Re: My limited understanding of why subsidization squelch's scarce resources(long post..)

filc — Tue, 16 Feb 2010 00:38:12 GMT

Bogart:

I could not find the word Entrepreneur in the text. This individual is critical to the process of production as this individual anticipates what consumers desire and then attempts to use scarce resources to satisfy that desire. If the Entrepreneur can satisfy these desires better than others then consumers will purchase these services or products from this person at a profit.

Great point. It's a poor habit of mine to assume the roll entrepreneur when I say "producer". When I mean Producer I am referring to entrepreneur, manager, capitalist, as individuals or grouped all together in concert.

Re: My limited understanding of why subsidization squelch's scarce resources(long post..)

Bogart — Mon, 15 Feb 2010 23:26:12 GMT

I could not find the word Entrepreneur in the text. This individual is critical to the process of production as this individual anticipates what consumers desire and then attempts to use scarce resources to satisfy that desire. If the Entrepreneur can satisfy these desires better than others then consumers will purchase these services or products from this person at a profit.

My limited understanding of why subsidization squelch's scarce resources(long post..)

filc — Mon, 15 Feb 2010 20:50:16 GMT

Critique or confirm in responses. Thanks!

Consumers are the responsible party for the direction of the flow of capital and investment. Consumers decide which firms will invest in capital and which will not. Consumers also decide the order of needs amongst goods and services through the catallactic system of free-exchange. In this short essay I hope to show how subsidization perverts the market and wastes natural resources. Critique’s, praises, corrections, and everything under the sun is appreciated.

Purchasing of Higher-Order Goods

Consider the following diagram.

The diagram shows 3 widget producers. Producer A, B, and C. Their purchasing power is represented by the number of dollar symbols. The volume at which they purchase is displayed by the size of arrow. In our situation purchasing power also represents and assumes consumer demand. We also see that each widget manufacturer, as a part of their production process, pull from the same limited resource pool. We can call this scarce resource, X. For all intense purposes the widgets created from each producer are not in direct competition with each other, they do however compete in the production process for the acquisition of limited resources.

Producer A is currently frequented with high profits. The market rate for his widget is extremely high. In a catallactic system Producer A uses the high market price as a signal indicating that he must producer more Widgets to satisfy the increasing level of demand. If his motive is profit he will want to produce a higher volume of widgets for his consumers.

Producer B has less of a purchasing power then producer A, but more of a purchasing power then producer C. He produces a widget that is in mild demand. Due to the lack of overall interest it is easier for him to satisfy the needs of his target audience and as a result does not need to produce such high volumes as Producer A does, nor does he profit as much.

Producer C is a specialty producer. He has found a niche market where occasional individuals have found interest in the product. He experiences little demand and does not need to produce many widgets to satisfy consumer demand.

Purchasing Power

What we take from this scenario is that all 3 producers are competing for the same limited resource pool. The function of the market is to satisfy the needs of all consumers, not just a specific majority or minority. The market is designed in such a way that producers which provide widgets in the highest demand will be graced with the greatest purchasing power.

The producer who is addressing the highest volume of needs amongst the market will likely have the purchasing power capable of securing the volume of resources he believes is necessary to satisfy demand. This is a crucial function of the market as this ensures that scarce resources are employed to satisfy the demands of the greatest number of individuals for what people consider are the highest order of needs

Producer B and C must compete with the great purchasing power of Producer A. They do not get special discounted volume price deals from the resource provider like Producer A is. They may find this unfair but they are providing for a smaller volume of individuals of widgets which are likely considered of less priority amongst people’s value scales.

The diagram shows that producers who are satisfying a greater volume of demand are gifted with the appropriate purchasing power to ensure that the greatest number of needs are met on the market. The demand of widgets from Producer B and C also plays a role in consumption of that scarce resource pool. In this way Producer A also has to compete with Producer B and C, even though their goods may be in less demand, but enough of a demand that some individuals are willing to pay the price for. What this ensures is that the scarce resource pool required to produce widgets is adequately distributed addressing the needs of majorities and minorities alike. It ensures that resources are not wasted in vain but used to address specific individuals on the market.

Marginal Producers

This diagram also shows how producers addressing the needs of many will often be given the purchasing power for major capital good acquisitions, like new factories. It should go without saying that a producer has incentive to make his production ever more efficient and raise his margin of profit.

A producer who acquires a new factory may be able to lower his widget price to an extent that he forces all of his marginal competitors out of the market. Otherwise marginal producers may need to upgrade their infrastructure to compete accordingly. Lets say that with the acquisition of a new factory Producer A finds that he can producer his widgets with a smaller volume of supplies from the scarce resource pool. What this does is allow more of that supply to be available for Producer B and C. This will cause a catalytic chain reaction of the reduction of prices, greater purchasing power, and higher volume of goods which will extend all the way down to the consumer, potentially across all products related to those now abundant resources.

