WEBVTT NOTE 6.04. The Time Market and the Production Structure 1 00:00:00.000 --> 00:00:05.760 4. The Time Market and the Production Structure 2 00:00:05.760 --> 00:00:11.680 The time market, like other markets, consists of component individuals whose schedules are 3 00:00:11.680 --> 00:00:19.040 aggregated to form the market supply and demand schedules. The intricacy of the time market 4 00:00:19.040 --> 00:00:25.360 and of the money market as well consists in the fact that it is also divided and subdivided 5 00:00:25.360 --> 00:00:32.520 into various distinguishable sub-markets. These are aggregable into a total market, 6 00:00:32.520 --> 00:00:38.180 but the subsidiary components are interesting and highly significant in their own right 7 00:00:38.180 --> 00:00:44.720 and deserve further analysis. They themselves, of course, are composed of individual supply 8 00:00:44.720 --> 00:00:47.380 and demand schedules. 9 00:00:47.380 --> 00:00:54.260 We may divide the present-future market into two main subdivisions, the production structure 10 00:00:54.260 --> 00:00:56.740 and the Consumer Loan Market. 11 00:00:56.740 --> 00:01:00.460 Let us turn first to the production structure. 12 00:01:00.460 --> 00:01:07.300 Money moves from consumers' goods back through the various stages of production, while goods 13 00:01:07.300 --> 00:01:14.540 flow from the higher through the lower stages of production, finally to be sold as consumers' 14 00:01:14.540 --> 00:01:15.540 goods. 15 00:01:15.540 --> 00:01:21.360 The pattern of production is not changed by the fact that both specific and non-specific 16 00:01:21.360 --> 00:01:23.420 factors exist. 17 00:01:23.420 --> 00:01:29.140 Since the production structure is aggregated, the degree of specificity for a particular 18 00:01:29.140 --> 00:01:34.140 product is irrelevant in a discussion of the time market. 19 00:01:34.140 --> 00:01:39.740 There is no problem in the fact that different production processes for different goods take 20 00:01:39.740 --> 00:01:42.160 unequal lengths of time. 21 00:01:42.160 --> 00:01:48.080 This is not a difficulty because the flow from one stage to another can be aggregated 22 00:01:48.080 --> 00:01:51.220 for any number of processes. 23 00:01:51.220 --> 00:01:56.940 There are, however, two more serious problems that seem to be involved in aggregating the 24 00:01:56.940 --> 00:02:00.900 production structure for the entire economy. 25 00:02:00.900 --> 00:02:06.580 One is the fact that in various processes, there will not necessarily be an exchange 26 00:02:06.580 --> 00:02:10.880 of capital goods for money at each stage. 27 00:02:10.880 --> 00:02:17.420 One firm may vertically integrate within itself one or more stages, and thereby advance 28 00:02:17.420 --> 00:02:21.140 present goods for a greater period of time. 29 00:02:21.140 --> 00:02:26.380 We shall see, however, that this presents no difficulty at all, just as it presented 30 00:02:26.380 --> 00:02:30.740 no difficulty in the case of particular processes. 31 00:02:30.740 --> 00:02:36.320 A second difficulty is the purchase and use of durable capital goods. 32 00:02:36.320 --> 00:02:42.680 We have been assuming, and are continuing to assume, that no capital goods or land are 33 00:02:42.680 --> 00:02:49.340 bought, that they are only hired, that is, rented, from their owners. 34 00:02:49.340 --> 00:02:56.260 The purchase of durable goods presents complications, but again, as we shall see, this will lead 35 00:02:56.260 --> 00:03:01.420 to no essential change whatever in our analysis. 36 00:03:01.420 --> 00:03:07.400 Let us begin with the expenditure of consumers on consumers' goods. 37 00:03:07.400 --> 00:03:13.400 The movement of money is from consumers to the sellers of consumers' goods. 38 00:03:13.400 --> 00:03:20.380 This is not a time transaction, because it is an exchange of present goods, money, for 39 00:03:20.380 --> 00:03:23.860 present goods, consumers' goods. 40 00:03:23.860 --> 00:03:30.440 The fact that consumers may physically consume all or part of these goods at a later date 41 00:03:30.440 --> 00:03:36.640 does not affect this conclusion, because any further consumption takes place outside the 42 00:03:36.640 --> 00:03:41.740 money nexus, and it is the latter that we are analyzing. 43 00:03:41.740 --> 00:03:48.000 These producers of consumers' goods are necessarily capitalists who have invested in the services 44 00:03:48.000 --> 00:03:53.420 of factors to produce these goods and who then sell their products. 45 00:03:53.420 --> 00:03:59.600 Their investment in factors consisted of purchases of the services of land factors and labor 46 00:03:59.600 --> 00:04:07.400 factors, the original factors, and first-order capital goods, the produced factors. 47 00:04:07.400 --> 00:04:14.600 In both these two large categories of transactions, exchanges that are made a stage earlier than 48 00:04:14.600 --> 00:04:21.180 the final sale of consumers' goods, present goods are exchanging for future goods. 49 00:04:21.180 --> 00:04:27.960 In both cases, the capitalists are supplying present money in exchange for factor services 50 00:04:27.960 --> 00:04:35.220 whose yield will materialize in the future, and which therefore are future goods. 