Currently I'm reading extensively Roger Garrison's "Time and Money" in preparation for my upcoming Macroeconomics class (I'm sure all of you would agree its always best to argue against mainstream graphs with your own graphs). However, while I understand fully the sequence of events in the ABCT, I keep having trouble comprehending what constitutes a "higher order good" that entrepreneurs would invest in due to low interest rates from a "lower order good" that constitutes what consumers demand (and the subsequent tug of war with F.O.P). I believe my confusion (and hopefully others) can be best illustrated by a quote from Time and Money (p. 47)
The time dimension that makes an explicit appearance on the horizontal leg of the Hayekian triangle has a double interpretation. First, it can depict goods in process moving through time from the inception to the completion of the production process. Second, it can represent the separate stages of production, all of which exist in the present, each of which aims at consumption at different points in the future.
By the first bolded statement, I assume Garrison means the process of a good being constructed throughout time (such as the building of a new mall or the development of a new toothbrush), and by the second he means the stages of production (he lists examples such as mining, refining, and manufacturing being in the earlier stages, while distributing and retailing are in the later stages). In terms of the second interpretation (which Garrison says is easiest to best understand the business cycle), a boom into higher order goods would be in industries such as mining, refining, and manufacturing, due to their time discount (lower interest rates increase their value) and not distributing and retailing.The boom occurs in those stages because they are most far removed from consumption, as we all know.
However, (and this is where my confusion starts), if we were to use the first interpretation of the triangle, then it seems as though the areas where malinvestment can occur (once the "smokestack" industries of mining, refining, and manufacturing plants) is now different. By concentrating on the construction of a new mall in its rudimentary forms, which due to low interest rates now becomes heavily profitable, i get confused because some construction like this clearly belongs in the "retailing" aspect of the second interpretation. Same with the research and development behind a new toothbrush. Clearly these are very remote from the consumer, the mall will not be built for 5-10 years and the toothbrush is still in the drawing board with scientists working on it. But they are still projects in consumer goods industries, which are in the later stages (as opposed to the "smokestack" capital goods industries)
In short, if I'm understanding the two interpretations (please critique if I don't), which one is it? In the first interpretation, construction of a new mall and toothbrush R&D are temporally remote from the consumer, where in the second interpretation, their construction is clearly in the consumer goods industries of the later stages of production. This confusion over capital has frustrated me for the longest time. Sometimes my mind will wonder over what constitutes a higher order good and I always run into dead ends because interpretations seem to contradict each other.
My only solution to the problem is that a good, development of something, etc, etc is a higher order good and in the earlier stages of the Hayekian triangle subject to malinvestment when the time discount effect (when a lowering of the interest rate increases the profitability of the project) is greater than the derived demand of a good (when a decrease in consumption will reduce the profitability of a project).I understand that a higher order good can praxeologically be described as a capital good, or one which is indirectly serviceable to the economic actor (see Rothbards MES chapter 1 for his classification of goods into consumer goods and FOP), but when describing the business cycle more explanation is nessary because we are dealing with different goods in different stages of production.
Hopefully I'm articulating my points clearly (and the two interpretations correctly). What are your thoughts?
nirgrahamUK: I think it would be wrong to categorise goods as higher order and lower order based on what effects bear on them to whatever degrees under certain conditions. goods are higher order and lower order based on the subjective considerations of those who utilise them in their plans. Quote Menger: ...
I think it would be wrong to categorise goods as higher order and lower order based on what effects bear on them to whatever degrees under certain conditions.
goods are higher order and lower order based on the subjective considerations of those who utilise them in their plans.
Quote Menger: ...
Yes, that was how I understood Garrison's Power Point presentation when he first used the lines in the Hayekian Triangle. Each little subsection might indicate a particular process or company and that as the goods and products progressed from left to right they would go from being a 3rd or 4th order good or whatever to being a 1st order good for that producer at which point it would be passed on to the next portion of the triangle or producer) who would take it in as perhaps a 3rd order good and transform it over time into a 1st order good from his perspective and pass it along to yet the next person who would subjectively consider it a 4th order good for his purposes. In other words, the good did not have an objective measurable basis upon which it could be determined to be a 1st or 3rd or whatever order good for everyone. Subjectively, each might view it quite differently. What was a 1st order good for one person/company would be a 4th order good for another.
For instance, in the process of making a radio a mining company might consider land or the rock they were to mine to make the copper they sell to be a 2nd or 3rd order good. After the copper is ready to sell they would consider it a 1st order good, but the company that made it into copper wire might consider that same copper to be a 2nd or 3rd order good. after the coils of wire are ready to sell they might be considered a 1st order good for that company, but a 3rd order good for the company that would assemble the radio... even the finished radio might be considered a 1st order good by the radio manufacturer, but a 3rd order good by the auto manufacturer who was going to install it in a car.
nirgrahamUK: I think it would be wrong to categorise goods as higher order and lower order based on what effects bear on them to whatever degrees under certain conditions......
