Interest Rates and Course Review

0:00First I'm going to finish up with what we have to cover, and the second I will review the term and answer questions and what all the rest of it. So, having covered the labor market, supply of labor, population, unions, etc. and the price and wage rates, we now have to wrap up two things, well, interest rates and along with it the difference between unit prices and the price of the whole product. When we talk about wage rates, or prices as factors of production, we've been talking about how the demand is determined by the marginal revenue product, which is marginal physical product times the marginal revenue.

0:52So what we want to do now is to focus on the time dimension, in other words, physical product means how much product is produced by one extra worker or whatever, one more acre of land in a certain time period. This of course means in a certain, that's been implicit all along, it's how much product is produced in a given time period. So the wage rate or the price of the land or the price of capital goods will be that that price given a certain time period so this means that the price per time period in other words for workers or for labor its wages either per hour or per month or per year because it's product per month or per year we're dealing with so in other words when we've been talking about prices especially prices of factors of production labor, land and Capital, we talk about the price per unit time, so it's the price per unit time, because it's also production per unit time, production takes place over a certain time period, so

2:01when you talk about a product, you know, you add one laborer to a certain amount of capital goods and land, and it produces 20 more bushes of wheat, 20 more bushes of wheat in what time period? Well, whatever the time period is, a month or a year, whatever, so therefore we're now I'm now going to focus on the time period involved here. So price per unit time means exactly that, wages per hour, and for physical products it means rent. In other words, the rent is the price per unit time. So for example, what we've really been talking about up until now is that workers are hired, they're paid per unit time. When an entrepreneur buys capital equipment, let's say, or land, you can either buy it or rent it.

2:47In other words, if you're a business man, you can either rent your building or rent your land, or rent machines or plants. There's a lot of renting going on in business, largely for tax purposes, get out of income tax. But there's a lot of rent, so you can either buy something or rent it. These are the choices which you have in any business. So what we've been talking about up till now, and we talk about price of factors of production, So we've really been talking about the price per unit time, wages per hour, and rent. In other words, price per unit, let's say, rental price per month or per year. So when you rent a house, as a consumer or a businessman, you're renting it for a year or a land, for a year or for a month or whatever, you're renting it for a time period.

3:33So the rental price of anything is the price per unit time. So, in a sense, what we're dealing with, what we've been talking about is the price determination of marginal productivity, price determination for rental prices, the price per month or per year of land or capital goods or labor, because what a wage really is, is really a rent of labor. In other words, since you can't buy a laborer, except under slavery, in a free system you can only rent a person, you can't buy him, buy his whole product, so to speak. So you're renting from the labor himself, you're renting services per unit time. So a wage is also a rent. In other words, I'm dealing with rent now, not just for land. A rent is for anything. When you rent something out, it means a price per unit time.

4:19When you rent a TV, you can either buy a TV set or rent it. You can either buy a car or lease it. It's all the same thing. In other words, when you rent a car for a year, for a day, or whatever it is, you're using its services per unit time. When you buy the thing as an outright, when you buy the house or buy the car, you're buying all the future services that the thing can give you. So you're buying the whole product or the whole thing. Whereas when you buy it per hour, per month or whatever, you're renting it. So we're using the term rent, not the way the textbooks use it usually, we're using it as a common sense phrase, as a price per unit time of anything, of any product that can give you a service. You're buying the services per unit, you can either rent a TV set or buy it, you can even rent tuxedos and things like that.

5:08The consumer or the producer is always faced with the choice of rental or buying the unit service or buying the whole thing and enjoying all the unit services, all future unit services. So rent is a really generalized concept to mean the price of any unit service. So, what we're saying here is that the prices are factors of production. The rental price of anything, the rental price is equal to the marginal revenue of product, or the demand for the labor service will yield the rent to be equal to the marginal revenue of product. So, the rental price, in a way, we're looking at it. Now, under slavery, one of the interesting things about slavery is that it illustrates The general concept for labor as well as for anything else, under slavery, slaves are often rented as well as bought. In other words, somebody who wants to say you're operating a plant or plantation or whatever seasonally, the master often instead of buying a slave would rent the slaves out from other masters. In that case, in other words, you can either

6:15buy a slave or rent them. So again, you have a situation where there's some kind of relationship between the rent and the purchase price. The rent, the slave rent, in other words, under slavery, you have a demand for labor, the demand curve is the marginal revenue product, this is the wage rate. In a free system, in a free labor system, the market wage will be equal to the marginal revenue product and the intersection of the marginal revenue product of the demand curve and the supply curve. Under slavery, it's still the same thing. Every slave has a marginal revenue product, usually lower than under a free system because there's not much incentive to work or to be creative or anything like that. But under a slave system, the slave master appropriates, the slave master rents out the slave.

7:09The rent is equal to marginal revenue product, it's up here. But the slave master will only pay the slave the amount, enough to keep a slave functioning, keep him eating and reproducing, and the master gets the appropriate or expropriates the difference, the surplus value, so to speak, goes to the slave master. So this is a subsistence level. The Marxist analysis of wages are determined by the subsistence level and the capitalists expropriate everything up to the barge revenue product, basically, only holds true for slavery where indeed the master can expropriate, the master has the guns to do it. So the rental price of the slave, the wage rate of the slave, whichever we want to call it, is still determined by the marginal revenue of the product.

