I am reading Chapter 8 of "Man, Economy, and State" and would like to clarify some things with your help.
On page 527 Rothbard writes
The increase in gross investment, in particular, raises the prices of capital goods at the highest stages, encouraging new stages and inducing entrepreneurs to shift factors into this new and flowering field.
In particular, I would like to clarify how increased prices of capital goods encourage new stages. I view it this way:
(1) lower time-preferences in economy translate into the increased savings that result in lower interest rates;
(2) since demand for consumer goods has fallen as the result of changes in time-preferences, investors have started to invest capital into higher stages of production taking advantage of lower interest rates making investment projects there more profitable;
(3) in response to higher demand on the part of investors the prices of capital goods in higher stages increase;
Until now, as I understand, there is no new stage of production.
(4) observing the rising prices of capital goods at higher stage N entepreneurs begin to invest capital into higher stage N-1 earning profit due to increased price spreads between 2 stages.
But again, the capital goods at stage N must have been produced before, in order for prices there to grow, hence stage N-1 must have existed before investors moved their capital there. So where is the new stage? And how this new stage would look like in the real world?
The mechanism through which happens complicates throughout Hayek's writing, but it requires that there be an increase in the demand for machinery. In this sense, the very last stage in the structure of production draws its inputs from the original factors of production (i.e. land and labor). When a new stage is added, it means that what was originally the last stage (your N) has begun to demand capital goods. This can occur for a variety of reasons: a rise in the price of labor or the intent to increase productivity are two examples.
Thank you, Jonathan, now it's much clearer to me. But isn't this new stage N-1 (or even the last stage N) - stage which consumes only land and labour as input - an imaginary construct given today's industrial economy? And if it's so, then what example of lengthening of production structure can we think of nowadays?
Consider this both a response and a slight correction to my first one. Hayek, in "Profits, Interest and Investment" actually makes it clear that the linear model introduced in Prices and Production is mostly pedogogical. It was meant to express a conception of a time-oriented structure of production. In his 1939 paper — a forerunner to to The Pure Theory of Capital — he gives us a new illustration. Imagine a plot with dots randomly scattered across. These dots represent firms. They produce products that can either be consumed or used for further production. There's still a time structure of production and the previous linear conception still makes sense, but we also see how it can be circular. The fact is that a firm in stage N can also be in Stage N+x, and so the firm in stage N might be demanding capital equipment (as a firm in a later stage). So, you're right, pedagogical tools oftentimes don't really transmit the true complexity of reality.
Thank you for the detailed response and reference to Hayek. Reading pp. 21-24 of "Profits, Interest and Investment" combined with your example made it totally clear to me. I've even drawn a graph to represent the circular structure of production. Stage VII on it is the highest one whose output goes to the 6th stage, and yet Stage VII itself uses machinery or whatever from Stage IV.
The production chains become longer, I don't think it has to be the "earliest" stages which are added, but for example more software to the OS of the smart phone in a much later stage. That too gives you a better more expensive phone later, which you prefer to wait for according to your knew time preference.
Helloween, you're absolutely right. In my opinion, this is the most natural (and realistic) way of thinking about the lengthening of production structure - as investment in already existing stages. Incidentally, I read yesterday in MES a passage that supports this view (p. 543):
Some critics charge that not all net investment goes to lengthening the structure—that new investments might duplicate pre-existing processes. This criticism misfires, however, because our theory does not assume that net saving must be invested in an actually longer process in some specific line of production. A longer production structure can just as well be achieved by a shift from consumption to investment that will lengthen the aggregate production structure by greater investment in already existing longer processes, accompanied by less investment in existing shorter processes.
However, the reason why I started this thread is that I wanted to clarify this theoretical, "pedagogical" model - the lengthening of structure of production entails the addition of new stages to it
Simple investigation will reveal that the only way that so much investment can be shifted from the lower to the higher stages, while preserving uniform (lowered) interest differentials (cumulative price spreads) at each stage, is to increase the number of productive stages in the economy, i.e., to lengthen the structure of production. (p. 519, emphasis is author's)
- which I could not apply to the real world.
P.S. But stictly speaking, new stage must be the earliest one.