concept, which von Boehm-Bawerk and the Austrian School introduced to the world. 361 00:28:38.320 --> 00:28:43.320 Orthodox economics today, capitalism is treated as one big blob, a homogeneous lump. 362 00:28:43.320 --> 00:28:49.320 And so there's all sorts of measurements, supposed measurements of capital output ratios and so forth and so on, 363 00:28:49.320 --> 00:28:53.320 and there's a statement that all you need to increase production is more capital, 364 00:28:53.320 --> 00:28:58.320 which leads to things, for example, like the government investing in underdeveloped countries, say government investing in a steel mill, 365 00:28:58.320 --> 00:29:08.800 We start with consumption on the lowest level. 366 00:29:08.800 --> 00:29:13.640 Consumers, let's say, spend $100 billion during the year on retail stores. 367 00:29:13.640 --> 00:29:19.720 So you have $100 billion going from the consumer to the first stage of production, which is 368 00:29:19.720 --> 00:29:20.720 the retail industry. 369 00:29:20.720 --> 00:29:27.400 Designate this by a bar, $100 billion is the length of the bottom. 370 00:29:27.400 --> 00:29:31.240 So money is going up this bar, in other words, money is going from the consumers to the retailers 371 00:29:31.240 --> 00:29:36.040 and goods of all sorts are going down from the retailers to the consumer, that's the 372 00:29:36.040 --> 00:29:37.040 first bar. 373 00:29:37.040 --> 00:29:40.920 Okay, the retailers now have a hundred billion in their pockets and what are they going to 374 00:29:40.920 --> 00:29:41.920 do with it? 375 00:29:41.920 --> 00:29:46.160 Well, most of it of course goes to the wholesalers to buy the inventory and so forth, but a certain 376 00:29:46.160 --> 00:29:51.840 amount gets siphoned off to the people in the retail industry, let's say ten billion, 377 00:29:51.840 --> 00:30:02.840 So 10 billion goes off to function as income. In other words, to wages, land rent, interest and profits. 378 00:30:02.840 --> 00:30:10.840 So we have 100 then going to the retail industry, 10 billion gets siphoned off, and the other 90 billion goes to the wholesalers. 379 00:30:10.840 --> 00:30:17.840 Now we have another bar, the wholesale bar, which is however shorter, because 10 billion dollars have already been siphoned off. 380 00:30:17.840 --> 00:30:21.640 The same thing that happens to the wholesaler. Here's a retailer, wholesaler. A wholesaler 381 00:30:21.640 --> 00:30:25.800 is swiping off another $10 billion, let's say, and $80 billion goes to the jobbers to 382 00:30:25.800 --> 00:30:31.520 get their inventory. And once again, you have $10 billion going to wages, land rent, interest 383 00:30:31.520 --> 00:30:37.800 and profits in the wholesale industries. And then we go to the jobbers. The $80 billion 384 00:30:37.800 --> 00:30:42.580 goes to, let's say, $90 billion and $80 billion. And we keep on going. We've got the manufacturing 385 00:30:42.580 --> 00:30:47.160 and then the mining and the forming. And as we keep on going, in each stage of production, 386 00:30:47.160 --> 00:30:52.960 Money gets hived off until finally, logically, you wind up with all the money going to personal 387 00:30:52.960 --> 00:30:53.960 income. 388 00:30:53.960 --> 00:30:55.440 This is the structure of production. 389 00:30:55.440 --> 00:30:57.400 This is the latter kind of effect. 390 00:30:57.400 --> 00:30:59.320 A lot of things happen here. 391 00:30:59.320 --> 00:31:01.840 First place, a hundred billion gets hived off. 392 00:31:01.840 --> 00:31:04.520 They have a hundred billion in personal income. 393 00:31:04.520 --> 00:31:10.480 Then the consumers, the wager earners, the land owners, the capitalists, etc., take the 394 00:31:10.480 --> 00:31:13.160 hundred billion and they might even invest it. 395 00:31:13.160 --> 00:31:18.040 So let's say for a minute that they just spend it again, then they have the so-called circular 396 00:31:18.040 --> 00:31:22.800 flow then, and the dollars get turned over as they go on up a ladder. 397 00:31:22.800 --> 00:31:27.600 We have the structure of production, as the capitalist system advances, as more and more 398 00:31:27.600 --> 00:31:33.200 capital gets invested, more and more the structure becomes higher and higher. 399 00:31:33.200 --> 00:31:36.600 And here we have this enormous structure of capital which keeps increasing, and we'll 400 00:31:36.600 --> 00:31:41.120 see when we get to the business cycle theory how this can be used very readily to explain 401 00:31:41.120 --> 00:31:49.200 The point is, all this money gets hived off in income, and this of course endorses the 402 00:31:49.200 --> 00:31:54.000 Marxian point to the extent, yes it's true, each stage of the way is produced by other 403 00:31:54.000 --> 00:31:59.680 stages and you wind up with all the income, all the 100 billion, gets exhausted by each 404 00:31:59.680 --> 00:32:06.080 step of the way, so there's no net profit accruing to capital machine producers, per 405 00:32:06.080 --> 00:32:15.080 The Interest and Profits can't be explained by the, it's still unexplainable in this diagram. 