The Critiques: An Analysis : economics, markets

Prices, and Production: Lecture III, Part V

laminustacitus — Fri, 04 Sep 2009 01:04:00 GMT

It is now time to move from a case where credits are given to producers to where consumers are being given credits. Indeed, the general effects of an increase of money via consumers' credits, which will result in an increased relative demand for consumers' goods compared to producers' ones, results in the inverse of the previous scenario where there is an increase through producers' credits. The sudden injection of money into the economy done by the purchasing of consumers' goods will result in entrepreneurs investing in shorter processes of production in order to take advantage of the large profit margins to be obtained in the markets for consumers' goods.

Obviously, once consumers have been given consumer-credits they will then proceed to purchase a greater quantity of consumers' goods than prior, but the structure of production at the time, having been created for a vastly lower consumer-demand, cannot produce enough to satiate consumer-demand. Due to the fact that there is now a large discrepancy between supply, and demand, the rise in consumer prices will be considerable, and this will result in greater profit-margins to be obtained from later stages of production compared to stages closer to the original means of production. The resulting prices, only the result of the scarcity of consumers' goods, will have the effect that production will shrink to fewer stages than will be necessary after those goods have reached equilibrium price once the scarcity has been alleviated.

While the structure of production is being altered to fit a more present-orientated economy, original factors, and the more mobile producers' goods will be in high demand, and, as a result, the longer production-processes will become less profitable – strengthening the trend towards shorter ones. Producers' goods of a more specific character created for the prior state of equilibrium will fall in price as their complementary nonspecific goods are reinvested in shorter processes; ergo, the production of those producers' goods will cease. In addition, though capital in the later stages of production is generally of a highly specific character, entrepreneurs may very well employ original factors in order to the consumers' goods that have yet to be finished. Nevertheless, the fall in the prices of intermediate products with be across the board, and entrepreneurs will hence stop work in the earlier stages of production once they realize their unprofitability.

However, the capital utilized in the longer processes of production cannot instantly be assimilated into the longer ones; rather, the process will be gradual. In order to employ the capital in the shorter processes, it must begin at the beginning as the product progresses toward consumption, and the available producers' goods are implemented in the process. The production of goods does not happen in an instant; instead, it is a process that, in a capitalistic structure of production, occurs over the course of years, and intermediate goods are created for a specific process of production. Hence, entrepreneurs just cannot add new capital to structures of production where the intermediate goods from the preceding stage are goods of a specific character designed for the capital existent in the following stages; rather, one must begin from the original factors of production, and proceed with a new process of production. Furthermore, the form of the end process will be further retarded by the uncertainty that entrepreneurs face as to what methods will be profitable once the scarcity of consumers' goods, and the resulting scarcity-level prices have been alleviated.

As Hayek notes: “It seems something of a paradox that the self-same goods whose scarcity has been the cause of the crisis would become unsaleable as a consequence of the same crisis.” The high demand for consumers' goods has diminished the supply of nonspecific producers' goods necessary to finish the reallocation of producers' goods in the structure of production. The crux of the matter lies in the fact that the specific producers' goods necessary for a structure that employs the quantity of capital at hand have not been produced. Here, we find a fundamental economic fact that mankind so often neglects: capitalistic production can continue only so long as man is content with consuming that goods that part of our wealth, which the structure of production has produced for consumption. Any increase in the quantity of consumption requires saving beforehand if it is not to disrupt current production, and if the increase in production is to be maintained continuously, then the amount of intermediate goods must be increased proportionately in all stages. “The impression that the already existing capital structure would enable us to increase production almost indefinitely is a deception.”

Overall, the increased demand for consumers' goods resulting from an injection of money into the economy via consumer-credits will result in a scarcity of consumer-goods, and, to satiated demand, there will be a resulting shortening of the structure of production toward a more present, consumption orientated economy.

Prices, and Production: Lecture III, Part II

laminustacitus — Fri, 26 Jun 2009 02:43:00 GMT

Once again, as done in previous lectures, we shall analyze the results of a scenario where consumers decide to save, and accordingly invest a larger portion of their income than before; however, here we shall see the effects the price of goods will have on the entire structure of production. As in the earlier elucidation, there will be an increased demand for producers' goods, and a decreased for consumers' goods that will result in a relative rise in the prices of the former compared with the latter. Nevertheless, the prices of producers' goods will not rise equally, nor even without exception; instead, they will be effected by their position in the structure of production.

