Prices, and Production: Lecture III, Part III

The initial changes in the relative prices between producers' goods, and consumers' goods, resulting from a change in their relative demands, cause a movement of goods to other stages of production – a definite price relationship will only result once this transition is complete. Later, it shall be shown that this process may result in discrepancies between supply, and demand where Say's law is not valid. Nevertheless, there happens to be one medium through which the effects of the shift in relative prices will be felt immediately, and will guide the decisions of the entrepreneur during the entire transition: the rate of interest.

The role of the loan market in the formation of a more capitalistic structure of production because very rarely are the ones who saved money, and the entrepreneurs who desire to utilize it in production are the same. In the majority of cases there will therefore need to be a medium through which money can pass into the hands of those who want it, and this medium is the loan market through which the question of who will receive the addition funds to invest will be solved. Only at a lower rate of interest than before will the new loans be possible to be lent out, and how far the interest-rate declines will be dependent on the additional quantity of funds, and the expectations of profits on the part of entrepreneurs willing to expand production. If the entrepreneurs correctly forecast the price changes that will result from the transition, then the new interest-rate should correspond to the price margins that will finally be established. Without a doubt, the loan market is important in order to ensure that the additional funds for investment created by savings reaches those who can make a productive use of them, and the corresponding interest-rate, unlike other prices, will be immediately effected by the overall transition.

It is here that the two methods of analyzing the business cycle, that is either starting from the changes in the relative magnitude of the demand for consumers' goods and that for producers' goods, or doing so from changes in the rate of interest, meet. In addition, one can even see that many use the rate of interest as the horizontal projection, or hypotenuse of the Hayekian triangle to show the price margin between the different stages of production.