Nov
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The basic premise of various economic theories is derived as ‘scarcity’. In fact the study of economics is limited towards ‘economic goods’, that is, goods that carry use value to people but are scarce compared to peoples’ infinite desires. Prices for these scarce ‘economic goods’ arise out of an implicit process of bidding.
In short, the market allocates resources among the several bidders who can outbid their counterparts.
While conventional mainstream economists do not falter till now, they’ve seldom recognized the scarcity of another important factor in human action — time. It should be obvious to anybody that time is not an abundant source available to human beings. Human beings contemplate the fact that time is scarce, and conform all their actions to harmonize with the limited time available. Thus arises the concept of ‘time preference’.
The ‘price’ of time
The thought of tagging a ‘price’ for time can sound weird first, but an example can make things clear. Lets take the case of a prosperous farmer wanting to acquire new land to increase production. How much would the farmer be willing to pay for the new land? According to mainstream productivity theory, the farmer will be happy to pay the amount of value that he expects the new land to add to his returns in the future. Suppose the farmer anticipates the land to boost his returns by $1000 per year, he would be ready to pay any price below $1000 for the first year(Let us, for a moment, assume that there is no well-developed financial system established which could offer interest returns on deposits).
So, if $1000 is the return from the new piece of land for a single year, and further since land is productive for centuries together, should the land be priced at infinity? It would have to be, if the world works merely as what the productivity theory claims. Unlike mainstream economists, the Austrian school recognizes the importance of time as an economic factor. The most important idea to keep in mind, with respect to our farmer example, is the fact that the farmer doesn’t live forever; or that he wouldn’t value returns from his land when he is bound to his bed in his twilight days(assuming the farmer has no heir). This solves the problem of the valuation of land. Land, like all other economic goods, has a finite price.
The valuation of land being one important lesson this example teaches us, that’s not all about it. The example also shows us how the infinite value of land is ‘discounted’ to a finite value(price) based on the amount of time elapsed. So how does the price of time express itself in the market place? The most basic expression of time discounting being expressed in the valuation of durable economic goods land, the other important market for time is, the loanable funds market.
The loanable funds market
The loanable funds market or the financial market is the most explicit expression of the time market in the economic world. This market witnesses suppliers and borrowers of present capital carrying out the same bidding procedure that is characteristic of any free market. Like the market for other commodities, the borrowers of capital in the loan market bid for present goods, and suppliers of present capital supply their capital to those borrowers who promise the highest amount of future goods. The interest rate thus expresses the premium or discount that is placed on present and future goods respectively.
Ill-effects of the lack of time accounting
While almost all mainstream economists consider land, labor and capital as the factors of production, Austrian economists have for long contended the possibility of the other factor of production — time. Over here looms a wide scope of disastrous implications that could be framed against various mainstream theories, that is, based on their failure to account for time as a factor of human action.
The major effect could be seen in policy recommendations of mainstream economists vying for the government to possess a monetary policy — that is, a set of guidelines to tamper with the time(loanable funds) market. The advent of fiat currency has helped governments to ‘fine-tune’ the economy with monetary tinkering of the time market.
Any sound theorist of the Austrian should feel aghast at the kind of ignorance that conventional economists lie under when they recommend tampering with key signals(i.e. interest rates) of the time market as one of the ways to ‘stabilize’ the economy. Inflation, currency debasement, business cycles, the doomsday event that follows any policy based on debasing the currency — hyperinflation, and many other side effects of intervention in the time market, are taken to be normal policy prescriptions in today’s economics mainstream — all because of the failure to recognize the role time plays in human action.
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86 views4 Responses to “The price of time”
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GP Says:
December 4th, 2009 at 4:30 amAre u saying Monitory policied adopted by Reserve Bank fo INDIA to encourage ppl to spend more rather than save - ( i.e. to increase cashflows in market) is wrong? and they don’t have to take any action and do nothing ( which ppl call - “waiting for market correction”)?