51 00:04:35.220 --> 00:04:42.660 So the capitalists who are producing consumers' goods, whom we might call first stage capitalists, 52 00:04:42.660 --> 00:04:47.020 engage in time transactions in making their investments. 53 00:04:47.020 --> 00:04:53.420 The components of this particular subdivision of the time market then are supply of present 54 00:04:53.420 --> 00:05:03.940 goods, capitalists one, supply of future goods, landowners, laborers, capitalists two. 55 00:05:03.940 --> 00:05:09.220 Capitalists 1 are the first stage capitalists who produce consumers' goods. 56 00:05:09.220 --> 00:05:16.760 They purchase capital goods from the producer-owners, the second stage capitalists or capitalists 57 00:05:16.760 --> 00:05:18.080 2. 58 00:05:18.080 --> 00:05:24.680 At the next stage, the capitalists 2 have to purchase services of factors of production. 59 00:05:24.680 --> 00:05:31.160 They supply present goods and purchase future goods, goods which are even more distantly 60 00:05:31.160 --> 00:05:35.540 in the Future than the product that they will produce. 61 00:05:35.540 --> 00:05:41.720 No important complication arises from the greater degree of futurity of the higher order 62 00:05:41.720 --> 00:05:43.000 factors. 63 00:05:43.000 --> 00:05:49.620 As we have indicated, a more distantly future good will simply be discounted by the market 64 00:05:49.620 --> 00:05:54.420 by a greater amount, though at the same rate per annum. 65 00:05:54.420 --> 00:06:01.740 The interest rate, that is, the discount rate of future goods per unit of time, remains 66 00:06:01.740 --> 00:06:06.780 the same regardless of the degree of futurity of the good. 67 00:06:06.780 --> 00:06:13.680 This fact serves to resolve one problem mentioned earlier, vertical integration by firms over 68 00:06:13.680 --> 00:06:16.180 one or more stages. 69 00:06:16.180 --> 00:06:23.460 If the equilibrium rate of interest is 5% per year, then a one-stage producer will earn 70 00:06:23.460 --> 00:06:30.380 5% on his investment, while a producer who advances present goods over three stages for 71 00:06:30.380 --> 00:06:37.880 three years will earn 15%, that is, 5% per annum. 72 00:06:37.880 --> 00:06:44.000 These future goods are supplied by landowners, laborers and capitalists. 73 00:06:44.000 --> 00:06:51.800 To sum up, at the second stage, supply of present goods is provided by capitalists too. 74 00:06:51.800 --> 00:06:58.440 Supply of Future Goods by Landowners, Laborers and Capitalists III 75 00:06:58.440 --> 00:07:05.280 This pattern is continued until the very last stage, at this final stage, which is here 76 00:07:05.280 --> 00:07:06.280 the sixth. 77 00:07:06.280 --> 00:07:12.560 The sixth stage capitalists supply future goods to the fifth stage capitalists, but 78 00:07:12.560 --> 00:07:20.440 also supply present goods to laborers and landowners in exchange for the extremely distant future 79 00:07:20.440 --> 00:07:32.440 The Transactions for the two highest stages are then as follows, with the last stage designated as N instead of 6. 80 00:07:32.440 --> 00:07:44.440 Fifth stage, supply of present goods provided by capitalists 5, supply of future goods by landowners, laborers and capitalists N. 81 00:07:44.440 --> 00:07:56.440 At the nth stage of production, supply of present goods is provided by capitalists n, supply of future goods by landowners and laborers. 82 00:07:56.440 --> 00:08:02.440 We may now sum up our time market for any production structure of n stages. 83 00:08:02.440 --> 00:08:10.440 Suppliers of present goods include capitalists 1, 2, 3 through n. 84 00:08:10.440 --> 00:08:23.340 Suppliers of future goods, demanders of present goods, include all landowners, all laborers, and capitalists II, III, through N. 85 00:08:23.340 --> 00:08:36.040 To illustrate clearly the workings of the production structure, let us summarize the quantities of present goods supplied and received by the various components of the time market. 86 00:08:36.040 --> 00:08:48.640 We may use the same figures here to apply to the aggregate production structure, although the listener may wish to consider the units as multiples of gold ounces in this case. 87 00:08:48.640 --> 00:09:03.040 Furthermore, the fact that the ERE interest rate will be the same for all stages and all goods in the economy especially permits us to aggregate the comparable stages of all goods. 88 00:09:03.040 --> 00:09:33.040 For if the rate is 5%, then we may say that for a certain stage of one good, payments by capitalists to owners of factors are 50 ounces, and receipts from sales of products are 52.5 ounces, while we can also assume that the aggregate payments for the whole economy in the same period are 5,000 ounces, and receipts, 5,250 ounces, 89 00:09:33.040 --> 00:09:38.440 The same interest rate connotes the same rate of return on investments, 90 00:09:38.440 --> 00:09:43.640 whether considered separately or for all goods lumped together. 91 00:09:43.640 --> 00:09:50.040 Suppose, for example, that we stipulate that in a production process of end stages, 92 00:09:50.040 --> 00:09:59.040 capitalists invest a total of 318 ounces, 83 ounces of which goes to land and labor owners, 93 00:09:59.040 --> 00:10:06.800 and 235 ounces of which goes to purchase factor services of capital goods of a higher order. 