Let’s assume Producer A’s new factory consumes fewer resources from the resource pool. Now that Producer A is extinguishing a smaller volume of supplies this causes the market rate of the scarce resource to begin to fall. Both Producer B and C may also be able to lower the price of their goods attracting more interested consumers to their widgets, further expanding their own markets. They may also expand production accordingly.

This reduction of prices from the resource pool may also make possible the introduction of new producers with new widgets. We may see new markets emerge as the price points become more feasible. This becomes an expansion in the market, an increase of available goods and selection.

Being Against Capital Upgrades

Typically in this situation people would be scolding Producer A for his monopolistic activity of upgrading his factory, driving out marginal competitors, and firing a portion of his now in-efficient labor force. But if we take Hazlitt’s lesson here we should be mindful of what is not seen. In the above scenario we have a lot to be thankful for. Both producer B and C should be thanking Producer A for upgrading his factory and consequently extinguishing a smaller volume of the scarce resource pool. New Producers D and E should also thank Producer A for the acquisition of their new factory. The reduction of prices in the limited resource pool has created a doorway of opportunity for their new businesses as well. Finally the consumer should be most thankful. The activities of Producer A has caused deflation; it has generally increased the consumers purchasing power by creating a way for the market to drop the prices of not just widgets from Producer A, but widgets from all producers sharing that resource pool. The consumers should be thankful for the cheaper prices and greater quantity of goods which occurred due to Producer A’s activities.

Reasons to be thankful to Producer A. The following has occurred across the entire economy, not just consumers of Producer A.

· Cheaper Goods

· Higher Quantity

· Possibility of new industries/markets(More/New Selection)

o Possibility of new needs addresses

Company or Industry Specific Subsidization

Now let’s describe a similar scenario above, except that one of the producers is granted additional purchasing power from the state. Let us consider a scenario where Producer B has a market competitor that has recently upgraded his factory and is able to undercut his price, drawing purchases away from Producer B and to the rival company. Producer B is in a situation where consumers are no longer willing to purchase their product at the rate they can offer. They are suffering losses, as they can no longer produce a good that consumers find desirable. In their present condition they cannot satisfy consumers and are not sustainable as a business.

Ignoring the fact that, based on the lesson above, this competitor of Producer B is a huge blessing to the economy, and ignoring the fact that Producer B is clearly wasting precious resources, instead we explore a situation where the catallactic system is perverted and broken via government interference. Let’s say that Producer B has had adequate influence on the State’s “powers that be” and in our scenario he is given additional purchasing power backed by the taxpayers. We need not fabricate a very elaborate argument for this stance. Such situations are fairly common. Perhaps we are attempting to defend local employees of Producer B, or since Producer B is built locally we must support him, or any other counter-economical arbitrary excuse that is commonly found in practice today. Here is example of such a situation.

In our scenario the state has raised the purchasing power of Producer B to that similar of Producer A. Despite the fact that these two businesses are not direct competitors they do however compete in the same resource pool for the construction of their widgets.

Here are the changes that occur. First, there may be additional consumption of scarce resources and a general rising of price of that resource. Producer B’s attempts to match the volume and price of his competitor, using his increased purchasing power, he purchases and builds a greater volume of widgets and in the process using more resources. He produces the same volume of resources as his competitor, but extinguishes more natural resources in the process, as he never build a process to match his competitors in production. Since there is a signal for new demand in our limited resource pool the price for those resources goes up. This new demand is introduced by Producer B’s greater purchasing power. The limited supply resources however are incapable of continuing to support a price feasible for Producer C. The increased market activity of that specific resource drives up its cost per unit. This pushes Producer C out of the market. Based on the prices provided Producer C is no longer capable of producing his widgets and returning a profit. He is removed from the market system. Producer D and E never enter are given the chance to even enter the picture.

Those consumers who were patrons of Producer C are now left without. The results of the subsidization are as follows.

· Increase consumption of the Scarce Natural resource

· Increase price of the limited resource

· Increase price of Producer A, decreased price of Producer B

· Elimination of Producer C

· Overall market price inflation(due to less resources and less goods)

· Fewer goods for consumers, fewer selection as well

· Fewer consumer demands met

· Dwindled purchasing power due to taxation, to support the sub

We must also consider the following situations. Now that Producer A’s margin of profit has been limited by the greater cost of supplies he may not be able to upgrade his own infrastructure, preventing him from any acquiring new capital goods, like a new factory. In addition to, the Competitor of Producer B cannot produce the greatest volume as well, as he is directly competing with Producer B in the same resource pool. The consumer benefits most from purchasing from the competitor of Consumer B, as his goods do not cost tax dollars. They don’t realize this however as their calculation is done at purchase, and taxation is not typically a part of the calculation system.