406 00:32:15.080 --> 00:32:20.080 Again, you can't explain the interest and profits by the purely productivity kind of explanation. 407 00:32:20.080 --> 00:32:22.080 So what is the explanation? 408 00:32:22.080 --> 00:32:24.080 Well, as I said, it's time explanation. 409 00:32:24.080 --> 00:32:26.080 Each stage of the game takes time. 410 00:32:26.080 --> 00:32:28.080 How does time enter in the picture? 411 00:32:28.080 --> 00:32:30.080 Well, it goes like this. 412 00:32:30.080 --> 00:32:36.280 The function of the capitalist, again, this is not talking about the manager or the entrepreneur, 413 00:32:36.280 --> 00:32:40.160 it's talking about the pure capital function, the pure supplying of capital. 414 00:32:40.160 --> 00:32:44.720 The function of the capitalist is this, he saves up money from previous profits or previous 415 00:32:44.720 --> 00:32:50.200 income or whatever, the capitalist pays out money and pays money out to existing producers, 416 00:32:50.200 --> 00:32:54.840 to existing workers and landowners while they're producing. 417 00:32:54.840 --> 00:32:59.480 In other words, let's assume for a minute there are no capitalists, and it's certainly 418 00:32:59.480 --> 00:33:04.360 Logically, there's no reason on the free market why you can't have a world of producers' co-ops, 419 00:33:04.360 --> 00:33:08.840 of workers' and landowners' co-ops, or pure workers' co-ops, or whatever, 420 00:33:08.840 --> 00:33:12.120 which have no capital function at all. There's no capitalists. 421 00:33:12.120 --> 00:33:15.800 Everybody gets together and decides they're going to produce an automobile or whatever. 422 00:33:15.800 --> 00:33:19.080 Supposing they do, why has this not flourished on the free market? 423 00:33:19.080 --> 00:33:24.600 Because certainly on the free market, there are no laws repressing this kind of producers' co-op. 424 00:33:24.600 --> 00:33:28.080 Well, producers' coffers have always been abysmal failures. They never have succeeded 425 00:33:28.080 --> 00:33:35.440 worth a dime. The major reason is very simple. The workers say they're out to build tungsten 426 00:33:35.440 --> 00:33:39.000 or they're out to build oil and be able to produce oil and be able to do whatever. It'll 427 00:33:39.000 --> 00:33:42.000 take them quite a while to do it. In other words, the workers all get together and they 428 00:33:42.000 --> 00:33:45.640 work on this thing. They get the landowners, et cetera, and they get the raw material. 429 00:33:45.640 --> 00:33:48.840 Let's say, take them, let's say, three years, five years or whatever, producing oil and 430 00:33:48.840 --> 00:33:53.200 be able. Five years, they ain't getting paid. They're hoping that they'll be able to sell 431 00:33:53.200 --> 00:33:55.040 Hello Automobile is going to get on the market. 432 00:33:55.040 --> 00:33:58.840 Now, aside from the risk function, which we'll get to, we'll get back to in a minute, everybody 433 00:33:58.840 --> 00:34:00.640 understands the risk function, I think, pretty well. 434 00:34:00.640 --> 00:34:06.240 There's a pure time problem here, it's our waiting, in other words, the sheer problem 435 00:34:06.240 --> 00:34:09.760 of having to wait five years without getting paid, until the money comes rolling in. 436 00:34:09.760 --> 00:34:15.320 So, while I'm concerned, I would not be able to last more than a couple of weeks without 437 00:34:15.320 --> 00:34:16.320 payment. 438 00:34:16.320 --> 00:34:19.400 And I think for most people, this is true also. 439 00:34:19.400 --> 00:34:24.120 The function that the capitalist performs here, the very, very vital function for the producers, 440 00:34:24.120 --> 00:34:28.960 the workers and landowners, is to give them money now, while they're working, every week 441 00:34:28.960 --> 00:34:33.200 or every month, so they don't have to wait five years until the automobile is produced. 442 00:34:33.200 --> 00:34:34.200 Who waits? 443 00:34:34.200 --> 00:34:35.200 The capitalist waits. 444 00:34:35.200 --> 00:34:39.320 In other words, the capitalist takes on the waiting function, and then at the end of the 445 00:34:39.320 --> 00:34:42.680 six months or the five years, whatever the period of production happens to be for that 446 00:34:42.680 --> 00:34:48.680 particular product, the capitalist sells the car and gets the revenue, and what does he 447 00:34:48.680 --> 00:34:54.680 How was he rewarded for this? He was rewarded by the interest rate. He was rewarded by the rate of time preference. 