94 00:10:08.000 --> 00:10:14.000 From this it is easy to derive the net money income of the various participants, 95 00:10:14.560 --> 00:10:21.920 their gross money income minus their money payments if we include the entire period of time 96 00:10:21.920 --> 00:10:28.720 for all of their transactions on the time market. The case of the owners of land and labor is 97 00:10:28.720 --> 00:10:34.680 is simple, they receive their money in exchange for the future goods to be yielded by their 98 00:10:34.680 --> 00:10:36.000 factors. 99 00:10:36.000 --> 00:10:42.280 This money is their gross and their net money income from the productive system. 100 00:10:42.280 --> 00:10:48.680 The total of net money income to the owners of land and labor is 83 ounces. 101 00:10:48.680 --> 00:10:55.160 This is the sum of the money incomes to the various owners of land and labor at each stage 102 00:10:55.160 --> 00:10:57.240 of production. 103 00:10:57.240 --> 00:11:00.800 The case of the capitalists is far more complicated. 104 00:11:00.800 --> 00:11:07.420 They pay out present goods in exchange for future goods and then sell the maturing, less 105 00:11:07.420 --> 00:11:13.220 distantly future products for money to lower stage capitalists. 106 00:11:13.220 --> 00:11:20.400 Their net money income is derived by subtracting their money outgo from their gross income 107 00:11:20.400 --> 00:11:24.200 over the period of the production stage. 108 00:11:24.200 --> 00:11:32.880 In our example, capitalists two spend 76 ounces out of a gross income of 80 ounces for a net 109 00:11:32.880 --> 00:11:36.000 income of 4 ounces. 110 00:11:36.000 --> 00:11:42.560 Capitalists three spend 57 ounces out of a gross income of 60 ounces for a net income 111 00:11:42.560 --> 00:11:45.240 of 3 ounces. 112 00:11:45.240 --> 00:11:51.720 Capitalists four spend 43 ounces out of a gross income of 45 ounces for a net income 113 00:11:51.720 --> 00:11:54.180 of 2 ounces. 114 00:11:54.180 --> 00:12:02.180 Capitalists 5 spend 28 ounces out of a gross income of 30 ounces for a net income of 2 ounces. 115 00:12:02.180 --> 00:12:11.180 Capitalists N spend 19 ounces out of a gross income of 20 ounces for a net income of 1 ounce. 116 00:12:11.180 --> 00:12:20.180 The total net income of the capitalists producing capital goods, orders 2 through N, is 12 ounces. 117 00:12:20.180 --> 00:12:27.500 What, then, of capitalists won, who apparently have not only no net income, but a deficit 118 00:12:27.500 --> 00:12:29.740 of 95 ounces? 119 00:12:29.740 --> 00:12:36.460 They are recouped not from the savings of capitalists, but from the expenditure of consumers, 120 00:12:36.460 --> 00:12:44.500 which totals 100 ounces, yielding a net income to capitalists won of 5 ounces. 121 00:12:44.500 --> 00:12:49.820 It should be emphasized at this point that the general pattern of the structure of production 122 00:12:49.820 --> 00:12:57.480 and of the time market will be the same in the real world of uncertainty as in the ERE. 123 00:12:57.480 --> 00:13:03.260 The difference will be in the amounts that go to each sector and in the relations among 124 00:13:03.260 --> 00:13:05.380 the various prices. 125 00:13:05.380 --> 00:13:09.000 We shall see later what the discrepancies will be. 126 00:13:09.000 --> 00:13:15.520 For example, the rate of return by the capitalists in each sector will not be uniform in the 127 00:13:15.520 --> 00:13:24.520 and the Real Market, but the pattern of payments, the composition of suppliers and demanders, will be the same. 128 00:13:24.520 --> 00:13:39.520 In analyzing the income-expenditure balance sheets of the production structure, writers on economic problems have seen that we may consolidate the various incomes and consider only the net incomes. 129 00:13:39.520 --> 00:13:48.020 The temptation has been simply to write off the various inter-capitalist transactions as duplications. 130 00:13:48.020 --> 00:13:56.020 If that is done here, then the total net income in the market is capitalists 17 ounces, 131 00:13:56.020 --> 00:14:06.520 12 ounces for capital good capitalists and 5 ounces for consumers good capitalists, land and labor factors 83 ounces. 132 00:14:06.520 --> 00:14:14.520 The grand total net income is then 100 ounces. This is exactly equal to the total of consumer 133 00:14:14.520 --> 00:14:23.720 spending for the period. Total net income is 100 ounces and consumption is 100 ounces. There is, 134 00:14:23.720 --> 00:14:31.720 therefore, no new net saving. We shall deal with savings and their change in detail later. 135 00:14:31.720 --> 00:14:57.160 Here the point is that in the endless round of the ERE, zero net savings, as thus defined, would mean that there is just enough gross saving to keep the structure of productive capital intact, to keep the production processes rolling, and to keep a constant amount of consumers' goods produced per given period. 136 00:14:57.160 --> 00:15:03.560 It is certainly legitimate and often useful to consider net incomes and net savings, 137 00:15:03.560 --> 00:15:11.320 but it is not always illuminating, and its use has been extremely misleading in present-day economics. 