I think concept of “loanable funds” is based on two other parameters i.e. “Rate of return on capital” and “Equilibrium interest rate” which plays huge role in fluctuation of demand and supply of loanable funds.
The demand for loanable funds takes account of the rate of return on capital ( which is additional revenue that a firm can earn from its employment of new capital.) Firms will demand loanable funds as long as the rate of return on capital is greater than or equal to the interest rate paid on funds borrowed.
If capital becomes more productive—that is, if the rate of return on capital increases, it will cause equilibrium interest rate to rise
The supply of loanable funds reflects the thriftiness of households and other lenders. If households become more thrifty—that is, if households decide to save more ( instead of spending )—the supply of loanable funds increases. The increase in the supply of loanable funds will cause the equilibrium interest rate to fall.
I am not sure if you already aware of this but you can take a look at diagram( Determination of the equilibrium interest rate) in http://www.cliffsnotes.com/WileyCDA/CliffsReviewTopic/Capital-Loanable-Funds-Interest-Rate.topicArticleId-9789,articleId-9787.html
I am sure those wise guys sitting over there must have put into lot of thinking - about possible outcomes before coming up with monetary policy rather than advocating “Do nothing approach and waiting for -Right Time for market correction”
prashanthguevara Says:
December 5th, 2009 at 2:07 pmGP, I am unable to get your point for once. You describe the process of interest rate determination quite well. But it’s surprising how you could still support government intervention, rooting from the blind trust that people in the high chairs must be right. The loanable funds market is just like any other market, and interest rate is a economic signal like any other, for instance, prices.
Businessmen decide on investment opportunities based on the prevailing interest rates. When the government is going to tamper with the interest rate then, it is going to surely affect businessmen’s investment decisions.
The government, with the help of the central bank, can artificially lower interest rates, but only temporarily. Once the original (higher) free market interest rate, determined by the savers’ time preference, is restored, business decisions taken during the low interest rate regime will turn out to be malinvestments.
So now, do you want to lower interest rates to fight the crisis that was caused by the low interest rates itself? You’re simply repeating the disastrous cycle once again when you do that. So, leave it to the market!
GP Says:
December 7th, 2009 at 7:25 am@Author
I don’t understand what makes you think that - in absence of Monetary and fiscal policies economies will keep running smoothly like perpetual motion machine. You have to accept the fact that - these policies are not fool proof as policy makers are humans who always learn through their experiences.
In simple terms all these policies help to regulate flow of money in country’s economy and there by address issues such as - inflation,unemployement,etc. These policies needs to be adapated after observing their effects on economy after certain period of time. Now, if you are saying - economy can run very well without
these policies then its like saying “Let the child have free play over the top of mountain so that he/she can enjoy but in turn forgetting the fact that his/her parents cannot just sit idle and take the risk of child falling from the clip of mountain - Just bcoz somebody is saying - “Your are enslaving your child by not allowing him/her runnning freely.” 2nd example - if u get sick and you take medicines in excess for cure but your condition gets deteriorated further due to side-effects of excess dosage of meds then will you blame the medicines OR yourself for not keeping a tab on its quantity? OR you will just say - I don’t take medicines at all coz there is risk of side-effects so I will just wait for my normal immunity to come back after regular diet and fight my disease? ( of course you can go far last choice but I hope u will get my point by now)
See the bottomline is - In absence of control mechanism - there will be chaos and anarchy.
Shashank Gupta Says:
December 20th, 2009 at 11:00 amThere`s one thing that still remains to be discussed. The price of time can only be taken into consideration if there was any method of determining the amount of time.
“The valuation of land being one important lesson this example teaches us, that’s not all about it. The example also shows us how the infinite value of land is ‘discounted’ to a finite value(price) based on the amount of time elapsed. So how does the price of time express itself in the market place?”
This is exactly what I`m trying to express. Suppose if, due to some circumstances, the farmer dies before 1 year and he has no heir left, then how do you take this time factor into consideration? In this case there is a loss and the value of productivity of land comes down form infinity to zero.