On the Structure of Production

0:00It's not that I'm a techno-phobe, but I have a jet lag, so it takes me about three times as much to do the things that I usually do. And therefore my lecture will last now 45 minutes. And that's how we will end the day. Well, I changed the title of my presentation in the meantime. As modeling the time structure of production, it's an offshoot of a current writing project, A project in which I am engaged which concerns revision of capital theory and one of the elements that seem to be important is the representation, the graphical representation of the time structure of production.

0:46In order to explain the problem in various ways and I will start from the point of view This is a preview of a recent paper that I published in 2008, namely the demand for present goods and the relationship between the demand of present goods and the time market. And then, in the light of these considerations, we'll talk about typical Austrian illustrations of the time market, namely triangles, which is the main one, Hayekian triangles or Javanese triangles, and then trapezoids, which have been introduced by Murray Rothbard. And then we'll turn to the proper interpretation of what I consider to be the proper interpretation of triangles and then turn lastly to the advantages of trapezoids.

1:34So rather than modeling the time structure of production, my talk could have been the case for trapezoids. So this is work in progress. I've published so far two papers on this. The first one is the time preference and investment expenditure in Profesos de Mercado three years ago. Then two years ago, the demand for money in the time structure of production. And then this paper, the time structure of production reconsidered, which is on my website. So for those of you who are interested in having a look at this, it does not contain my present presentation. Okay, so let's start with the relationship between the demand for present goods and the time market. In the traditional Austrian literature, we have the most detailed discussion in Murray Rothbard's Man Economy and State, and here Rothbard gives us an analysis of the factors determining the demand for present goods.

2:33First of all, a definition, so present goods are goods that can be used immediately, that do not require any further transformation, which distinguishes them from future goods, which do require further transformation in order to be turned into final goods that can be finally used, so consumer goods in particular, and tools. And then Rothbard answers two questions, namely, what determines the demand for present goods? And he gives the answer, the ultimate factor determining this demand is time preference. So one particularity of Rothbard's theory is not particular as compared to previous authors such as Mises or Fetter, is that both sides of what he calls the time market, that is the market for monetary capital, are determined exclusively by time preference, both the supply and the demand for present goods.

3:28Who demands present goods? So we have three, four major groups. The owners of original factors of production, that is laborers. The owners of raw materials. Third, we have the owners of produced factors of production, that is, intermediate goods, tools, capital goods, and so on. And fourth, we have people, consumers, who want to obtain consumer credit. So these are the four main groups who ask for present goods. So based on this theory, we can easily derive an explanation of the changes of the demand for present goods. These changes must result if one of those factors that determine the demand for present goods among the typical groups change.

4:22So we have here particular changes in time preference which can express itself in a greater willingness to work. We have the discoveries of new raw materials and immigration, So new original factors or additional quantities of original factors of production become available and we have new technology. And that is simply because Rothbard was reasoning so the equilibrium on the time market is being derived in a framework of general equilibrium or otherwise set in an evenly rotating economy and such an evenly rotating economy is constructed under the hypothesis that factor endowments So if one of those things changes, then we can get a variation in the demand for present goods.

5:12So how does this look then on the time market? And here then my contribution in this 2008 paper was to show that the consequence is different from the one that is typically envisioned in the Austrian literature. and literature, namely a general rise of time preference brings about an increase of the demand for money and a simultaneous reduction in the supply of present goods. So when we get into the inverse case, we have here, you see, why does the red dot disappear? So this is the old equilibrium here, this is the new equilibrium, so of course we can read it also the other way around, then we get the typical Austrian scenario.

6:00Let's suppose that this is the new equilibrium, the old equilibrium, and then from there we get an increased supply of present goods, so the supply curve shifts from here to here as one. Then we would get a new equilibrium at this point, but this would not represent a general decrease in time preference, but it would only represent an increase of the supply of present goods while the demand for present goods stays the same. That is, we suppose implicitly that the reduction of time preference concerns only the suppliers of present goods, of Present Goods, not the demanders of present goods, which is not a general decrease of time preference.

6:45So if we get a general decrease of time preference, we move from this equilibrium to this one, and the other way around. If the time preference generally decreases, we move from here to this point here. Oh, I'm trembling. It's time that I get a drink or something. And then we can consider various other circumstances. I'll just give you one other example here. A simultaneous increase of the supply of present goods and of the demand for present goods and then the equilibrium shifts out from this point to this point so we get a higher exchange, a higher volume of gross savings on the time market being exchanged at by and large the same interest rate. So there's no systematic impact on the interest rate.

7:32Now, of course, demand and supply do not necessarily have to change in the same direction and this implies a very important implication, namely that on the time market any combination of changes is possible. That is, we do not only have the combination that we typically underline in Austrian reasoning and Austrian literature, namely a higher savings rate and a lower pure rate of interest, But we get also a higher savings rate and a higher pure rate of interest or higher savings rate at a constant pure rate of interest or a higher and a lower pure rate of interest at a constant savings rate. I will focus later on in particular on this case here, the higher savings rate and a higher pure rate of interest.

8:18Now, from here then, the problem of my present talk is then how do we translate this into a graphical representation of the time structure of production. And the usual, the most commonly used graphical representation is the triangular representation according to Jevons and Hayek. So Jevons in 1871 and then Hayek in his Prices of Production in 1933 introduces and most, virtually all other Austrian authors have used the triangular form as well and so what we see here is that at some point, this needs to be read from left to right, the production process starts at some point of time removed from final consumption which is here and then produces First, intermediate goods, and then finally, so intermediate goods are transformed, increase in monetary value, and finally are transformed into consumer goods, which are sold at this exchange value, this payment.