138 00:15:11.320 --> 00:15:17.960 Use of the net national income figures, it is better to deal with social income, 139 00:15:17.960 --> 00:15:24.200 extending throughout the market community using the money, rather than to limit the scope to 140 00:15:24.200 --> 00:15:30.300 and National Boundaries, leads one to believe that the really important element maintaining 141 00:15:30.300 --> 00:15:34.320 the production structure is consumer spending. 142 00:15:34.320 --> 00:15:41.080 In our E.R.E. example, the various factors and capitalists receive their net income and 143 00:15:41.080 --> 00:15:47.640 plow it back into consumption, thus maintaining the productive structure and future standards 144 00:15:47.640 --> 00:15:52.120 of living, that is, the output of consumers' goods. 145 00:15:52.120 --> 00:15:56.000 The inference from such concepts is clear. 146 00:15:56.000 --> 00:16:01.360 Capitalist savings are necessary to increase and deepen the capital structure. 147 00:16:01.360 --> 00:16:08.080 But even without any savings, consumption expenditure is alone sufficient to maintain 148 00:16:08.080 --> 00:16:12.680 the productive capital structure intact. 149 00:16:12.680 --> 00:16:16.680 This conclusion seems deceptively clear-cut. 150 00:16:16.680 --> 00:16:22.940 After all, is not consumer spending the bulwark and end product of activity? 151 00:16:22.940 --> 00:16:26.400 This thesis, however, is tragically erroneous. 152 00:16:26.400 --> 00:16:32.820 There is no simple automatism in capitalist spending, especially when we leave the certain 153 00:16:32.820 --> 00:16:40.560 world of the E.R.E., and it is in this real world that the conceptual error plays havoc. 154 00:16:40.560 --> 00:16:46.280 For with production divided into stages, it is not true that consumption spending is 155 00:16:46.280 --> 00:16:50.800 is sufficient to provide for the maintenance of the capital structure. 156 00:16:50.800 --> 00:16:56.660 When we consider the maintenance of the capital structure, we must consider all the decisions 157 00:16:56.660 --> 00:17:01.340 to supply present goods on the present-future market. 158 00:17:01.340 --> 00:17:03.760 These decisions are aggregated. 159 00:17:03.760 --> 00:17:06.900 They do not cancel one another out. 160 00:17:06.900 --> 00:17:13.500 Total savings in the economy, then, are not zero, but the aggregation of all the present 161 00:17:13.500 --> 00:17:19.760 Capitalist Goods Supplied to Owners of Future Goods During the Production Process. 162 00:17:19.760 --> 00:17:28.420 This is the sum of the supplies of Capitalists One through Capitalists N, which totals 318 163 00:17:28.420 --> 00:17:30.580 ounces. 164 00:17:30.580 --> 00:17:38.960 This is the total gross savings, the supply of present goods for future goods in production, 165 00:17:38.960 --> 00:17:43.460 and also equals total gross investment. 166 00:17:43.460 --> 00:17:51.060 Fund is the amount of money spent on future good factors and necessarily equals savings. 167 00:17:51.060 --> 00:18:03.460 Total expenditures on production are 100 consumption plus 318 investment or savings equals 418 168 00:18:03.460 --> 00:18:05.260 ounces. 169 00:18:05.260 --> 00:18:13.340 Total gross income from production equals the gross income of capitalists one, 100 ounces, 170 00:18:13.340 --> 00:18:22.420 plus the gross income of other capitalists, 235 ounces, plus the gross income of owners 171 00:18:22.420 --> 00:18:31.120 of land and labor, 83 ounces, which also equals 418 ounces. 172 00:18:31.120 --> 00:18:36.480 The system depicted in our example of the production structure, then, is of an economy 173 00:18:36.480 --> 00:18:46.960 in which 418 gold ounces are earned in gross income, and 100 ounces are spent on consumption, 174 00:18:46.960 --> 00:18:55.040 while 318 ounces are saved and invested in a certain order in the production structure. 175 00:18:55.040 --> 00:19:04.320 In this evenly rotating economy, 418 ounces are earned and then spent, with no net hoarding 176 00:19:04.320 --> 00:19:11.680 or dis-hoarding, that is, no net additions or subtractions from the cash balance over 177 00:19:11.680 --> 00:19:14.620 the period as a whole. 178 00:19:14.620 --> 00:19:19.520 Problems of hoarding and dis-hoarding from the cash balance will be treated in Chapter 179 00:19:19.520 --> 00:19:25.520 2011 on Money, and are prescinded from the present analysis. 180 00:19:25.520 --> 00:19:32.160 Thus, instead of no savings being needed to maintain capital and the production structure 181 00:19:32.160 --> 00:19:39.400 intact, we see that a very heavy proportion of savings and investment, in our example 182 00:19:39.400 --> 00:19:46.120 three times the amount spent on consumption, is necessary simply to keep the production 183 00:19:46.120 --> 00:19:48.260 structure intact. 184 00:19:48.260 --> 00:19:55.820 The contrast is clear when we consider who obtains income and who is empowered to decide 185 00:19:55.820 --> 00:19:58.860 whether to consume or to invest. 186 00:19:58.860 --> 00:20:05.240 The net income theorists implicitly assume that the only important decisions in regard 187 00:20:05.240 --> 00:20:13.300 to consuming versus saving investing are made by the factor owners out of their net income. 188 00:20:13.300 --> 00:20:19.800 Since the net income of capitalists is admittedly relatively small, this approach attributes 189 00:20:19.800 --> 00:20:23.980 little importance to their role in maintaining capital. 