I think it would be wrong to categorise goods as higher order and lower order based on what effects bear on them to whatever degrees under certain conditions......
I understand those, I just find that when talking about the business cycle they are weak definitions because a "higher order good" can range from a capital good employed in a consumer good industry or a large scale industrial power plant. It seems that questions like these will invariably come up if the ABC is to become more mainstream, and especially concerning criticisms that more recent booms have been in less of the "smokestack" industries and more consumer/service related, causing us to defend the theory in a more time aggregate instead of certain individual industries.
Let me try to rephrase my question in a different way:
What separates certain consumer goods as being "quasi capital goods/early stages" from being "consumer goods/late stages"? Austrians consider consumer durables to be investment goods, but since we know consumer durable is more of a degree than a distinction, all consumer goods are durable in some sense, so where is the dividing line?
(Sorry for repeatedly using a mall example). Businessmen are planning to construct a new mall to be completed in five years. Society has saved more and as a result, people have stopped consuming mall products. However, even with the lower interest rates, which will certainly help the financing in the next five years, because consumption has decreased, the profitability of constructing the mall to be ready five years from now has decreased as well (including the lower interest rates). Is this mall a late stage investment, or an earlier stage investment? Or put in other words, is this investment(if the interest rates were credit induced and consumption did not decrease) something that reflects the "Overinvestment" part of the cycle, or the "Overconsumption" part of the cycle?
JeffB:even the finished radio might be considered a 1st order good by the radio manufacturer
not quite. only if the manufacturer gained immediate satisfaction in consuming the services of the radio would it be a 1st order good, if he has to sell the radio in order to get money, in order to by items to directly consume (goods of the first order) then the radio is a good of a higher order (from his p.ov.)
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
BlackNumero: A Higher order good is one where the Time Discount effect (decrease in interest rate increases profitability) is greater than the Derived Demand effect (decrease in consumption reduces investment in those areas). This is where the Overinvestment and its expansion of stages occurs.
A Higher order good is one where the Time Discount effect (decrease in interest rate increases profitability) is greater than the Derived Demand effect (decrease in consumption reduces investment in those areas). This is where the Overinvestment and its expansion of stages occurs.
I'm a little confused here. That may be because I'm not familiar with the "Derived Demand effect", but it would seem to me that a decrease in interest rates would increase consumption rather than reduce it.
JeffB: BlackNumero: A Higher order good is one where the Time Discount effect (decrease in interest rate increases profitability) is greater than the Derived Demand effect (decrease in consumption reduces investment in those areas). This is where the Overinvestment and its expansion of stages occurs. I'm a little confused here. That may be because I'm not familiar with the "Derived Demand effect", but it would seem to me that a decrease in interest rates would increase consumption rather than reduce it.
In a non boom atmosphere, interest rates can only be reduced through a decrease in consumption. People consume less, save more, and put up a supply of their savings in the loanable funds market. Just like in any supply and demand analysis, a shift in the supply curve to the right (change in Time Preferences, people are saving more) lowers the price of loanable funds, i.e the interest rate.
BlackNumero, your question concerns thymology and the challenge of applying economic theory so as to understand some concrete episode of history. you should not expect economic theory itself to have all that much to say about how you should apply your understanding of it, and your understanding of the people of the world, their values, and their plans.
If you are simply concerned about discussing ABCT with other people, do it like this, you make the economic theoretic statements. you ask who you are talking to what they consider to be goods of higher and lower orders, and you can use these peoples own examples to put bones on the theory for them. then you shouldnt have the problem of them saying that you have ordered the goods incorrectly from their p.o.v....
my own thymology, understanding of values, and plans and the like. would classify malls as higher order, rather than lower order, (like things that can be bought in malls). but this is only my perspective.
The question of whether something is higher or lower order is one as to the degree of indirectness of its supplying utility. there is a wide scope of agreement, even though this is a subjective concept. so you can't be completely objectively scientific about concrete and precise pronouncements of 'applied' ABCT knowledge. but most people wont need you to be. they can fill in the blanks. they can understand indirect utility and higher and lower order. there is large scope for agreement
nirgrahamUK: my own thymology, understanding of values, and plans and the like. would classify malls as higher order, rather than lower order, (like things that can be bought in malls). but this is only my perspective. The question of whether something is higher or lower order is one as to the degree of indirectness of its supplying utility. there is a wide scope of agreement, even though this is a subjective concept. so you can't be completely objectively scientific about concrete and precise pronouncements of 'applied' ABCT knowledge. but most people wont need you to be. they can fill in the blanks. they can understand indirect utility and higher and lower order. there is large scope for agreement
Firstly, I'm not necessarily talking about malls, I'm talking about this mall, or any other good that I could put in this problem. (I put mall down as an example, and it relates more to the modern economy and how we are much more consumer/service oriented). Secondly, by "this mall", I mean how the given scenario (decrease in interest rate, decrease in consumption, decrease in profitability) puts its construction in the early/later stages. For all I know, despite decreases in consumption, malls with a lower interest rate could be more attractive investments. I'm just saying that given this particular good, in the structure of production, where it fits (on the view of an analyst). So my question is, if the low interest rate was artificially induced and consumption never decreased, would construction of this good constitute expansion in "overinvestment" (earlier) stages(and be a malinvestment), or expansion in "overconsumption"(later) stages?
