Hi, I'm new,
From the perspective of say's law, how are real wealth and real income created. According to logic there are two ways in which real income is increased.
1) Increase your productivity and thus your purchasing power increases
2) Others increase their productivity, industry competetion occurs, drives down prices, and thus increases your purchasing power.
But, metaphysically speaking, how does this happen? Say's law says that your purchasing power, and thus income, is determined by your ability to produce. Thus, if your producitivty increases, this should increase your purchasing power and thus your real income and thus wealth. But this is a chicken and an egg problem. Let me use an example.
Let's say all spending equals income in the economy and it is in perfect equilibrium. Each individuals real income equals his spending, and all total income equals total spending. Each individual's spending power is determined by his income, which is determined by his producitivty.
Let's a say I am a shoemaker in this situation. Given my labor, capital, land, and technology I can produce 50 shoes each week. This determined my purchasing power and thus my real income, spending and wealth, etc.
Then, my producivity increases through an new innovation and I ca now produce 100 shoes with all the same previous resources. According to basic theory this means I should become wealthier and my standard of living should increase.
But if nobody else's real income has gone up, then who can purchase my new 50 shoes? My purchasing power can only increase if other's purchase my goods. But there's nobody to purchase it.
Its like there's some missing gap here that I'm missing. In other words, how do you put say's law and economic growth together, at its deepest metaphysical level. I can't figure it out.
Help is appreciated,
Joe
Let us say the quantity of money is absolutely fixed and cannot be increased or decreased. Let us now take all real goods and services in the economy and place them on the left side of a ledger each week. We count all houses, farms, cars, businesses and, yes, shoes, in the ledger. As you said, this should be a constant. On the right side of the ledger, place the number of money units in existence, which is also a constant. Let us say it is 1,000,000 units.
Now, the shoemaker creates in addition to his usual 50 shoes per week another 50 shoes due to the new innovation. At the end of this week, there will be everything that was on the left side of the ledger plus an additional 50 shoes. On the right side of the ledger will be the 1,000,000 units of money.
However, note that by adding the 50 shoes to the left side of the ledger, the purchasing power of a unit of money has increased. One unit of money is now more valuable than it used to be since it can be exchanged for everything it could be exchanged before plus an additional 50 shoes. Real wealth consists solely of real goods and services. Money has no intrinsic value and is only valuable because it enables indirect exchange, profit&loss calculation, and so on.
Does that answer your question?
Clayton -
Thank you for replying Clayton.
I can't explain what I don't understand. I can't put it into words. I just cannot visualize the process that is going on.
I wish I could say more, but no matter how many times I read what you wrote, even though I know it is correct and is the answer, nothing is ticking up there.
The problem could be that you're thinking of the value of a unit of money as an absolute in itself, much like a meter or a kilogram is an absolute measurement. The reality is that money is just another good - even though it's in a category by itself - and its value fluctuates based on supply and demand just like the value of apples fluctuates based on supply and demand. If the number of apples in the economy stays constant and the number of all other goods were to double, apples would be twice as valuable as they were before the doubling. Similarly, if the number of dollars in the economy stays constant and the number of all other goods were to double, dollars would be twice as valuable as they were before the doubling.
I just cannot visualize the process that is going on.
Think of a video of man making shoes and a man baking bread played first in slow-mo, then in fast forward.
joemac:Thank you for replying Clayton. I can't explain what I don't understand. I can't put it into words. I just cannot visualize the process that is going on. I wish I could say more, but no matter how many times I read what you wrote, even though I know it is correct and is the answer, nothing is ticking up there.
Welcome joemac. Have you taken into account that prices of shoes aren't fixed? Everything is sold at some price. So if the shoe production doubles, the price of shoes would go down to where they are all sold. Society has enough income to buy everything. Higher real income is not a requirement to buy more stuff, real income goes up because people can buy more stuff for the same money. The shoe-maker might only become a bit richer, not twice as rich.
Smartass. And you're not fooling any of us with that class photo from 1975...
But if I create so many new shoes, the price will fall until they all sell. But where will the buyers get the money to purchase it? Any income they spend on this item will have to be taken from someone else. Everytime an individual becomes more productive and can sell more products than before (and thus become a little bit wealthier), the price will obviously fall, but spending by consumers will simply be moved from other suppliers (of other goods) towards these cheap new shoes. In other words, anyone who attempts to grow richer through increases in productivity will automatically cause someone else to become poorer.
Can this whole process be explained purely in a barter economy, before money enters into the system?
Here's one from Arnold kling, "Note that as a matter of simple arithmetic, labor moves from industries where productivity grows faster than demand to industries where demand grows faster than productivity."
Surely some professional economists has explained this process in detail? I've searched everywhere but strangely this post is the first time anyone has discussed this issue.
But if I create so many new shoes, the price will fall until they all sell.
And the price of everything else falls with them... think of it as the opposite of inflation. Inflation occurs when money is printed, all else remaining equal. Deflation occurs when money is taken out of the system, all else remaining equal. However, if the money remains the same and the number of goods increases, deflation also occurs since the same money can now purchase more. Vice versa if the number of goods is decreased (think of a country in which 90% of everything is bombed to oblivion... wouldn't prices would go up?)