190 00:20:23.980 --> 00:20:32.020 We see, however, that what maintains capital is gross expenditures and gross investment, 191 00:20:32.020 --> 00:20:34.540 and not net investment. 192 00:20:34.540 --> 00:20:40.420 The capitalists at each stage of production, therefore, have a vital role in maintaining 193 00:20:40.420 --> 00:20:52.820 Concretely, let us take the case of the capitalists' one. 194 00:20:52.820 --> 00:20:58.100 According to the net income theorists, their role is relatively small, since their net 195 00:20:58.100 --> 00:21:00.860 income is only 5 ounces. 196 00:21:00.860 --> 00:21:08.180 But actually, their gross income is 100 ounces, and it is their decision on how much of this 197 00:21:08.180 --> 00:21:19.720 In the ERE, of course, we simply state that they save and invest 95 ounces. 198 00:21:19.720 --> 00:21:25.560 But when we leave the province of the ERE, we must realize that there is nothing automatic 199 00:21:25.560 --> 00:21:27.300 about this investment. 200 00:21:27.300 --> 00:21:32.360 There is no natural law that they must reinvest this amount. 201 00:21:32.360 --> 00:21:37.880 It is, for example, that the capitalists, one, decide to break up the smooth flow of 202 00:21:37.880 --> 00:21:45.220 the ERE by spending all of the 100 ounces for their own consumption, rather than investing 203 00:21:45.220 --> 00:21:47.240 the 95 ounces. 204 00:21:47.240 --> 00:21:53.200 It is evident that the entire market-borne production structure would be destroyed. 205 00:21:53.200 --> 00:22:00.000 No income at all would accrue to the owners of all the higher-order capital goods, and 206 00:22:00.000 --> 00:22:05.880 and all the higher-order capital processes, all the production processes longer than the 207 00:22:05.880 --> 00:22:09.320 very shortest, would have to be abandoned. 208 00:22:09.320 --> 00:22:15.720 We have seen, and shall see in more detail, that civilization advances by virtue of additional 209 00:22:15.720 --> 00:22:20.160 capital, which lengthens production processes. 210 00:22:20.160 --> 00:22:25.920 Greater quantities of goods are made possible only through the employment of more capital 211 00:22:25.920 --> 00:22:28.480 in longer processes. 212 00:22:28.480 --> 00:22:34.880 Should capitalists shift from saving investment to consumption, all these processes would 213 00:22:34.880 --> 00:22:40.840 be necessarily abandoned, and the economy would revert to barbarism, with the employment 214 00:22:40.840 --> 00:22:45.160 of only the shortest and most primitive production processes. 215 00:22:45.160 --> 00:22:51.300 The standard of living, the quantity and variety of goods produced, would fall catastrophically 216 00:22:51.300 --> 00:22:54.200 to the primitive level. 217 00:22:54.200 --> 00:23:00.060 What could be the reason for such a precipitate withdrawal of savings and investment in favor 218 00:23:00.060 --> 00:23:01.700 of consumption? 219 00:23:01.700 --> 00:23:07.340 The only reason on the free market would be a sudden and massive increase in the time 220 00:23:07.340 --> 00:23:13.900 preference schedules of the capitalists, so that present satisfactions become worth very 221 00:23:13.900 --> 00:23:18.080 much more in terms of future satisfactions. 222 00:23:18.080 --> 00:23:23.320 Their higher time preferences mean that the existing rate of interest is not enough to 223 00:23:23.320 --> 00:23:28.040 to induce them to save and invest in their previous proportions. 224 00:23:28.040 --> 00:23:35.100 They therefore consume a greater proportion of their gross income and invest less. 225 00:23:35.100 --> 00:23:41.300 Each individual on the basis of his time preference schedule decides between the amount of his 226 00:23:41.300 --> 00:23:47.680 money income to be devoted to saving and the amount to be devoted to consumption. 227 00:23:47.680 --> 00:23:54.680 The aggregate time market schedules determined by time preferences determine the aggregate 228 00:23:54.680 --> 00:24:00.100 social proportions between gross savings and consumption. 229 00:24:00.100 --> 00:24:06.120 It is clear that the higher the time preference schedules are, the greater will be the proportion 230 00:24:06.120 --> 00:24:13.360 of consumption to savings, while lower time preference schedules will lower this proportion. 231 00:24:13.360 --> 00:24:19.360 At the same time, as we have seen, higher time preference schedules in the economy lead 232 00:24:19.360 --> 00:24:26.720 to higher rates of interest, and lower schedules lead to lower rates of interest. 233 00:24:26.720 --> 00:24:33.360 From this it becomes clear that the time preferences of the individuals on the market determine 234 00:24:33.360 --> 00:24:41.840 simultaneously and by themselves both the market equilibrium interest rate and the proportions 235 00:24:41.840 --> 00:25:04.840 In our example, the increase in time preference schedules has caused a decline in savings, absolute and proportionate, and a rise in the interest rate. 236 00:25:04.840 --> 00:25:11.520 The fallacies of the net product figures have led economists to include some grossness in 237 00:25:11.520 --> 00:25:14.320 their product and income figures. 238 00:25:14.320 --> 00:25:21.100 At present, the favorite concept is that of the gross national product and its counterpart, 239 00:25:21.100 --> 00:25:23.560 gross national expenditures. 