9:27Now, in Rothbard, we get to find a trapezoid representation of the time structure, which is therefore somewhat different. We see, of course, in the trapezoid form, this line, which represents the progressing exchange value of the intermediate goods and of the final goods, does not cross the The structure of production starts at some positive value, which is not zero, and this is significant and important, and helpful, especially. So the point is now to explain why this is helpful, and in order to do this we will first have a look at, well first of all to show that the traditional scenario can be illustrated with both representations.

10:16The adjustment of the structure of production in the tradition Hayekian scheme works like this, so we start off with this structure of production here in blue and then we get on the time market an increase of the supply of present goods at a constant demand which entails a greater volume exchange, so greater savings rate at a lower price that is at a lower interest rate. Now this entails, therefore, because the savings rate increases, the final consumer expenditure diminishes and because the interest rate diminishes, the curve becomes flatter. So this is the traditional way of illustrating this and we can do the same thing with Rothbard's trapezoid diagram.

11:01We start here from the curve A and then on the time market there's an increased supply of present goods. Present Goods So the curve becomes flatter and the structure becomes longer. Now if we turn to another case we will see that we, the case that we discussed before namely higher savings rate and a higher interest rate so we suppose here that the supply of present goods remains the same but there is an increase of the demand for present goods for whatever reason, one of the changes that we considered before, and we ask ourselves how can this be represented, the corresponding changes in the time structure, how can these be represented graphically, well the answer is they cannot be represented graphically with a traditional triangle, and the reason is that in a triangle the curve would have to become steeper and at the same time the volume that is under the curve would have If the curve becomes steeper and starts at the same point, or even at a lower point because the savings rate increases, then the volume under the curve of the surface becomes smaller, so the savings rate would have to necessarily diminish.

12:25So this constellation that we find here on the time market, increasing pure interest rate and a higher savings volume could not be represented with a triangle. But it can be illustrated with a trapezoid, so we have one first advantage, and what we see is the following, the savings rate increases, so consumer expenditure diminishes, and the curve becomes steeper, so you see they move out from one another, and the volume under this curve is, well here it's not very beautifully, but you can construct such cases more and more clearly, in which the volume under this curve, the surface under this curve, is bigger than the surface under the blue curve. So what then is the proper interpretation of triangles? What are the premises that we have to make?

13:13The first one is we have unchanging monetary conditions in an evenly rotating economy. The question is do we have any money at all in an evenly rotating economy? It's a different question, so I assume we have unchanging monetary conditions. And then in the evenly rotating economy we have these three or four mentioned premises, conditions that we find also in the Austrian literature. Rothbard stresses that we always assume unit services, otherwise we couldn't get a progression of value across time. But then, and these are the two additional premises that I wish to stress now, there are in fact no purchases of factors of production. And the product here that matures from intermediate products into a final good is only sold from one capitalist to another.

14:02There is never any sale of a factor of production from the owner of an original factor to a capitalist. Otherwise said, all owners of original factors of production are capitalists. All capitalists use factors of production that they own themselves. For example, their own labor and their own raw materials. These are never purchased. Translated in other terms, the typical Hayekian triangle representation of a time structure of production corresponds to an economy exclusively composed of producer cooperatives. And the last point is that we can only illustrate primitive structures.

14:48Now, by a primitive structure, I mean a structure of production that always starts without capital goods, that is, the value of the original factor is always zero at the beginning, or close to zero at the beginning. There is no use of capital goods in the highest stage of production. And this, of course, corresponds to the case discussed in Rothbard's textbook, which starts off with the example of a primitive, a cruiser type economy, But it does not correspond to the conditions that we find in a modern economy in which even those stages of production furthest removed from the production of final consumer goods operate with capital goods produced in later stages. So this would be an advanced economy. So we have these two. So it makes that the triangular representation is not wrong, but it corresponds to a very specific set of conditions that are not representative of our present day conditions.

15:46So what about trapezoids? Here we have to use the first three premises as well, but trapezoids give us the advantage that we can do without the last two premises. That is, we can here assume that there are purchases of factors of production, namely the factors of productions are purchased here. Here we have the purchase initially of, for example, original factors of production. And fifth, we can also represent advanced structures By introducing one additional element, namely that we have a reinterpretation of the structure. The structure needs to be interpreted as a forward-looking tool, not as a backward-looking tool. This is important. You see here on the abscess I put length of production in terms of planned numbers of stages.

16:36So we are looking from the point of time at which we are finding ourselves right now, And from this point of time, of course, all producers' goods that have been produced in the past and all intermediate goods are like original factors of production. They are there. So they can be interpreted exactly as original factors of production. So we get this type of structure. So this case that we have here, so I put it in blue, this surface in blue corresponds to the savings volume. This structure here corresponds to a case in which all factors that are being bought are bought only in the last stage of production, which is not the case in empirical practice, but this is useful for illustrative purposes.

17:23If you read my paper, you'll see I use this a lot because it simplifies numerical illustrations. and it can be changed very easily by adjusting the trapezoid representation with the case in which factors are purchased at each stage and then it would look something like this. So you see here we have the same interest rate at each stage, this and this, and then at each stage we have this capital or these capitalists operating in this stage here. They buy original factors of production here in this volume and because it's forward-looking they also buy produce factors of production and they produce factors of production from owners of the businesses in the stage before. So we have a great flexibility here. And so this gives us the following conclusions, namely three main conclusions.

18:12The conventional triangular illustration is suitable, but suitable only for a very limited set of circumstances. of Circumstances, and these are defined by the prevalence of producer cooperatives and primitive structures of production, whereas trapezoids can be used to illustrate all possible changes on the time market and therefore a more flexible tool to represent changes on the time market and on the time structure of production. Thank you for your attention!