The prices of producers' goods will be greatly effected by the prices of the goods in the next stage of production, and when the demand for consumers' goods decreases there will be a narrowing in the price margins between the stages resulting from a shift in the funds used in each stage. In addition, the stages of production that are closer to the finished goods will be effected by the falling prices for consumers' goods with greater influence than the stages of production closer to the original means of production. As the prices fetched for consumer goods decrease, those for the producers' products adjacent to them will similarly, and some of the funds used there will be shifted to earlier stages, which are now more profitable than the later ones, resulting in the narrowing of the price margins between the different stages. This shift will overcome the tendency towards a fall in the prices for the producers' goods in earlier stages as the funds arriving from the later stages creates a tendency for a rise in prices. Generalizing the above, the rise in the price of a product in any stage of production will result in a greater bounty of profits to be made in the preceding stage, and hence boost its production, and as funds are sent to earlier stages of production, entrepreneurs there will begin purchasing more producers' goods from the earlier stage, resulting in an increased price there. In the end, through the fall of the prices in later stages, and the rise of those in earlier, the price margins throughout the entire structure of production will have decreased.

Other results will be that nonspecific producers' goods will be attracted towards the earlier stages, which will continue until the diminution of returns there has equaled the profits to be made in all stages, and the general narrowing of price margins will make it possible to start production in new, and more distant stages that have hitherto been unprofitable. With specific producers' goods though, the effects are not as straight forward as they are with nonspecific ones, because they will be effected by the alteration in the entire structure of production, since they can be used only in specific roes. If a specific producers' good is adapted to a later stage, then its return will diminish as their supply remains constant as the demand diminishes, and its production will be curtailed, and the entire process is logically vice versa for those adapted to the earlier states. Further, the additional stages created as a result of increased investment will most likely require new specific goods, including natural resources unprofitable to utilize prior. Not only will the transition of the structure of production into a more capitalistic process effect the price margins between the stages, but it will also effect the types of producers' goods demanded, and used.

.Overall, the prices that goods in any stage of production are able to demand are important factors in determining the structure of production for if one stage is booming, then it will then require a greater supply of goods for antecedent stages, thus making business good for those as well. Furthermore, when the prices of consumer goods decline, then the finances used in the later stages will be reinvested in the structure of production thus stimulating earlier stages, rising the prices of the producers' goods manufactured there, and therefore lowering the price margins throughout the entire structure of production, which will accordingly effect the markets for both nonspecific, and specific producers' goods. Finally, we have arrived to the point at which the title Prices, and Production finally makes sense.

Prices, and Production: Lecture II, Part IV

laminustacitus — Sat, 06 Jun 2009 19:33:00 GMT

At last we are ready to begin the main problem of this lecture, that is the problem of how a transition to a more capitalistic structure of production, or vice versa, is brought about, and what are the conditions that must be fulfilled for a new equilibrium to be brought about. The first of the two is simple the answer: such a change will manifest itself if the total demand for producers' goods (of course, expressed in money) increases relatively to the demand for consumers' goods. There are two ways that this would happen: either as a result of an alteration in the volume of voluntary saving (or its opposite), or due to a change in the quantity of money available to entrepreneurs for the purchase of producers' goods. We shall first consider the former, where we assume that the quantity of money remains constant, then move on to the latter, where we do not assume the quantity of money remains constant.

As a starting point, we shall take the situation depicted in the previous live-blog entry of a structure of production whose Hayekian triangle has a proportion of 40:80, or 1:2, in respect to the demand for consumers' goods compared to the demand for producers' goods. Supposing that consumers save, and invest an amount of money equivalent to one-fourth of their income for one period, the previous proportion will, in the end, be changed from 40:80, to 30:90. The additional amounts of money now available for the purchase of producers' goods must be applied in such a method that the output (consumers' goods) may be sold for the sum of thirty, rather than forty arbitrary units as it was previously. In order to meet that condition, the roundabout processes of production is increased in the same proportion as the demand for producers' goods has increased with respect to consumers' goods, and more goods are sold between the producers' themselves. Overall, the nature of the transition to a more capitalistic structure of production consists in stretching out the money stream flowing from the consumers' goods to the original means of production. Like the Hayekian triangle, this stream has become both longer, and narrower than it was prior. While the quantity of money spent in each of the later stages of production, those closest to the finished output, will have decreased after this transition, the amount used in the earlier stages, those closest to the original means of production, will have increased, and the total spent on producers' goods will also have increased because of new stages of production. Since, in this example, the changes in the consumer preferences were voluntary there is no reason why there would suddenly begin consumptions at the previous proportions again; hence the initial variations in the proportion between the two goods become permanent, and a new equilibrium will be established on this basis.