240 00:25:23.560 --> 00:25:29.700 These concepts were adopted because of the obvious errors encountered with the net income 241 00:25:29.700 --> 00:25:30.700 concepts. 242 00:25:30.700 --> 00:25:36.220 That gross figures, however, are the height of illogicality, because they are not gross 243 00:25:36.220 --> 00:25:39.400 at all, but only partly gross. 244 00:25:39.400 --> 00:25:46.880 They include only gross purchases by capitalists of durable capital goods, and the consumption 245 00:25:46.880 --> 00:25:55.220 of their self-owned durable capital, approximated by depreciation allowances set by the owners. 246 00:25:55.220 --> 00:26:00.300 We shall consider the problems of durable capital more fully later. 247 00:26:00.300 --> 00:26:06.260 But suffice it to say that there is no great difference between durable and less durable 248 00:26:06.260 --> 00:26:07.260 capital. 249 00:26:07.260 --> 00:26:12.900 Both are consumed in the course of the production process, and both must be paid for out of 250 00:26:12.900 --> 00:26:18.100 the gross income and gross savings of lower-order capitalists. 251 00:26:18.100 --> 00:26:24.140 In evaluating the payment pattern of the production structure, then, it is inadmissible to leave 252 00:26:24.140 --> 00:26:30.060 the consumption of non-durable capital goods out of the investment picture. 253 00:26:30.060 --> 00:26:37.040 It is completely illogical to single out durable goods, which are themselves only discounted 254 00:26:37.040 --> 00:26:43.740 embodiments of their non-durable services, and therefore no different from non-durable 255 00:26:43.740 --> 00:26:45.240 goods. 256 00:26:45.240 --> 00:26:53.240 The idea that the capital structure is maintained intact without savings, as it were, automatically, 257 00:26:53.240 --> 00:26:56.640 is fostered by the use of the net approach. 258 00:26:56.640 --> 00:27:03.000 If even zero savings will suffice to maintain capital, then it seems as if the aggregate 259 00:27:03.000 --> 00:27:08.480 value of capital is a permanent entity that cannot be reduced. 260 00:27:08.480 --> 00:27:14.360 This notion of the permanence of capital has permeated economic theory, particularly through 261 00:27:14.360 --> 00:27:21.160 the writings of J.B. Clark and Frank H. Knight, and through the influence of the latter has 262 00:27:21.160 --> 00:27:25.820 molded current neo-classical economic theory in America. 263 00:27:25.820 --> 00:27:32.300 To maintain this doctrine, it is necessary to deny the stage analysis of production, 264 00:27:32.300 --> 00:27:38.060 and indeed to deny the very influence of time in production. 265 00:27:38.060 --> 00:27:44.240 If permanence is attributed to the mythical entity, the aggregate value of capital, it 266 00:27:44.240 --> 00:27:51.280 becomes an independent factor of production, along with labor, and earns interest. 267 00:27:51.280 --> 00:27:58.240 The all-pervading influence of time is stressed in the period of production concept and in 268 00:27:58.240 --> 00:28:04.760 the determination of the interest rate and of the investment consumption ratio by individual 269 00:28:04.760 --> 00:28:07.240 time preference schedules. 270 00:28:07.240 --> 00:28:14.800 The Knight Doctrine denies any role to time in production, asserting that production now, 271 00:28:14.800 --> 00:28:22.800 in a modern complex economy is timeless, and the time preference has no influence on the interest rate. 272 00:28:22.800 --> 00:28:27.800 This doctrine has been aptly called a mythology of capital. 273 00:28:27.800 --> 00:28:37.800 Among other errors, it leads to the belief that there is no economic problem connected with the replacement and maintenance of capital. 274 00:28:37.800 --> 00:28:42.800 A common fallacy, fostered directly by the net income approach, 275 00:28:42.800 --> 00:28:50.400 holds that the important category of expenditures in the production system is consumers' spending. 276 00:28:50.400 --> 00:28:57.400 Many writers have gone so far as to relate business prosperity directly to consumers' spending, 277 00:28:57.400 --> 00:29:02.100 and depressions of business to declines in consumers' spending. 278 00:29:02.100 --> 00:29:06.900 Business cycle considerations will be deferred to later chapters, 279 00:29:06.900 --> 00:29:14.000 But it is clear that there is little or no relationship between prosperity and consumer spending. 280 00:29:14.000 --> 00:29:16.900 Indeed, almost the reverse is true. 281 00:29:16.900 --> 00:29:24.400 For business prosperity, the important consideration is the price spreads between the various stages, 282 00:29:24.400 --> 00:29:28.400 that is, the rate of interest return earned. 283 00:29:28.400 --> 00:29:36.800 It is this rate of interest that induces capitalists to save and invest present goods in productive factors. 284 00:29:36.800 --> 00:29:46.300 The rate of interest, as we have been demonstrating, is set by the configurations of the time preferences of individuals in the society. 285 00:29:46.300 --> 00:29:53.800 It is not the total quantity of money spent on consumption that is relevant to capitalists' returns, 286 00:29:53.800 --> 00:30:03.300 but the margins, the spreads between the product prices and the sum of factor prices at the various stages, 287 00:30:03.300 --> 00:30:16.160 There is, in fact, never any need to worry about the maintenance of consumer spending. 