448 00:34:54.680 --> 00:35:00.680 So he is performing an extremely important and vital function, a function which everybody should love. 449 00:35:00.680 --> 00:35:07.680 They really thought about it. It enables them to get money now instead of having to wait for five years until the money pours in. 450 00:35:07.680 --> 00:35:10.680 For this service they pay the capital as a discount. 451 00:35:10.680 --> 00:35:14.680 You have to modify, and this again you'll not find in the textbooks unfortunately, 452 00:35:14.680 --> 00:35:20.120 You have to modify the marginal productivity theory to say labor and land and all the other 453 00:35:20.120 --> 00:35:25.480 products, yet not their marginal revenue product, but their marginal revenue product discounted 454 00:35:25.480 --> 00:35:26.480 by the rate of interest. 455 00:35:26.480 --> 00:35:33.360 So the rate of interest, or the rate of long-run profit, is a willing exchange, since we realize 456 00:35:33.360 --> 00:35:37.520 in contrast to the Marxist and the free market, exchanges are voluntary, so we have to be 457 00:35:37.520 --> 00:35:41.840 some sort of function that this capitalist profit is reaping for this discount they're 458 00:35:41.840 --> 00:35:47.400 Capitalists are getting, the function is precisely handing out money now instead of the producers 459 00:35:47.400 --> 00:35:48.400 having to wait for it. 460 00:35:48.400 --> 00:35:54.160 To put it another way, this is a time preference change, or a time market, very, very similar 461 00:35:54.160 --> 00:35:58.800 as a matter of fact, economically, analytically identical to the credit debt change. 462 00:35:58.800 --> 00:36:04.160 What's happening when a capitalist hires workers, for example, the capitalist has saved up money 463 00:36:04.160 --> 00:36:08.680 previously, the capitalist is paying out money now, he's paying out a present good. 464 00:36:08.680 --> 00:36:13.140 In other words, money is a present good, money is something which can be used at any time 465 00:36:13.140 --> 00:36:16.000 in the present, any time a person wants to, you can spend it. 466 00:36:16.000 --> 00:36:23.220 So this is the so-called present good, workers and landowners, etc., producers in general, 467 00:36:23.220 --> 00:36:28.480 are getting the money now and in exchange for this, the capitalist is receiving future 468 00:36:28.480 --> 00:36:29.480 good. 469 00:36:29.480 --> 00:36:34.680 In other words, he's expecting, he's receiving a future income from the car or whatever. 470 00:36:34.680 --> 00:36:40.800 In other words, he is changing a present good for a future good, and here we get to the 471 00:36:40.800 --> 00:36:43.200 primordial universal fact of time preference. 472 00:36:43.200 --> 00:36:47.500 Again, Boehm-Bawerk was the first one to really govern and analyze. 473 00:36:47.500 --> 00:36:52.320 Time preference meaning, if you remember the old motto that a bird in the hand is worth 474 00:36:52.320 --> 00:36:56.000 two in the bush, where the time preference motto says a bird in the hand is worth more 475 00:36:56.000 --> 00:36:57.360 than one bird in the bush. 476 00:36:57.360 --> 00:36:59.080 Forget about two in the bush. 477 00:36:59.080 --> 00:37:03.880 The point is that a present good is worth more than the expectation of a future good. 478 00:37:03.880 --> 00:37:07.880 Now, different people and different groups and different societies have different rates of time preference. 479 00:37:07.880 --> 00:37:10.880 Some people have very high time preference. 480 00:37:10.880 --> 00:37:15.880 For example, myself, just before the next paycheck arrives, I have a very high rate of time preference. 481 00:37:15.880 --> 00:37:24.880 I've been willing to borrow at high rates for the three days or whatever it is as my money runs out, as my bad management takes over. 482 00:37:24.880 --> 00:37:25.880 That's a high rate of time preference. 483 00:37:25.880 --> 00:37:31.880 And then there are low rates of time preference with people who have great foresight and plan ahead for the future and so forth and so on. 484 00:37:31.880 --> 00:37:35.520 So there are all sorts of different rates of time preference, just as with other marginal 485 00:37:35.520 --> 00:37:39.400 utilities, there are all sorts of value scales in society, there are all sorts of value scales 486 00:37:39.400 --> 00:37:43.080 for hula hoops and for doughnuts and whatever. 