Prices, and Production: Lecture III, Part IV

Published Thu, Jul 9 2009 4:50 PM | laminustacitus

The importance that the adjustments of the price mechanism free of any external influences has in respect to a prospering economy is highlighted when we investigate the results of the “'natural' movement of prices” is disrupted by monetary policies. These may take the form of either injections of new money into circulation, or the withdrawal of a portion of the current circulating quantity, and here, as prior, the results of two typical cases shall be elucidated: a) the case of injected money being utilized to purchase producers' goods, and b) the case of the injected money being utilized to purchase consumers' goods12. As before, the analysis is begun with the supposition that an additional amount of money is injected into the structure of production via credits to producers that can only be spent purchasing producers' goods.

If the injector desires to seek borrowers for this additional quantity, then the rate of interest must be suppressed below the equilibrium rate in order that the employment of this sum, and just this sum, is profitable3. To complicate matters, borrowers will only be able to use their loans to purchase producers' goods though if they are able to outbid those who are currently utilizing them, but borrowers who plan on creating a longer, more capital-intensive production-process will be given a boost against those whose means of production were profitable at the equilibrium rate. It must be understood that the alteration in the interest-rate will also change the relative profitability of different factors of production, and will give a relative advantage towards more capital-intensive investments. Without a doubt, though, the result of this increased bidding, and competition on the part of entrepreneurs will result in a general rise in the prices of producers' goods4, and this coupled by the low rate of interest will induce entrepreneurs into spending a portion of what they once spent on original means of production on intermediate products, or capital. As companies buy parts of their products, which they once produced for themselves before the rate of interest was reduced, from another firm, they can employ the labor so dismissed in producing these parts on a large-scale thanks to the aid of new capital. This will then have the result of transitioning the structure of production into a more capitalistic process, and will relinquish the necessary original means of production, and nonspecific producers' goods for the newly created stages. In the end, a reduced rate of interest will result in a more capitalistic structure of production, and the transition to one will probably be done without an increase in the resources at the disposal of entrepreneurs resulting in them investing less in the original means of production, and more on intermediate goods.

Unlike the scenarios where the entire process is begun by voluntary savings on the part of consumers, the investments necessary to bring about a more capitalistic structure of production as a result of monetary injection will result in decreased consumption being forced upon the consumers. This results from the fact that, while in the case of voluntary savings the transition is a result of the consumption preferences, and the application of producers' goods to longer processes will be done without any reduction in consumption, in the current case the investments are not done as a reaction to any change in preferences, but due to the availability of newly injected credit. Nevertheless, there will be a time during which the transition-process will go about without a reduction in consumption due to the fact that there will still be consumers' goods being finished off in the roundabout structure of production, but these goods will eventually be finished. Once the final consumers' goods have been sold, a scarcity of consumers' goods will then occur, and its price will then rise as a result since the consumers still desire to continue their previous rate of consumption.

Even though the consumers will, as a result of the investments in the structure of production, be forced into consuming at a lower rate than before that does not mean that they will passively accept the decrease in consumption, and not attempt to resist it. In fact, the real income of the consumers, as a result of this, will be retrenched, and it is improbable that consumers will acquiesce to this for they will most likely try to fight their decreasing rate of consumption by spending more of their total income on consumption. At the same time many entrepreneurs will know that they are in command of, at least nominally, a greater quantity of resources, and ergo a greater expected profit, and the income of wage earners will be increasing as a result of the increased amount of money in the hands of entrepreneurs; much of this income will be spent on consumption thus pushing the prices of consumers' goods ever higher. As the consumers are trying to regain their prior level of consumption, the prices of consumers' goods will rise relative to the prices of producers' goods, and this will point towards a return to a shorter, less future-orientated process of production if the increase in the demand for consumers' goods is not compensated for by a proportional injection of money by new loans granted to producers'. As long as there is further credit-expansion, then entrepreneurs will not have much of an incentive to liquidate much of their long-term investments aimed at satiating the demands of a more roundabout structure of production; however, the process of credit expansion cannot go on ad infinitum.

Once the banks cease to inject new credit to producers then the absolute increase in the quantity of money spent on consumers' goods will no longer be compensated by a proportional increase in the demand for producers' goods. This will result in an increased demand for consumers' goods that will be very much similar to the second case above, and hence shall be discussed along with the second case in the next liveblog entry.



1“The corresponding cases of a diminution of the amount of money we may neglect because a diminution of the demand for consumers' goods would have essentially the same effects as a proportional increase of the demand for producers' goods, and vice versa.” (Hayek, pg. 265)

2For the sake of portioning this liveblog into posts that are only of moderate, or short length, I shall only cover a here, and leave b for the next entry.

3However, the efficiency with which the injector would be able to calculate the rate of interest referred to here is sub par due to the fact that he is attempting to centrally plan a price, and the critiques against central planning as elucidated by both F.A. Hayek, and L.v. Mises are applicable, though on a small scale.

4Remember that the original means of production are a form of producers' good.