Now we come to the point at which we investigate the latter, and proceed to drop our previous assumption that the volume of money in circulation remains constant. In addition, we shall investigate the most likely case: where there is an “increase of money in the form of credits granted to producers.” For a second time, we will start from a proportion of 40:80 between consumers' goods, and producers' goods respectively, and now, though, the change in the proportion between the two will not be a result of voluntary saving, but instead as a result of the granting of additional credits to producers. The producers, in this scenario, will have received , a quantity of forty arbitrary units of extra money, and the changes of the structure of production that must result from the necessary changes in the employment of the original means of production will correspond to the transition to a more capitalistic structure of production brought about by savings. The total value of producers' goods in the varying stages of production will have grown to thrice, instead of twice as large, as before, as the value of consumers' goods produced during the same period. In addition, the output of each stage of production, including the final one, measured in physical units (unlike the monetary units we are mostly concerned with here), will be exactly the same as the previous voluntary saving example; the difference is that the money values of these goods will have grown by one-third compared to the previous example.

The most important difference between the two examples, though, will only be apparent after a lapse of time. Unlike when the changes in the structure of production were brought about by saving, in which example an assumption that the changed distribution in the proportions between producers' and consumers' goods would remain permanent was just, when it does not result from a voluntary shift in consumer preferences then this assumption is anything but. The use of a larger amount of original factors of production for the manufacturing of producers' goods can only be brought about by the reduction in the production of consumers' goods. Consumers end up consuming less not because they forgo a portion of their consumption in favor of saving, and investing, but because they are able to purchase less goods for their money income. Without a doubt, if the money receipts should again rise then the consumers would attempt to resume their previous consumption-proportion (in the next lecture, Hayek will elucidate why receipts will rise as a consequence of the increase of the quantity of money in circulation – for the moment we shall assume that it occurs). Once the consumers resume their previous proportion of consumption, then then money stream will be redistributed between consumptive, and productive uses according to the volition of the consumers, and the artificial distribution, the result of the injection of new money ex nihilo, will have to return to the previous proportion too. Nevertheless, it is not necessary that the proportion between the demand for consumers' goods, and that of producers' goods need result to the former dimensions as soon as the injections of new money cease, for entrepreneurs may very well be in the position to continue the new processes until eventually the consequence of prices changes resulting from an increase in the demand for consumers' goods make their enterprises unprofitable. As a result of this transition, the processes of production will become less capitalistic, and the new capital that was sunk in equipment adapted only to the more capitalistic one will be lost in the process. In the next lecture, we shall see how that such a transition to a less capitalistic structure of production must take the form of an economic crisis.

Sine dubio, while a transition to a more capitalistic structure of production resulting from an increase in savings, and investment based on voluntary consumer preferences will result in a permanent shift in the proportion between the demand between consumers', and producers' goods, when the same is based upon injections of new money, the resulting proportion is a masquerade that will eventually be dispelled once the consumers are able to resume the consumption they were unable to partake in during the period of transition. While in the former the conditions for meeting a new equilibrium with respect to the structure of production are met, in the latter they are not, a fact that has devastating consequence that Hayek will proceed to describe.

Prices, and Production: Lecture II, Part III

laminustacitus — Fri, 05 Jun 2009 00:15:00 GMT

It is now time to add the flow of money into Hayek's theoretical apparatus. While the Hayekian triangle is used to illustrate the movement of goods through the economy's structure of production, it is just as legitimately utilized as a schematic to elucidate the flow of money. When the goods are moving from the bottom to the top of the triangle, money is moving in the opposing direction, being first paid for the consumers' goods, and moving downward until it is paid to the owners of the factors of production as income. In order to analyze the relationship between the proportional quantities of money used in each stage of production, and the opposing movement of goods, it is necessary that we take a definite assumption with respect to the division of the process among different firms for if more than one consecutive stage is owned by a single firm than there is no need for an exchange of goods against money in those stages. Here, we shall take the simplest assumption: that the previous division of the economy into stages of production with respect to the Hayekian triangles happens to coincide with the points at which goods change hands between separate companies.