487 00:37:43.080 --> 00:37:48.000 In a similar way, there are all sorts of value scales and relative marginal utilities for 488 00:37:48.000 --> 00:37:49.000 time. 489 00:37:49.000 --> 00:37:54.240 These time preferences get all intermixed in the time market, which spreads throughout 490 00:37:54.240 --> 00:37:59.000 the whole system, which results in one single or tendency toward one single rate of time 491 00:37:59.000 --> 00:38:03.640 time preference, which is a resultant of all these individual time preferences, just as 492 00:38:03.640 --> 00:38:07.800 the price of hula hoops on the market is a resultant of all of the marginal utility value 493 00:38:07.800 --> 00:38:10.160 scales for hula hoops. 494 00:38:10.160 --> 00:38:14.160 So if everybody has a low rate of time preference, you'll have a low rate of interest, a low 495 00:38:14.160 --> 00:38:15.160 rate of discount. 496 00:38:15.160 --> 00:38:18.120 If everybody has a very high rate of time preference, you'll have a very high rate of 497 00:38:18.120 --> 00:38:19.120 discount. 498 00:38:19.120 --> 00:38:23.000 This is analytically the same thing as a credit transaction. 499 00:38:23.000 --> 00:38:29.280 In a credit transaction, if I borrow $100 from my friendly local porn broker or whatever, 500 00:38:29.280 --> 00:38:38.280 the creditor pays out present money, let's say $100 as a present good, to the debtor. 501 00:38:38.280 --> 00:38:45.560 He's getting from the debtor, say from me, an IOU, a claim on some future good, money 502 00:38:45.560 --> 00:38:50.440 in the future, say a year from now, and instead of paying $100 back, I'm going to pay more 503 00:38:50.440 --> 00:38:55.000 More than that, I'm paying, let's say, $108, 8% rate of interest. 504 00:38:55.000 --> 00:38:58.280 Why am I willing to pay the 108 and why is he charging the 8% and why am I willing to 505 00:38:58.280 --> 00:38:59.280 pay it? 506 00:38:59.280 --> 00:39:04.320 For the same reason, because both of us, and the society in general, faces this premium 507 00:39:04.320 --> 00:39:05.320 on time. 508 00:39:05.320 --> 00:39:09.680 So that in this situation, it's worth more to me to borrow now, it's worth more than 509 00:39:09.680 --> 00:39:11.800 the 8%, so I will borrow. 510 00:39:11.800 --> 00:39:15.680 He has lower time preference than I've got, in other words, within this 8% framework, 511 00:39:15.680 --> 00:39:17.880 so he lends money to me. 512 00:39:17.880 --> 00:39:24.880 The point then is, for both of us, and society in general, values present goods more than 513 00:39:24.880 --> 00:39:31.120 future goods, values $100 now much more than the present value of $100 a year from now, 514 00:39:31.120 --> 00:39:34.920 and therefore the rate will be set accordingly in the market. 515 00:39:34.920 --> 00:39:39.560 Now sometimes the rate will be lower, if everybody's thriftier or more foresighted, the rate might 516 00:39:39.560 --> 00:39:45.160 shift to 4%, full or 4% or whatever, other times it might rise to 20%, but whatever the 517 00:39:45.160 --> 00:39:51.720 The rate is determined by the social time preferences of all the individuals in society. 518 00:39:51.720 --> 00:39:57.540 One example of what Ludwig von Mises used to give is that the year 1000 approached. 519 00:39:57.540 --> 00:40:01.880 Most Christians, the interpretation of the Bible was that the year 1000 Jesus would return 520 00:40:01.880 --> 00:40:04.400 to earth and the whole world would come to an end and we would have the kingdom of heaven 521 00:40:04.400 --> 00:40:05.400 on earth. 522 00:40:05.400 --> 00:40:06.400 This is a millennialist view. 523 00:40:06.400 --> 00:40:12.480 And so as you get to 998 AD, 999 AD, when most people expected the world would come 524 00:40:12.480 --> 00:40:17.040 In the end of the year 1000, nobody is very anxious to lend money for a three year period 525 00:40:17.040 --> 00:40:23.160 after that, to be returned in 1000 CAD, because it won't be of much use. As a result, the 526 00:40:23.160 --> 00:40:26.360 interest rates began to go up. People really expect the world to come to an end, interest 527 00:40:26.360 --> 00:40:31.400 rates would start going up to infinity, they really expected that. So as you get very close 528 00:40:31.400 --> 00:40:35.920 to the point of day of Armageddon, the interest rates would zoom up to 10,000% a day or whatever 529 00:40:35.920 --> 00:40:39.000 it would be. This would be a time preference rate. 530 00:40:39.000 --> 00:40:43.240 The function of the capitalist is very similar to the function of the creditor. The capitalist 531 00:40:43.240 --> 00:40:47.600 is supplying present goods, the creditor is supplying present goods. Instead of receiving 532 00:40:47.600 --> 00:40:52.680 a fixed debt in return, he's getting another kind of future good. He's getting the car 533 00:40:52.680 --> 00:40:56.320 when it's going to come off the assembly line and he'll be able to sell it. He's getting 534 00:40:56.320 --> 00:41:02.520 the ownership of the car when it eventually emerges. In both cases, the economic function 535 00:41:02.520 --> 00:41:07.320 is the same. What the capitalist is doing then, in the real world, he's performing two functions. 