We must also consider the situation where Producer B has no incentive of making his own major capital investments or upgrades. If he is to be sponsored by the state his economic calculation is skewed. Depending on that level of subsidization will change the degree of how poorly he performs. More on this can be found in a previous article I wrote here. Business's have incentive to upgrade their infrastructure based on profit. A subsidized company does not have this incentive, they lobby for the state instead.

So in our scenario of subsidization we have created an economy that is overall poorer. We have not helped the individual consumer, but hurt everyone in the entire economy. We have saved a few jobs at the expense of everyone. In a nutshell subsidizing a specific company squelches capital and resources into areas that are least efficient. If anyone should be against subsidization at all it should be the environmentalists, as subsidization ensures that the most wasteful company will succeed. It is also a direct attack on the poor, as the ability to improve major production processes are squelched. Quantity of goods is limited and price is kept higher than it needs to be.

Subsidization of specific goods

Let’s explore a more complex subsidization scenario. A case where a higher-order good is subsidized. Not necessarily a specific company but an entire industry. This can be observed in the United States through examples like the Corn Industry.

In this scenario we have three limited resource pools. Resource B however has the advantage of being subsidized by the state. There are a few things we can take from this example. Normally Producer C would other wise prefer the A+C formula as the cheapest method possible of producing his widget. However in our scenario he finds that he can acquire Resource B with a $20 discount. This causes several interesting behaviors revolving around Resource B and C.

First off, Resource C is now entirely un-used. Resource B however becomes a resource in high demand. If it’s costs are fixed by the State it will ultimately be depleted. This would be an example of where Price Fixing causes a shortage, as the market rate is not allowed to reflect the goods scarcity.

A more common attribute however is a situation where the good does not deplete, but more manufacturing of the good occurs. What occurs typically is that resources are drawn from the economy as a whole to bolster and satisfy the new demand for Resource B. A great example of this today would be the United States Corn Industry. Rather than allowing the market to function on its own, having created items to address the needs of consumers, instead a portion of the economy is drawn to the industry that is subsidized. A portion of our economy is essentially ante'd to the corn industry to support it's subsidy. It's all wasted capital however because we know that if the market had wanted corn, then no subsidization would have been necessary in the first place.

What ultimately has occurred is a fundamental alteration of the Market as a whole. The market is less efficient than it otherwise would have been, as it has incentives to conform to the subsidy. A great example of this, using the Corn Industry, is comparing our sweetener industry to that of neighboring third world countries. There is a reason why Central America and much of South America uses Sugar Cane as its sweetener crop as opposed to Corn. The reasoning is simply that it is cheaper. It should be fairly obvious that in the absence of corn subsidies we would all be drinking Mexi-Cola’s, only they would be bottled in the US, not Mexico! So interestingly enough subsidization of specific goods can alter the entire catallactic process. Producer C is no longer using the available scarce resources in the most efficient sense, but instead is drawn to an already crowded resource pool.

The Cost of Subsidization

There are those that argue that subsidization works. Though to argue that it ‘works’ seems to be in conflict with itself if the goal is ultimately to create a more economic environment. Subsidized goods can only function at a diminished purchasing power of the consumer. The subsidized good may experience increased sales but the purchasing power of consumers as a whole is dwindled to pay for this subsidy. Ignoring all the points I mentioned above, we must also consider the following as well.

Here we see that a consumer is unwilling to pay for his Orange at the market rate of $6. In a healthy economy the provider his orange would be purged from the market and a more efficient one in its place. If the orange however agitates the state for sponsorship its behavior is observed differently. In this case the consumer is fooled into thinking that the orange is cheap and affordable, he may even choose to purchase this good. In his calculations he sees that the orange has cost him $1, what is not seen however is the payment to the state to sustain this good and support this inefficient provider. What’s worse are those individuals who do not wish to participate in acquiring the subsidized good, they are essentially paying for everyone else, how benevolent of them!

Conclusion

I made this small essay to help solidify some concepts I pulled from Human Action. In the process I hoped to have made a case that subsidizing any good always results in an economic loss. Subsidization is counter-economical. It squelches resources, moves changes in the direction of capital away from the consumer preferred business's, and supports inefficient business activity. Ultimately subsidization never supports the consumer and should be done away with all together.

Comments appreciated, thanks guys!

Economics Questions

Re: My limited understanding of why subsidization squelch's scarce resources(long post..)

Re: My limited understanding of why subsidization squelch's scarce resources(long post..)

My limited understanding of why subsidization squelch's scarce resources(long post..)

Purchasing Power

Marginal Producers

Being Against Capital Upgrades

Company or Industry Specific Subsidization

Subsidization of specific goods

The Cost of Subsidization

Conclusion