288 00:30:16.160 --> 00:30:18.900 There must always be consumption. 289 00:30:18.900 --> 00:30:24.660 As we have seen, after a certain amount of monetary saving, there is always an irreducible 290 00:30:24.660 --> 00:30:31.740 minimum of his monetary assets that every man will spend on current consumption. 291 00:30:31.740 --> 00:30:39.300 The fact of human action ensures such an irreducible minimum, and as long as there is a monetary 292 00:30:39.300 --> 00:30:46.440 economy and money is in use, it will be spent on the purchase of consumers' goods. 293 00:30:46.440 --> 00:30:53.900 The proportion spent on capital in its various stages and in total gives a clue to the important 294 00:30:53.900 --> 00:31:00.260 consideration, the real output of consumers' goods in the economy. 295 00:31:00.260 --> 00:31:05.580 The total amount of money spent, however, gives no clue at all. 296 00:31:05.580 --> 00:31:10.740 Money and its value will be systematically studied in a later chapter. 297 00:31:10.740 --> 00:31:16.960 It is obvious, however, that the number of units spent could vary enormously, depending 298 00:31:16.960 --> 00:31:20.940 on the quantity of the money commodity in circulation. 299 00:31:20.940 --> 00:31:37.940 100 or 1000 or 10,000 or 100,000 ounces of gold might be spent on consumption without signifying anything, except that the quantity of money units available was less or greater. 300 00:31:37.940 --> 00:31:47.940 The total amount of money spent on consumption gives no clue to the quantity of goods the economy may purchase. 301 00:31:47.940 --> 00:31:59.340 The important consideration, therefore, is time preferences and the resultant proportion between expenditure on consumers' and producers' goods. 302 00:31:59.340 --> 00:32:07.140 Investment. The lower the proportion of the former, the heavier will be the investment in capital structure, 303 00:32:07.140 --> 00:32:14.540 and after a while, the more abundant the supply of consumers' goods and the more productive the economy. 304 00:32:14.540 --> 00:32:28.540 The obverse of the coin is the determining effect of time preferences on the price spreads that set the rate of interest and the income of the capitalist savers investors in the economy. 305 00:32:28.540 --> 00:32:41.540 We have already seen the effect of a lowering of investment on the first rank, and later we shall analyze fully the effect on production and interest of a lowering of time preferences 306 00:32:41.540 --> 00:32:49.540 and the effects of various changes in the quantity of money on time preferences and the production structure. 307 00:32:49.540 --> 00:33:01.540 Before continuing with an analysis of time preference and the production structure, however, let us complete our examination of the components of the time market. 308 00:33:01.540 --> 00:33:13.540 The pure demanders of present goods on the time market are the various groups of laborers and landowners, the sellers of the services of original productive factors. 309 00:33:13.540 --> 00:33:25.540 Their price on the market, as will be seen, will be set equal to the marginal value product of their units, discounted by the prevailing rate of interest. 310 00:33:25.540 --> 00:33:40.540 The greater the rate of interest, the less will the price of their service be, or rather, the greater will be the discount from their marginal value product considered as the matured present good. 311 00:33:40.540 --> 00:33:47.320 Thus if the marginal value product of a certain labor or land factor is 10 ounces per unit 312 00:33:47.320 --> 00:33:55.080 period, and the rate of interest is 10%, its earning price will be approximately 9 ounces 313 00:33:55.080 --> 00:33:59.700 per year if the final product is one year away. 314 00:33:59.700 --> 00:34:06.020 A higher rate of interest would lead to a lower price, and a lower rate to a higher 315 00:34:06.020 --> 00:34:18.020 Although the maximum price is one slightly below the full MVP, marginal value product, since the interest rate can never disappear. 316 00:34:18.020 --> 00:34:30.020 It seems likely that the demand schedule for present goods by the original productive factors will be highly inelastic in response to changes in the interest rate. 317 00:34:30.020 --> 00:34:35.580 with the large base amount the discounting by various rates of interest 318 00:34:35.580 --> 00:34:40.900 will very likely make little difference to the factor owner. The rate of interest 319 00:34:40.900 --> 00:34:45.900 however will make a great deal of difference in so far as he is an owner 320 00:34:45.900 --> 00:34:52.780 and seller of a durable good. Land is of course durable almost by definition, in 321 00:34:52.780 --> 00:34:58.580 fact generally permanent. So far we have been dealing only with the sale of 322 00:34:58.580 --> 00:35:06.060 of Factor Services, that is, the hire or rent of the factor, and abstracting from the sale 323 00:35:06.060 --> 00:35:12.060 or valuation of durable factors which embody future services. 324 00:35:12.060 --> 00:35:16.100 Durable land, as we shall see, is capitalized. 