I understand what you mean as a solution to use my own theoretic statements. I could easily talk to someone, take their examples, and make a scenario based on "toothbrushes" and "Oil refiners". However, what allows people to understand things much more better is when you put things in context of events, such as the last crises. People want to learn to understand human events. In taking our last boom/bust, lets say I describe the crises with the examples of Overinvestment in housing, green technologies, and oil exploration and Overconsumption in clothes, restaurants, food, "my" malls, and retail stores. In the context of the past 10-12 years, am I right or wrong?
BlackNumero: JeffB: BlackNumero: A Higher order good is one where the Time Discount effect (decrease in interest rate increases profitability) is greater than the Derived Demand effect (decrease in consumption reduces investment in those areas). This is where the Overinvestment and its expansion of stages occurs. I'm a little confused here. That may be because I'm not familiar with the "Derived Demand effect", but it would seem to me that a decrease in interest rates would increase consumption rather than reduce it. In a non boom atmosphere, interest rates can only be reduced through a decrease in consumption. People consume less, save more, and put up a supply of their savings in the loanable funds market. Just like in any supply and demand analysis, a shift in the supply curve to the right (change in Time Preferences, people are saving more) lowers the price of loanable funds, i.e the interest rate.
OK, my mistake. I was thinking of our current fairyland situation, where the Fed can lower interest rates with a wave of their magic wand, creating the "necessary" additional money out of thin air.
nirgrahamUK:not quite. only if the manufacturer gained immediate satisfaction in consuming the services of the radio would it be a 1st order good, if he has to sell the radio in order to get money, in order to by items to directly consume (goods of the first order) then the radio is a good of a higher order (from his p.ov.)
The ordering of goods is looked at from the process of production--that is, its role in turning inputs into finished goods. The finished radio sold on the market is a consumer good.
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
BlackNumero:So my question is, if the low interest rate was artificially induced and consumption never decreased, would construction of this good constitute expansion in "overinvestment" (earlier) stages(and be a malinvestment), or expansion in "overconsumption"(later) stages
if the good in question is a large store from which consumer goods can be purchased. this is relatively higher order than the consumer goods themselves and relatively lower order than the goods from which the mall was constructed. I say this having considered the degree of direct utility satisfaction..
BlackNumero:am I right or wrong?
Esuric:The ordering of goods is looked at from the process of production--that is, its role in turning inputs into finished goods. The finished radio sold on the market is a consumer good.
nirgrahamUK: JeffB:even the finished radio might be considered a 1st order good by the radio manufacturer not quite. only if the manufacturer gained immediate satisfaction in consuming the services of the radio would it be a 1st order good, if he has to sell the radio in order to get money, in order to by items to directly consume (goods of the first order) then the radio is a good of a higher order (from his p.ov.)
Thanks for the clarification for me.
nirgrahamUK:to the person that buys it who will directly partake of its services
Yeah, If it's no longer used in the production process then it can't be considered a producer good. Also, I don't see how a radio could be used in the production process.
BlackNumero:Firstly, I'm not necessarily talking about malls, I'm talking about this mall, or any other good that I could put in this problem. (I put mall down as an example, and it relates more to the modern economy and how we are much more consumer/service oriented). Secondly, by "this mall", I mean how the given scenario (decrease in interest rate, decrease in consumption, decrease in profitability) puts its construction in the early/later stages. For all I know, despite decreases in consumption, malls with a lower interest rate could be more attractive investments. I'm just saying that given this particular good, in the structure of production, where it fits (on the view of an analyst). So my question is, if the low interest rate was artificially induced and consumption never decreased, would construction of this good constitute expansion in "overinvestment" (earlier) stages(and be a malinvestment), or expansion in "overconsumption"(later) stages?
Lower interest rates make more roundabout methods of production possible or seem possible, and since remoter production methods are more profitable, they are undertaken. Lower interest rates also increases the profitability of long-term durable capital goods (malls, houses, for example). As the capital good depreciates, its future costs are deducted while it yields present goods (until it's completely depreciated--that is, when the last future good is turned into a present good).
Esuric:Yeah, If it's no longer used in the production process then it can't be considered a producer good. Also, I don't see how a radio could be used in the production process.
Rothbard talks about transforming food on the plate to food in your mouth as an act of production.
to some extent its an exercise in pedantry :-)