536 00:41:07.320 --> 00:41:11.200 One, he's performing the short-run function of, hopefully, successful entrepreneurship 537 00:41:11.200 --> 00:41:17.560 and forecasting, and forecasting changing future trends and meeting consumer demands 538 00:41:17.560 --> 00:41:21.880 in the future, forming his entrepreneurial uncertainty function, and two, he's performing 539 00:41:21.880 --> 00:41:27.660 his 8% function, he's performing his time function of supplying present goods and taking 540 00:41:27.660 --> 00:41:30.440 on the burden of waiting for the future. 541 00:41:30.440 --> 00:41:35.000 For this, as I say, the worker is happy to give him the 8%, at least they might think 542 00:41:35.000 --> 00:41:40.800 The point is in action they are happy to do it, otherwise they wouldn't be doing it. 543 00:41:40.800 --> 00:41:43.800 Otherwise they'd be forming workers' co-ops. 544 00:41:43.800 --> 00:41:49.040 So the two reasons we can say why workers' co-ops have failed, one, because most workers 545 00:41:49.040 --> 00:41:53.560 don't have the money to start in, to pay themselves out, they don't want to wait for five years 546 00:41:53.560 --> 00:41:57.120 before they get paid, and two, because they don't want to take on the risks of losing 547 00:41:57.120 --> 00:41:58.120 all their money. 548 00:41:58.120 --> 00:42:03.160 They want to take on the uncertainty risks, both of which the capitalist assumes, both 549 00:42:03.160 --> 00:42:09.960 the uncertainty bearing and the weighting burden. So that we have a selective sort of process 550 00:42:09.960 --> 00:42:14.680 where the capitalist entrepreneurs tend to be those who are most able to do both of these 551 00:42:14.680 --> 00:42:23.200 things, weight and forecast the future. So now we see a vision, so to speak, of the economic 552 00:42:23.200 --> 00:42:29.200 system, looming up, where the consumer goods prices are determined by values of consumers, 553 00:42:29.200 --> 00:42:32.360 In other words, it's too much value scale by the marginal utility and the law of diminishing 554 00:42:32.360 --> 00:42:33.360 marginal utility. 555 00:42:33.360 --> 00:42:39.880 Producers' goods prices, in other words, wages, land rents, machines, etc., are determined 556 00:42:39.880 --> 00:42:45.360 by marginal revenue product, the marginal productivity, set by the marginal productivity, 557 00:42:45.360 --> 00:42:50.160 and going through this whole system, discounting all the marginal productivity, whenever there's 558 00:42:50.160 --> 00:42:55.080 time involved, there's a rate of interest or a rate of time preference, where the capitalist 559 00:42:55.080 --> 00:42:56.080 earns the discount. 560 00:42:56.080 --> 00:43:01.880 So, as I say, von Boehm-Bawerk was the one who cleared up this problem. There's another 561 00:43:01.880 --> 00:43:07.040 similar problem, an addition to the Marxian problem, which Hornswoggle eventually laid 562 00:43:07.040 --> 00:43:12.400 low Catholic scholastic philosophers. Catholic scholastic philosophers, not only in the Middle 563 00:43:12.400 --> 00:43:17.720 Ages, but also much later than that, in the late 16th, 17th century, were extremely brilliant 564 00:43:17.720 --> 00:43:22.360 social analysts and also economists. And they analyzed, first of all, one of the reasons 565 00:43:22.360 --> 00:43:24.960 This hasn't been discovered until about 20 years ago. 566 00:43:24.960 --> 00:43:27.760 They all wrote in Latin, and you know how many people read Latin now. 567 00:43:27.760 --> 00:43:31.760 Nobody reads them, and nobody read them for a long, long time. 568 00:43:31.760 --> 00:43:35.960 And it turns out that in Book 12, there's some theologica or something. 569 00:43:35.960 --> 00:43:39.160 Here's a very sophisticated analysis of the market. 570 00:43:39.160 --> 00:43:40.760 They understood much about the market. 571 00:43:40.760 --> 00:43:42.960 As a matter of fact, they almost discovered marginal utility. 572 00:43:42.960 --> 00:43:45.560 They didn't quite do it, but they almost came up to that point. 