325 00:35:16.100 --> 00:35:23.860 That is, the value of the factor as a whole is the discounted sum of its future MVPs, 326 00:35:23.860 --> 00:35:27.880 and there the interest rate will make a significant difference. 327 00:35:27.880 --> 00:35:34.760 The price of durable land, however, is irrelevant to the supply schedule of land services in 328 00:35:34.760 --> 00:35:38.000 demand for present money. 329 00:35:38.000 --> 00:35:43.440 Large changes in the interest rate, which would make an enormous difference to capitalists 330 00:35:43.440 --> 00:35:49.360 and determine huge differences in interest income and the profitableness of various lengthy 331 00:35:49.360 --> 00:35:55.720 productive processes, would have a negligible effect on the earnings of the owners of the 332 00:35:55.720 --> 00:35:58.720 and the original productive factors. 333 00:35:58.720 --> 00:36:03.720 On the time market we are considering all factors in the aggregate. 334 00:36:03.720 --> 00:36:10.720 The interest rate of the time market permeates all particular aspects of the present future market, 335 00:36:10.720 --> 00:36:14.720 including all purchases of land and labor services. 336 00:36:14.720 --> 00:36:19.720 Therefore, when we are considering the supply of a certain factor on the market, 337 00:36:19.720 --> 00:36:26.720 We are considering it in general, and not its supply schedule for a specific use. 338 00:36:26.720 --> 00:36:32.720 A group of homogeneous pieces of land may have three alternative uses, 339 00:36:32.720 --> 00:36:38.720 say for growing wheat, raising sheep, or serving as the site of a steel factory. 340 00:36:38.720 --> 00:36:43.720 Its supply schedule for each of the three uses will be elastic, 341 00:36:43.720 --> 00:36:48.720 and will be determined by the amount it can obtain in the next best use. 342 00:37:18.720 --> 00:37:25.720 Labor services may place evaluation on the possibility of contemplating the virgin beauty of the unused land. 343 00:37:25.720 --> 00:37:32.720 In practice, however, the importance of such reservation demand for land is likely to be negligible. 344 00:37:32.720 --> 00:37:39.720 It will, of course, be greater where the owner can use the land to grow food for himself. 345 00:37:39.720 --> 00:37:46.720 Labor services are also likely to be inelastic with respect to the interest discount, 346 00:37:46.720 --> 00:37:56.720 But probably less so than land, since labor has a reservation demand, a subjective use value, even in the aggregate labor market. 347 00:37:56.720 --> 00:38:03.720 This special reservation demand stems from the value of leisure as a consumer's good. 348 00:38:03.720 --> 00:38:14.720 Higher prices for labor services will induce more units of labor to enter the market, while lower prices will increase the relative advantages of leisure. 349 00:38:14.720 --> 00:38:31.720 Here again, however, the difference that will be made by relatively large changes in the interest rate will not be at all great, so that the aggregate supply of labor will tend to be inelastic with regard to the interest rate. 350 00:38:31.720 --> 00:38:41.720 The two categories of independent demanders of present goods for future goods, then, are the landowners and the laborers. 351 00:38:41.720 --> 00:38:53.720 The suppliers of present goods on the time market are clearly the capitalists, who save from their possible consumption and invest their savings in future goods. 352 00:38:53.720 --> 00:39:01.720 But the question may be raised, do not the capitalists also demand present goods as well as supply them? 353 00:39:01.720 --> 00:39:10.720 It is true that capitalists after investing in a stage of production demand present goods in exchange for their product. 354 00:39:10.720 --> 00:39:18.480 Product. This particular demand is inelastic in relation to interest changes, since these capital 355 00:39:18.480 --> 00:39:26.240 goods also can have no subjective use value for their producers. This demand, however, is strictly 356 00:39:26.240 --> 00:39:33.680 derivative and dependent. In the first place, the product for which the owner demands present goods 357 00:39:33.680 --> 00:39:42.080 is of course a future good, but it is also one stage less distantly future than the goods that the 358 00:39:42.080 --> 00:39:49.200 owner purchased in order to produce it. In other words, capitalists three will sell their future 359 00:39:49.200 --> 00:39:56.880 goods to capitalists two, but they had bought future goods from capitalists four, as well as 360 00:39:56.880 --> 00:40:08.880 Every capitalist at every stage, then, demands goods that are more distantly future than the product that he supplies, 361 00:40:08.880 --> 00:40:16.880 and he supplies present goods for the duration of the production stage until this product is formed. 362 00:40:16.880 --> 00:40:24.880 He is therefore a net supplier of present goods and a net demander of future goods. 363 00:40:24.880 --> 00:40:29.880 Hence, his activities are guided by his role as a supplier. 364 00:40:29.880 --> 00:40:35.880 The higher the rate of interest that he will be able to earn, that is, the higher the price spread, 365 00:40:35.880 --> 00:40:39.880 the more he will tend to invest in production. 366 00:40:39.880 --> 00:40:45.880 If he were not essentially a supplier of present goods, this would not be true. 367 00:40:46.880 --> 00:40:48.880 Thank you for watching.