May
6
The fallacious argument of these economists can be busted by looking into a basic fact of production in a capitalist economy. And that is, the cost of production of goods and services can never be more than the purchasing power of the workers (who are also the consumers).
Lets assume a very simple economy of 100 persons all involved in cultivating apples, and consumers (who are also the workers) are content eating apples that they don’t try producing any other good. All that the consumers want is 100 apples, nothing more and nothing less. As a note of caution: do not be concerned about the unrealistic example, this will help us catch the crux of the issue. So, for instance, the land-owner produces 100 apples at labor cost of $100, and hence he wouldn’t be happy with a price below $1 dollar per apple. Note that the farmers have $1 dollar each as wage. So, the farmers now are in a state of affairs in which they are capable of spending at least $1 for an apple, which will certainly cover the production costs of the land-owner. So, there is no question of a lack of purchasing power as such.
The cost of any product is embedded in the wages paid to the laborers, either in a single stage of production or spread through a chain of round-about production stages. So, this automatically implies that wages in the economy will equal (or cover) the production costs in the economy, and hence no question of lack of purchasing power. It’s a self-evident proposition.
One could argue against the example I have provided as non-expressive of various market phenomenon. The most probable opposition to the example I have proposed would be the absence of profits and losses in this hypothetical economy. That’s actually not a problem. The hypothetical economy I have used is an economy in equilibrium with perfectly satisfied consumers. Profits and losses occur whenever this equilibrium is disturbed, that is, when a ‘disequilibrium’ sets in.
The money that was unspent on any further puchase of apples was rather spent on oranges, and the efficient entrepreneur who was able to anticipate future demands in the best way was able to rake in profits. The change in consumer preference lead to a ‘disequilibrium’ phenomena which leads to losses to those who stick to production of goods which have lost consumer preference; and high profits to those entrepreneurs who forecasted consumer demand in the best possible way. These initial profits of course cease to exist as new producers enter the market sensing high profits and profits are brought down by the bidding up of wages, and increased production which leads to lowering of prices.
The study of a more realistic ‘disequilibrium’ market does not change the basic fact that cost of production of goods and services can never be more than the purchasing power of the workers. The losses that happen in particular sectors, for various reasons, is not because workers (or consumers) lack the monetary purchasing power to buy the products at above production costs, but because they don’t prefer any more of that particular product.
So, although production costs equal the purchasing power of the consumers profits and losses are made possible (and thus not causing a contradiction with real life market happenings) whenever there is a ‘disequilibrium’ in the market caused mostly by change in consumer preference, or even entrepreneurial errors in properly judging consumer demand could lead to relative overproduction of particular goods at the cost of relative underproduction of other goods.
One should be careful here not to assume that profits in an economy will always equal losses. This is possible only in a stationary economy where no improvement in capital occurs. In such an economy the profits of a particular entrepreneur occur causing equal losses to other entrepreneurs. If the capital per head in an economy increases, profits (owing to lowered production costs) will be more than losses. The exact opposite happens in a retrogressing economy with a diminshing capital per head.
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1 viewsNo Responses to “The under-consumption doctrine”
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GP Says:
May 7th, 2009 at 6:41 pmThe study of a more realistic ‘disequilibrium’ market does not change the basic fact that cost of production of goods and services can never be more than the purchasing power of the workers.
<<<<Your assumption seems incorrect. No businessman wants to sell his product at production cost which again could be more than purchasing power of customers ..Guess why?
Reason — > he/she wants to make a profit so selling price will include his profit margin + production cost.
Apple example you given seems to be height of ignorance :- )
>>>>
prashanthguevara Says:
May 12th, 2009 at 8:58 amGP, I did not say that producers have turned dumb to sell products at the cost of production. I only pointed out that wages in the economy will equal production cost. Can you prove me wrong on that? I bet NO!
(Profits and losses arise only when ‘disequilibrium’ due to various reasons sets in. You should read my article on ‘Overproduction’ to know more)
GP Says:
May 14th, 2009 at 8:55 amI only pointed out that wages in the economy will equal production cost. Can you prove me wrong on that? I bet NO!
<<<<<Well, I already did ! But let me try to clarify more —
I read your article thoroughly but their are few basic flaws in your premise of -
”How consumers buy the product if producer/manufacturee did not sell them at consumer affordable rates? ” is
#1 — You assumed that the workers/resources working for a particular company are the sole buyers of your product hence,how can they buy product if the product price is more than their wages — > which is quite a naive assumption.
#2 — Production cost = wages of workers + maintenance of infrastructure/machineries/tools + rentals & taxes on property, ater being used + electricity bills and all other sundry costs
So I do not agree that wages being paid to workers are equal to production cost.
Please Note — I am strictly staying away from diverting this discussion to “Cut down prices to gain more market share” argument here ..coz that’s not fitting here and its a part of your Marketing strategy which is not a point of discussion here!
prashanthguevara Says:
May 14th, 2009 at 5:44 pmGP, don’t try hard. Any money spent to produce a product goes to wages, either directly or indirectly. Whether it is maintenance or rent or any other cost, it still is labor cost which is paid out to producers/consumers, only that the indirect path fails to catch your eyes.
Regarding my assumption of an equlibrium apple-only economy, although it does not share resemblance with reality, it still is a nice place to start from to analyze economic problems. In fact, critical acclaim of this example of mine was already done by a couple of people before it was posted here at RFL. And that’s why the second part of my article was added exclusively to explaining things in terms of a two-commodity example, which enforces the scope of entrepreneurial activity. I don’t understand why you still make a big fuss.