573 00:43:45.560 --> 00:43:49.960 But there was one thing that they completely flubbed on, which later discredited them, 574 00:43:49.960 --> 00:44:19.960 And that was, they couldn't understand, they couldn't understand about risks, they couldn't understand why people would be risk-bearing and get a profit, they couldn't understand about making money on a risky investment, they couldn't understand about all sorts of stuff about profits, they could never understand about time preference, they could never understand the legitimacy of charging interest rate on a pure consumer loan. So they call this usury. Their analysis was, well, taking from Aristotle, which they were very good Aristotelians, they said, well, Aristotle says that money is a dead thing. 575 00:44:19.960 --> 00:44:43.960 It's not moral. It's sinful to charge any interest whatsoever on a pure loan. And they call that usury. Now, we think of usury now as somebody charging 28% per day interest. But usury, the technical definition of usury is any interest whatsoever, because this is the philosophical problem the classics had. 576 00:44:43.960 --> 00:44:50.240 And so the church, taking off from this, condemned usury for almost until about the middle of 577 00:44:50.240 --> 00:44:51.240 the 19th century or so. 578 00:44:51.240 --> 00:44:55.280 Now there were many problems involved in this, it meant that if you say that all interest 579 00:44:55.280 --> 00:45:00.520 is illegal and immoral, everybody started evading it, even very good Catholics started evading 580 00:45:00.520 --> 00:45:01.520 it. 581 00:45:01.520 --> 00:45:05.880 So they started discovering that the scholastic philosophers themselves would ratify all sorts 582 00:45:05.880 --> 00:45:10.140 of devious ways of getting around this prohibition, they had all sorts of things like forward 583 00:45:10.140 --> 00:45:14.100 Market and Foreign Exchange, those of exchange, maneuver it in such a way that you'd be charging 584 00:45:14.100 --> 00:45:19.220 interest but not saying it, pretending it's only a foreign exchange market. 585 00:45:19.220 --> 00:45:24.460 And also the very sophisticated devices, the church itself and its loan money charged interest, 586 00:45:24.460 --> 00:45:26.140 was therefore engaged in the sin of usury. 587 00:45:26.140 --> 00:45:31.140 So this whole usury thing, the spread of at least the economic analysis of the scholastics, 588 00:45:31.140 --> 00:45:35.140 was partly responsible for the decay of scholastic philosophy in general. 589 00:45:35.140 --> 00:45:38.340 The problem was they never discovered time preference, so they didn't have Boehm-Bawerk 590 00:45:38.340 --> 00:45:46.860 The problem in other words being that, yes you are performing a function by lending out 591 00:45:46.860 --> 00:45:51.820 money, you're giving somebody money now in return for future money, in other words you're 592 00:45:51.820 --> 00:45:55.340 giving them a present good, you're satisfying their time preference, their desire to have 593 00:45:55.340 --> 00:45:59.900 money now instead of the future, this is just as important as any other service, therefore 594 00:45:59.900 --> 00:46:01.900 nothing will charge interest on it. 595 00:46:01.900 --> 00:46:04.980 However, as I say, they hadn't, they didn't ever discover that. 596 00:46:04.980 --> 00:46:12.080 The other thing I should say here about wages and land rent, the theory of rent, which again 597 00:46:12.080 --> 00:46:16.820 was discovered by Frank Fetter as one of my favorite economists, Austrian School economist 598 00:46:16.820 --> 00:46:23.900 of Princeton Cornell in the 20th century, who built on Boehm-Bawerk time preference, 599 00:46:23.900 --> 00:46:29.180 purified the time preference theory of Boehm-Bawerk, kicked out the productivity stuff I've been 600 00:46:29.180 --> 00:46:30.940 talking about. 601 00:46:30.940 --> 00:46:34.180 More clearly than Boehm-Bawerk did, because Boehm-Bawerk kind of fudged a little bit till 602 00:46:34.180 --> 00:46:35.180 the end. 603 00:46:35.180 --> 00:46:41.580 Also, a very interesting theory of rent, saying that after all, rent is not just land rent. 604 00:46:41.580 --> 00:46:43.700 What really is, is very similar to renting out. 605 00:46:43.700 --> 00:46:48.020 In other words, it's a common sense view of renting a tuxedo or renting a house instead 606 00:46:48.020 --> 00:46:49.020 of buying it. 607 00:46:49.020 --> 00:46:51.100 So we have two different things here. 608 00:46:51.100 --> 00:46:56.460 Rent then becomes a charge for a service per unit time, rent per hour, rent per month, 609 00:46:56.460 --> 00:46:58.580 rent per year, etc. 610 00:46:58.580 --> 00:47:02.660 In English Classical Economics, in the old days in England, very few people, aristocratic 611 00:47:02.660 --> 00:47:06.580 families didn't sell land, they only rented it out, so you think of land only in terms 612 00:47:06.580 --> 00:47:12.660 of rent. What really happens is that every good and service, every labor and wages, land 613 00:47:12.660 --> 00:47:18.380 and rent, machines and so forth and so on, every productive factor earns a product, productivity 614 00:47:18.380 --> 00:47:23.780 per unit time, and this is there, it's rent. In other words, if a machine is worth $10,000 615 00:47:23.780 --> 00:47:27.020 a year, it's going to get $10,000 a year in rent, minus the rate of interest. This is 616 00:47:27.020 --> 00:47:36.660 and so rents then permeate the economy, not just for land but for everything. 