Normally, this increase in real goods and services versus money is so gradual as to be unnoticeable. During the 1990's, however, growth in the number of goods and services in the tech industry quickly outpaced the gradual inflation rate which usually masks such growth in other sectors of the economy and prices precipitously fell in consumer and commercial computer hardware and software even as the Federal Reserve continued to print money at unprecedented rates in the late 1990's.
But where will the buyers get the money to purchase it? Any income they spend on this item will have to be taken from someone else.
If I can purchase shoes for less, I can sell my labor at a slightly lower price, and my employer can sell his products at a slightly lower price, so on and so forth.
Everytime an individual becomes more productive and can sell more products than before (and thus become a little bit wealthier), the price will obviously fall, but spending by consumers will simply be moved from other suppliers (of other goods) towards these cheap new shoes. In other words, anyone who attempts to grow richer through increases in productivity will automatically cause someone else to become poorer.
Well, profits are the natural reward for innovation in the market. The first to innovate gets the biggest advantage by being the first to sell at the new, lower price point. Quickly, other shoemakers will imitate the innovation and the price of shoes generally will fall which will affect the price of everything... there will be more shoes in the world and everything will be slightly less expensive due to the reduced cost of shodding oneself.
Wow. Nice to know you can be treated with some decency here. I may have to update my stance in the scholarship thread.
Clayton:And the price of everything else falls with them... think of it as the opposite of inflation. Inflation occurs when money is printed, all else remaining equal. Deflation occurs when money is taken out of the system, all else remaining equal. However, if the money remains the same and the number of goods increases, deflation also occurs since the same money can now purchase more.
The price of anything else wouldn't be affected by an increase in the shoe supply. Price deflation is not the opposite of monetary inflation. Just the price of shoes will go down. Prices of other goods might be lowered in order to compete with cheaper shoes, but only if businessmen decide to do so. Although...
Clayton:If I can purchase shoes for less, I can sell my labor at a slightly lower price, and my employer can sell his products at a slightly lower price, so on and so forth.
... essentially wages compensate you for the cost of having to wear shoes. When that cost goes down, wages will adjust. That means production of everything becomes a bit cheaper.
joemac:Everytime an individual becomes more productive and can sell more products than before (and thus become a little bit wealthier), the price will obviously fall, but spending by consumers will simply be moved from other suppliers (of other goods) towards these cheap new shoes. In other words, anyone who attempts to grow richer through increases in productivity will automatically cause someone else to become poorer.
Shoes from other producers will still sell, just at that lower price. They will be poorer. But that's how capitalism works, there are always losers. That's why producers who don't want to lose their market share generally support state regulation that stifles innovation. That's why the business elite always opposes free markets.
joemac:Can this whole process be explained purely in a barter economy, before money enters into the system? Here's one from Arnold kling, "Note that as a matter of simple arithmetic, labor moves from industries where productivity grows faster than demand to industries where demand grows faster than productivity." Surely some professional economists has explained this process in detail? I've searched everywhere but strangely this post is the first time anyone has discussed this issue.
I don't know. Surely somebody has. It might be helpful to think of labor as just another natural resource. Economists talk about that a lot.
If this is some sort of personal attack I'd ask you refrained from making them and handled it via private messages.
Inflation occurs when money is printed, all else remaining equal. Deflation occurs when money is taken out of the system, all else remaining equal. However, if the money remains the same and the number of goods increases, deflation also occurs since the same money can now purchase more. Vice versa if the number of goods is decreased (think of a country in which 90% of everything is bombed to oblivion... wouldn't prices would go up?)
Is it correct to speak of inflation/deflation in this context when the Ms (and presumably Md) remains unchanged? They're not to be confused with price increases/reductions (which attend upon them all else remaining equal.)
Freedom of markets is positively correlated with the degree of evolution in any society...
I'd rather he doesn't share his views on my looks via PM either.
Just a small point concerning the idea that when someone gains someone else loses. I don't think that's true especially with technological advancement. You are assuming that the new innovation in shoe-making can only be applied in that context. What is this innovation? Take steam power for instance. I don't know for sure, but it's possible that at one time it was only used in a small number of applications. Then, after a time it would be used in other, more productive ways in various fields and industries. This, I think, can be true of other technological advances as well. The atomic bomb for instance. While the destructive power of it is great, the underlying theories and science behind it can be used to produce energy. Same with the shoe-making example. The concepts behind the the shoe-making innovation can be applied to other industries in different ways.
Phaedros:Just a small point concerning the idea that when someone gains someone else loses. I don't think that's true especially with technological advancement. You are assuming that the new innovation in shoe-making can only be applied in that context. What is this innovation? Take steam power for instance. I don't know for sure, but it's possible that at one time it was only used in a small number of applications. Then, after a time it would be used in other, more productive ways in various fields and industries. This, I think, can be true of other technological advances as well. The atomic bomb for instance. While the destructive power of it is great, the underlying theories and science behind it can be used to produce energy. Same with the shoe-making example. The concepts behind the the shoe-making innovation can be applied to other industries in different ways.
Innovating means that your competitors lose out in the short term. That's necessarily so. Of course society is better off as a whole because of innovation, but not everyone can win at the same time in capitalism.
Also, nukes were not invented by private business, but by the state. Nuclear energy has a profitable application and would likely have been invented if the state had never invented nukes. Same with microwave ovens and the internet.