GP Says:
May 15th, 2009 at 8:42 amForget it dude! You treat everything as wages so no point in further fuss over it :-)..By the way , I like it when someone call it fuss :-)
prashanthguevara Says:
May 15th, 2009 at 2:25 pmGP, everything is a pay (wage). You don’t pay money to bulbs and wires, do you? You pay PEOPLE in exchange for such products (like bulbs and wires). So, the cost of production is nothing but money paid to labor or some sort or the other (be it manual or entrepreneurial, anything is labor). You seem to miss seeing this indirect path, and that’s why the confusion.
And I like it when you take it easy :)
Hank E. Pankee Says:
June 16th, 2009 at 3:04 amIn my country, we have Bankers who loan money (which they do not actually have) to people (including business owners) which they then make a profit from in the form of interest. If my government was the entity introducing money into the economy (and not doing so for the purpose of making a profit) then our underconsumption problem would be much less dire. But for us, the underconsumption is a real phenomenon. Bankers will be the death of us all.
prashanthguevara Says:
June 20th, 2009 at 8:31 amPankee, you are right on the fractional banking system. Even the Indian banking system is the same. Such a system allows cheap credit to make booms appear. That means ‘malinvestment’, which the Marxists take as ‘over-production’ and Keynesians take as ‘lack of aggregate demand’. The problem is neither. The problem is malinvestments caused by manipulation of interest rates.
Art Shipman Says:
June 22nd, 2009 at 1:28 am6 prash: “everything is a pay (wage)” // Schumpeter (I think) said all distinctions are arbitrary but if we don’t make them, we can’t say anything useful. Adam Smith [The Wealth of Nations] described THREE factors of production: land, labor, and capital. His factors were important because each has a cost: rent, wage, profit. Thus Adam Smith was able to examine the interplay of three sectors of the economy, and you are not.
Prash, your post provides an *excellent* description of underconsumption (including your remarks on Keynes). But in your “very simple economy of 100 persons” apparently the land-owner is working for free! I think this is the point made in 1-GP and 3-GP. The land-owner should get a dollar also, say, so he can only pay his workers 99-cents each! Now either nobody can afford an apple, or they start to use credit. Now 7-Hank’s remarks become relevant.
Arthur Shipman
http://sites.google.com/site/arthurianeconomics/
p.s. look for the “Stimulus Watch” google gadget.
prashanthguevara Says:
June 23rd, 2009 at 3:26 pmArt Shipman, I really meant it when I said ‘a very simple economy’.
For your satisfaction let us assume the land owner gets a dollar, in a ‘little more’ complex economy, by eating out $1/99 from each worker’s dollar. Do you think that would cause any harm to my case?
I don’t think so. Because, still, cost-of-production can’t be higher than the wages paid(which includes labor).
I just want to clarify that, I have made my case very simple by assuming that every pay is a wage. Even the pay towards renting land or capital. Because, the money that you pay for any of the factors of production goes to owners of the factors of production(who are in turn consumers who purchase products). So every pay could be traced down to pay for labor.
Take a bulb for example. The bulb receives zero pay, it is only the workers (which includes credit provider, laborer, land owner etc.) who receive pay.
Art Shipman Says:
June 23rd, 2009 at 4:21 pmNo. My arithmetic proves nothing! Watch:
Time pass in Apple-town. Sadly, one of the workers dies. But technology improves. By sheer coincidence of numbers, 99 workers can now produce 100 apples. Thus, 99 workers are each paid a dollar, and 99 each buy an apple for a dollar. The land-owner recovers the cost of paying his workers, and is left with an apple as his own profit. He’s not getting paid in money (and this is a flaw in the Apple-town story), but at least he makes a profit.
Sheer coincidence of numbers made my previous objection sound reasonable. And sheer coincidence of numbers also makes your Apple-town story sound reasonable, I think.
However, if any of the Apple-town folk decide to set something aside as savings, the problem of underconsumption must arise, don’t you think? It can be postponed for 80 years or so by a combination of inflation and economic growth, but eventually Kondratieff has his day and a Great Depression ensues.
Simplistic, I know.
Art Shipman Says:
June 23rd, 2009 at 4:25 pmprash, I wasn’t quick enough. #11 is a response to #9. Delete it if you want… I’ll get back to you on #10…
I really like your blog. There is a lot of thinking going on here.
PLEASE DELETE THIS ONE!
prashanthguevara Says:
June 26th, 2009 at 6:21 pmArt Shipman, regarding your doubt on savings being bad for the economy; please do read this article I wrote some months back: http://www.reasonforliberty.com/employment/are-savings-bad-for-the-economy.html
art shipman Says:
June 26th, 2009 at 9:48 pm13 prashanthguevara:
But my only comment on savings was that it is bad for your model of the economy. Anyway (if economics is science) there is no good or bad; there is only the attempt to understand.
I will read more and get back to you after that.
Taica Says:
August 17th, 2009 at 12:39 amSo, you have an economy where everybody works for apples. They cultivate apples in order to buy apples …
“You don’t pay money to bulbs and wires, do you?”
You pay money for bulbs and wires. How those came into existence is not your concern, the seller already took care of that.
“In fact, critical acclaim of this example of mine was already done by a couple of people”
So stupidity runs freely in the world, what else is new!
Taica´s last blog ..Cine nu are batrani, sa nu isi ia