617 00:47:36.660 --> 00:47:38.900 We can then look on wages as also a rent. 618 00:47:38.900 --> 00:47:45.220 A laborer sells his services per unit time, he doesn't sell his body, except under slavery. 619 00:47:45.220 --> 00:47:51.180 Absenting slavery, then, you can only rent yourself out, you can't sell yourself. 620 00:47:51.180 --> 00:47:53.260 And so wages are also a rent. 621 00:47:53.260 --> 00:47:56.340 You don't have only really two forms, in a world of certainty, there are only two forms 622 00:47:56.340 --> 00:47:59.900 In the world of income is rent and interest. In other words, every productive factor earns 623 00:47:59.900 --> 00:48:06.060 a rent, whether it's labor or land or capital goods. And then finally, the capitalist earns 624 00:48:06.060 --> 00:48:10.060 a discount, which is the rate of time preference and rate of interest. And then, of course, 625 00:48:10.060 --> 00:48:14.220 in the world of uncertainty, we have profits and losses, short-run profits and short-run 626 00:48:14.220 --> 00:48:21.300 losses. So that rent then becomes a universal kind of productive income in which everybody 627 00:48:21.300 --> 00:48:24.860 in a sense earns. And we can see this. One of the problems is that economists haven't 628 00:48:24.860 --> 00:48:30.860 I'm going to analyze the economics of slavery. Slavery is a fascinating institution from an economic point of view. 629 00:48:30.860 --> 00:48:33.860 How could I want to restore it for that reason? 630 00:48:33.860 --> 00:48:39.860 Because under slavery, for example, in the South, sometimes slaves were sold and sometimes they were rented out. 631 00:48:39.860 --> 00:48:44.860 So, in other words, the slave then became a slave master, treated the slave as any other capital, 632 00:48:44.860 --> 00:48:50.860 and so the slave was often rented out to other capitalists seasonally or whatever. 633 00:48:50.860 --> 00:48:56.660 Okay, so we've explained consumer goods prices, we've explained profits, wages, rents, marginal 634 00:48:56.660 --> 00:49:00.900 productivity, interest, time preference, etc., and even short-run profits. 635 00:49:00.900 --> 00:49:04.140 There's one thing left to go, really, in this explanation. 636 00:49:04.140 --> 00:49:07.580 We've explained the rental price of labor, or the rental price of the land, or the rental 637 00:49:07.580 --> 00:49:09.420 price of the machine, but not the price of the whole good. 638 00:49:09.420 --> 00:49:10.420 Where does that come from? 639 00:49:10.420 --> 00:49:11.420 Presumably it's some sort of relationship. 640 00:49:11.420 --> 00:49:18.780 If a slave could be rented out, say, for $1,000 a year, the sale price of the slave must have 641 00:49:48.780 --> 00:49:59.780 The capital value applies not just to that, it applies to everything. It applies to land, it applies to people under slavery, it applies to anything which can be owned. 642 00:49:59.780 --> 00:50:03.780 What's the capital value of a house or a machine or whatever? 643 00:50:03.780 --> 00:50:12.780 Well, the first approximation is it will be the sum of expected future returns, or in our terminology, expected future rent. 644 00:50:12.780 --> 00:50:19.780 Let's say you have a machine which you think you can rent out for $10,000 a year, and it's a 10 year life. 645 00:50:19.780 --> 00:50:28.780 So in that case, you expect a return now of $10,000 over 10 years, and a total return of $100,000. 646 00:50:28.780 --> 00:50:33.780 So therefore you might think the capital value, if you're going to sell the machine, 647 00:50:33.780 --> 00:50:38.780 you'll be able to get on the market $100,000 because that's how much the guy will get in return. 648 00:50:38.780 --> 00:50:41.780 That's the first approximation. However, of course, it's wrong. 649 00:50:41.780 --> 00:50:45.740 The reason why it's wrong is because you have to discount the expected future returns by 650 00:50:45.740 --> 00:50:46.740 what? 651 00:50:46.740 --> 00:50:47.740 By the rate of interest. 652 00:50:47.740 --> 00:50:49.620 So you have the discounted sum. 653 00:50:49.620 --> 00:50:50.620 You have this machine. 654 00:50:50.620 --> 00:50:51.620 You're thinking about buying this machine. 