The proportion of money spent for consumers' goods, and producers' goods is equal to the proportion between the aggregate demand for consumers' goos, and that of producers' goods (this is done with the assumption of a stationary state, which is the only one we are concerned with right now). In this case, there is a demand for 40 arbitrary units of consumers' goods, and 80 of producers' goods, ergo a proportion of 40:80, or 1:2, in the output between the two; this can also reflect the proportion between consumption, and investment during any period of time . Similarly, 1:2 is the proportion of money spent for consumers', and producers' goods . Once we have established this method, a couple fundamental facts become clear.

The first is that the quantity of money spent on producers' goods during any period of time may very well be far greater than the quantity spent on consumers' goods in that period of time. This fallacy originated with Adam Smith, who wrote: “The value of goods circulated between the different dealers can never exceed the value of those circulated between dealers and consumers; whatever is bought by the dealer being ultimately destined to be sold to the consumers.”¹ It is easy to see that this error results intuitively from the fact that the total expenditures made during production must be covered by the return from the sale of the eventual products. Nevertheless, it is also easily solved by the realization that most goods are exchanged several times against money before finally being sold to the consumer, a realization that can be visualized in a Hayekian triangle divided between different stages of production.

The second conclusion that follows is that the amount of capital invested in the structure of production, what Hayek referred to as the “capital equipment of society,” is not a magnitude that is brought into existence, and hence forth remains constant. To the contrary, whether the capital allocation there remains the same depends on whether entrepreneurs find it profitable to return the normal amount of their returns from selling the product of their respective stages in producing goods of the same sort a la J.S. Mill's “perpetual consumption and reproduction of capital.” It totally depends on the entrepreneur on whether he will continue to invest his net income in the same proportions as before, as Hayek wrote: “The continuance of the existing degree of capitalistic organization depends, accordingly, on the prices paid and obtained for the product of each stage of production; and these prices are, therefore, a very real and important factor in determining the direction of production” - hence the title Prices and Production.

1Wealth of Nations, book 2, chap. 1, ed. E. Cannan (London: Methuen, 1904), p. 305.

Towards a Greater Understanding of Say’s Law

laminustacitus — Wed, 04 Mar 2009 05:36:00 GMT

The most renown theory of the French economist, Jean Baptiste Say (1767-1832), the eponymous Say’s Law has been one of the most important contributions of Classical economics even though it was but a minor facet of Say’s own economics. He introduced it in Chapter XV of Book I of his A Treatise on Political Economy, and has been summarized by later economists under the catchphrase: “supply creates its own demand”. Ever since the integration of the doctrine into Classical economics by Ricardo, and J.S. Mill, Say’s Law has been the victim of intellectuals who have only understood its role in Classical economics without understanding its role in Say’s own economics. But, a firm understanding of what Say’s Law truly entails is not only a great facet to one’s education in economics, but also in understanding the very process by which the markets function.

Above all, Say’s Law is meant to communicate the most basic principle of economics: that man lives in a world of limited means, despite his unlimited desires. There are very few goods that are given to man without cost, and hence he must utilize his labor to transform nature-given resources into the goods he demands. From this, Say realizes that not only are men consumers, but they are also producers: man cannot procure the goods he desires for free; rather he must, in isolation, independently create everything he consumers, and, in a market economy, create goods that others demand to sell for money to be able to buy the goods he demands. Forgetting the former, individuals do not acquire money as a good for consumption per se, but because it is a medium of exchange that enables them to supply themselves with the commodities that they wish for. By this reasoning, money serves as only an intermediary role in the economy; commodities are not truly paid for in money, but, other commodities. Therefore, every good produced serves as a price for others produced.

Without a doubt, the key to Say’s Law is that what is produced must be desirable to other individuals; otherwise, the product simply will not sell and the producer will be at a loss. The entrepreneurs who successfully anticipate market demand will be the ones whose enterprises expand, and this will lead to the majority of the products sold upon market being produced by them. Surely, there can be a short-term glut in the markets when there is the quantity of commodities produced has far outstripped the demand for them. Nevertheless, the profit and loss mechanism of the market will dissuade further production in that industry, and capital there will be driven to industries that promise greater return. In fact, the only barriers in the way of a change in production is, in the short-run, natural disasters, and, in both the short-run and the long-run, government policies preventing liquidization and further reinvestment in the economy.

In the end, Say’s Law describes basic fundamental aspects by which the markets work: that money plays a mere intermediary role in the procurement of goods, and how the market works to equalize the supply of a good to the demand for it. Without a doubt, “supply creates its own demand” does not capture the true integrity of Say’s Law, and as so it is utilized as an item to display how “primitive” the Classical economists were by many modern day professors. Later, I shall write about how they have misinterpreted this law, and why their critiques of it fail.