Can someone please help me understand this article?: http://mises.org/story/2804
I am able to get the basic argument put forward by Foster and Catchings, but I fail to understand Hayek's answer. Please help me out!
I think this argument plays an important role in complaints that Capitalism is a demand-constrained system.
Foster and Catchings claim that an increase in volume of production leads to bankruptcy of producer as there's just not enough money demand to buy the additional products, and lowering prices is out of question as costs will be above prices then. The obvious answer is that production should be improved in a way that allows to lower prices AND still get a profit, namely to increase the quantity of capital per worker. A worker with a stick can only dig so much in a day, but a worker with a shovel can dig much more, and a worker with an excavator is more effective than a dozen men with shovels. So when all diggers on the market work with sticks, you can invest in shovels, lower the prices dramatically and still get a nice profit. You also free up labor (fired diggers with sticks) for producing some other goods, and you free up part of consumers' funds (previously spent on stick-dug holes) to be spent on those other goods.
Also, there is nothing wrong with businesses going out of business as consumers prefer other products to theirs. Joseph Schumpeter theorized this in the late 19th century and called the process creative destruction. That The buggy whip is the most famous example but there are others: Large Screen TVs with Picture Tubes, Model T Fords, Private passenger rail service, GM, etc. The reality is that consumers are constantly adjusting what they desire and some companies cease to exist while others prosper.
The converse of this is also a fallacy. That is if we create money and give it to consumers then those consumers are wealthier. Money is easy to make. Stuff isn't. So if we make money out of thin air then consumers are equally wealthy but have more pieces of paper to show for it. Consumers may be comparatively wealthier but the wealth in society has not changed.
I find your answer very clear, but isn't it too simplistic? Are you sure entrepreneurs are going to anticipate price movements in the future correctly most of the times?
Sure, there's no guarantee, noone can predict future flawlessly, but those enterpreneurs who are good at anticipating price movements and changes in consumer preferences are rewarded with bigger profits, those who are bad at it suffer losses and eventually go bankrupt, freeing up resource for better entrepreneurs. Thus the free market system rewards desirable behaviour and punishes undesirable one, which seems like a rational and stable system to me.
Normal 0 false false false EN-US X-NONE X-NONE
Prashanth Perumal,
The fallacy which is dealt with in the article is that savings would lead to increased production, and there wouldn’t be adequate purchasing power to buy the produced goods, which will have a depressing effect on the economy.
There are several problems with this theory.
1) As Rothbard had pointed out in “America’s Great Depression”, falling prices do not necessarily have a depressing effect on business.What matters is the price differential between the selling prices and cost. He also points out that if wage rates fall more rapidly than product prices, it would stimulate business activity.
2) The issue is not “spending” or “not spending”. People save in order to spend in the future. So, ultimately what is saved would be spent in the future. If everyone decides to cut down their food today night in order to be able to buy a car in the future, it would be obvious that there would be a depressing effect on restaurants. But, it wouldn’t have a depressing effect on the society as a whole. What people spend now, they spend on cars in the future. Their saving would drive down interest rates and car producers would be able to invest in higher orders of production.
3) It should also be obvious that the society as a whole can’t save at the expense of consumers.
4) It is not possible to carry out productive activity in spite of falling prices. A fall in prices results in a cutback in production.
5) Savings would lead to an extension in production, which would reduce the cost of production per unit, and hence would not lead to losses when the product is sold. This point is crucial in understanding the fallacy of this theorem.
Thanks for the reply. What do you think of this:
"It is necessary to comprehend that the very appearance of an excess inthe total amount of entrepreneurial profits over the total amount of entrepreneuriallosses depends upon the fact that this process of the elimination of entrepreneurial profit and loss begins at the same time as the entrepreneurs begin to adjust the complex of production activities to the changed data.There is never in the whole sequence of events an instant in which theadvantages derived from the increase in the amount of capital available andfrom technical improvements benefit the entrepreneurs only. If the wealthand the income of the other strata were to remain unaffected, these peoplecould buy the additional products only by restricting their purchases of otherproducts accordingly. Then the profits of one group of entrepreneurs wouldexactly equal the losses incurred by other groups."
If I am right, this quote passage says that as a particular industry expands, entrepreneurs would want new laborers to operate these capital machines, and thereby they bid up the prices of complementary factors of production, including labor. Mises says this spreads out the benefits to the non-entrepreneurial groups, thereby providing them with the purchasing power required. What do you think about my comprehension of the passage?
Yeah. Mises says that due to capital accumulation, marginal productivity of labor increases and hence a rise in the wages.
This quote of Mises would explain it clearly:
A butler waits at the table of the British prime minister in the same way in which once butlers served Pitt and Palmerston. In agriculture some kinds of work are still performed with the same tools in the same way in which they were performed centuries ago. Yet the wage rates earned by all such workers are today much higher than they were in the past. They are higher because they are determined by the marginal productivity of labor. The employer of a butler withholds this man from employment in a factory and must therefore pay the equivalent of the increase in output which the additional employment of one man in a factory would bring about. It is not any merit on the part of the butler that causes this rise in his wages, but the fact that the increase in capital invested surpasses the increase in the number of hands.