655 00:50:51.620 --> 00:50:53.780 You know that after 10 years it will give you $100,000. 656 00:50:53.780 --> 00:50:55.780 Let's say you know that. 657 00:50:55.780 --> 00:51:01.980 Your value that you place on the 10th year of $10,000 is a lot less than on today's $10,000. 658 00:51:01.980 --> 00:51:05.900 And the discount that you'll charge, that you'll consider or estimate it at, is the 659 00:51:05.900 --> 00:51:09.300 rate of interest, the going time preference rate and going rate of interest. 660 00:51:09.300 --> 00:51:17.300 Let's say it's 10% to make it simple. In that case, let's say you're getting the money in now, just to make it for the first year, 661 00:51:17.300 --> 00:51:24.300 your total sum that will be charged on the market, the market equilibrium price of the machine as a total sale value, 662 00:51:24.300 --> 00:51:30.300 will be $10,000 plus, not $10,000, but $10,000 discounted by, say, 10%, say $9,000, 663 00:51:30.300 --> 00:51:38.300 and then the second year's $10,000 will be discounted by that plus another 10%, possibly $8,100, $7,300, etc. 664 00:52:08.300 --> 00:52:24.300 In the next 20 years, the price won't be bid up to the $100,000 or $200,000 or whatever, it'll be that minus the rate of interest, so when you buy the house at the lower price, you'll have a room for the 10% return per year, or whatever the interest return happens to be. 665 00:52:24.300 --> 00:52:36.300 This process, by the way, of summing up this kind of future returns into a present value is called capitalizing expected future returns into a present sum. 666 00:52:36.300 --> 00:52:42.800 That's pretty obvious if we didn't have capitalization. Land, for example, wouldn't be able to be sold at all, because land is permanent. 667 00:52:42.800 --> 00:52:50.800 Assuming the Fifth Avenue or 42nd Street will always be there, because it's a fixed part of the earth, sort of an atom bomb explosion, something will always be there. 668 00:52:50.800 --> 00:52:59.800 So, we can expect that land is perpetual, or makes some sort of perpetual return. If we expect that land will bring you $10,000 return forever, let's say, 669 00:52:59.800 --> 00:53:05.800 without an interest rate this kind, you'll never be able to sell it, because the price would be infinite. I can sell something at an infinite price. 670 00:53:05.800 --> 00:53:10.680 Obviously the point then is that you sell land because the expectation of getting $10,000 671 00:53:10.680 --> 00:53:15.240 all the year and C-1000AD doesn't loom very large in your consciousness, you're discounting 672 00:53:15.240 --> 00:53:19.600 it by very heavily, it means almost nothing, you get down to a sort of asymptotic relationship 673 00:53:19.600 --> 00:53:24.680 where it's virtually zero and this sum becomes the amount that you're willing to sell it 674 00:53:24.680 --> 00:53:26.760 for and the amount the other guy is willing to buy it for. 675 00:53:26.760 --> 00:53:33.440 So in equilibrium, the market price of the entire thing, whether it's a slave under slavery 676 00:53:33.440 --> 00:53:39.880 or machine or a land or aggregations of these things will tend to be the discounted sum 677 00:53:39.880 --> 00:53:43.480 of effective future rents or effective future returns. 678 00:53:43.480 --> 00:53:48.200 The formula for a perpetual resource, the life of the thing is infinite such as land, is 679 00:53:48.200 --> 00:53:53.440 a simple formula for this which sort of illustrates the capital value of C is equal to R, the 680 00:53:53.440 --> 00:53:58.160 annual rent or the annual rate of return, divided by the rate of interest. 681 00:53:58.160 --> 00:54:04.280 So if the annual return is $1,000 a year and the rate of interest is 10%, capital value 682 00:54:04.280 --> 00:54:05.280 will be $10,000. 683 00:54:05.280 --> 00:54:09.080 Now we see this happening all the time, by the way, in the stock market. 684 00:54:09.080 --> 00:54:14.160 The point is that as returns increase, increased returns tend to increase the capital value 685 00:54:14.160 --> 00:54:15.160 and vice versa. 686 00:54:15.160 --> 00:54:21.120 The capital value of anything is proportionate to the annual return, expected annual return, 687 00:54:21.120 --> 00:54:22.480 inversely proportionate to the rate of interest. 688 00:54:22.480 --> 00:54:27.920 As the rate of interest goes up, it tends to lower the general capital value of everything. 689 00:54:27.920 --> 00:54:32.320 And we'll see how this applies to conservation and why copper miners will produce a certain 690 00:54:32.320 --> 00:54:36.880 amount now and wait for the next ten years to produce the rest of it, etc. 691 00:54:36.880 --> 00:54:38.960 I think we have enough for this lecture.