Production & the Market Process

Robert P. MurphyMises AcademyAugust 17, 2011

Lecture 5: 1st Half of Chapter 8 of Man, Economy, and State

1st Half ofChapter 8 of MES

I. Sources of Income

1. So Close, Yet So Far Away

2. Opportunity Cost

3. Role of Risk?

V. What’s in a Name?

VI. “Paradox” of Saving

I. Sources of Income

Rothbard says: In ERE, there are only two “ultimate” sources of income, interest and wages. But in real world, there is a third source: entrepreneurial profit.

What about rent from land factors (i.e. natural resources)?! Is Rothbard saying that’s not income?!

A. Rent IS Interest

Suppose a man (in the ERE) has $1 million and continually rolls it over in bonds yielding 5%. How do we classify the perpetual stream of $50,000 annual payments?

Suppose instead man (in the ERE) uses $1 million to buy a plot of land, which he rents to sharecroppers for $50,000 per year. How do we classify that source of income?

B. Now It’s Time for Change

Now, suppose man (outside ERE) uses $1 million to buy plot, which “the market” initially expects he can rent to sharecroppers for $50,000 per year.

Land is unexpectedly fertile, and he can rent to sharecroppers for $75,000 per year. How classify?

� A one-time capital gain / profit (which is income) of $500k, when market price of land jumps to $1.5m.

C. Are Wages Interest?

II. So Close, Yet So Far Away

In real world, “capitalist-entrepreneurs” tend to whittle away pure profit opportunities, moving factor prices toward their ERE configuration. Yet things always change, creating a new “target” to which the economy tends.

A. Arbitrage

Pure profits (and losses) due to mispriced factors of production. Successful entrepreneurs spot underpriced factors; unsuccessful ones don’t realize they are buying overpriced factors (compared to the uses to which they put them).

B. Rothbard vs. Kirzner

C. Giving Back to the Community

Profitable entrepreneurs adjust resources to better satisfy the desires of consumers. (This is what Mises [perhaps unfortunately] called “consumer sovereignty.”)

High price of a particular resource is a signal saying, “Use with care!” to all the entrepreneurs.

III. Opportunity Cost

Suppose entrepreneur invests $1,000 in factors of production, and sells the output one year later for $1,020. Going rate of interest is 5%. Has he made a profit or loss?

IV. Role of Risk?

V. What’s in a Name?

Hayek in Prices and Production:

“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.”

VI. “Paradox” of Saving

Term Hayek gave for the apparent fact that increased saving leads to lower expenditures on consumer goods, which apparently makes it impossible to support higher investment expenditures—though we know saving is necessary for capital accumulation.

(Note not same thing as typical statement of Keynesian “paradox of thrift,” though very similar.)

A. Illustration

B. Solution to “Paradox”