8:00So then the question is, we now have to determine all the rental prices for everything, in other words, for land, labor and capital, then the question is what determines the price of the whole thing if you buy it, either a slave under slavery or capital goods or equipment or Land or whatever you're purchasing. Is there any relationship between the rental price and the price of the whole thing, so to speak? That's the next step too. So, in other words, what we've been talking about all this time is really the rental price, the price per unit, the wage rate, the rental, the land rent and the capital price per, the rental price of the capital equipment. So now we have to determine what is the relationship between the price of the whole thing and the rental price of anything, whether it's a TV or a TV set, or a house, or a laborer under slavery, or a capital good, or a land, or anything else.

8:47All these factors of production can be purchased as a whole. Okay, so let's look at this. I call it the price of the whole thing, the price of the whole factor. When you buy something, when you buy a capital equipment, or you buy a land, or you buy a TV set, or whatever, What you're doing is you're buying a house, you're buying the right to appropriate all the future services, the future unit product or the future rental product, so to speak, of the item. So if, for example, a machine has a ten-year life, let's say, and if the revenue product of the machine is, say, $10,000 a year, in other words, you use it, you get a marginal revenue product of $10,000 a year, You can rent it out, you'll pay $10,000 a year for it. Or if you buy it and you rent it out, somebody else, he will pay you $10,000 a year for it.

9:46So we're just assuming now the rental price of this machine, which is equal to the marginal revenue product, will be $10,000 per year. So, let's say the machine, let's assume for a minute the machine, you know, dies out at 10 years. I mean, usually these things are much more variable than that. Let's assume you use it for 10 years and it collapses like a one-horse shea. All right, so that means if you buy it, if you buy this machine and then rent it out, or then if you use it in production, you will earn from it $10,000 per year for 10 years, okay? in your life. So the first approximation we can say is the price of the whole thing will be the summation, price of the machine as a whole, will be the sum of the rental price, or the sum of the marginal revenue of products over the life of the machine. So it should be, you'd think it would be $100,000 because you're getting $100,000 worth of equipment.

10:57So that's sort of the initial first approximation. You're getting the sum of the rents, the sum of the returns. You have a rental value of $10,000 a year from this machine. You buy the machine, you get 10 years worth, 10 years life, and you will earn either by producing it, using it in production, or by renting it out to somebody else who uses it in production. You'll earn $10,000 a year. So you think there it could be $100,000. Of course it won't, However, it could be a lot less than that because the reason for that is the basic fact of time preference. In other words that, which I talked about at the beginning of the class, I haven't mentioned much since, but the basic point is that everybody prefers income now to income in the future, to the prospect of income in the future.

11:44In other words, if you're presented with the idea of I'll give you a million dollars now or anything, give you a hundred dollars now, let's say, or else I'll give you a hundred $100 10 years from now, aside from price changes. Let's just forget about prices changing. You obviously prefer getting $100 now. Even if you want to save it, save some of it. You want to control it yourself instead of having me control it. Everybody prefers getting money or anything else now to waiting for it. Like they're getting it 2 years from now, 10 years from now, 100 years from now, but long you have to wait unless you like it. So there's a basic time preference. Money prefers present goods, in other words, getting goods now, getting money now or products now, to future goods, which means the present prospect of getting money in the future.

12:29Notice we're not saying that you prefer to get $100 now than getting it 10 years from now. What we're saying is we prefer $100 now to the current prospect of getting $100 10 years from now, the different point. In other words, here we are in 1986, we're confronted with two choices. Either we get $100 right now, or else we don't have to wait for it for 10 years. What we're saying is we prefer right now to get the $100 now, not to wait, than getting an IOU for $100 for 10 years from now. That's the point. In other words, what we have all over the market, the economy, we have a time market, which permeates the entire system. Unfortunately, most microeconomics doesn't deal much with. It deals with very peripherally. There's a time market. There's a market of present goods and future goods all over the place.

13:16And part of the market is the most obvious part of the market, of course, is the loan market. I loan you $100, $1,000 and get an IOU for the future. So here we have a time market, in other words the time market is a vast market where present and future goes to be an exchange for each other, an exchange of present for future. Future, for example, the credit market is, as I say, an obvious example of this, a loan market. I lend $1,000 to somebody here, and what happens now is the creditor turns over $1,000, which the debtor can use right now.

14:04Here's the creditor and here's the debtor. So what happens is the creditor, this $1,000 can be used right away as a present good. In return for that, the other person gives me an IOU saying I will pay you a certain amount next May. So I get an IOU for a future good, which is from 1987. Now what I'm saying is that present goods are always worth more than future goods, both for the creditor and for the debtor. Everybody in the country, they have different rates of preference. Some people have a high time preference, some have a high time preference, they want money right away, they don't care about that much about the future, they're willing to pay up a lot in the future to get money now.

14:49Others have a much lower time preference, but everybody's got a positive time preference. Everybody prefers, to some extent, present to future goods. And the time market will then resolve this to one price system like anything else. Some people have a high time preference, others have a low time preference. And they exchange it until interest rates become more or less the same. These tend to become more or less the same. And so let's say it's 8%. An IOU for future goods, so that the, I'm exchanging $1,000 now for an IOU for $1,080, so that's 8%. In other words, in that case, the price of time, so to speak, is 8%. That's the time rate, per annum, of course, per year. When interest rates are lower, they were in the old days, for various reasons.

15:36If interest rates are 5%, then you exchange this for IOU for $1,050. So that's, in the days when it was up to 20% for a year or so, it was up to about 20% in the early 70s, then it would have been $1,200 or 10% of $1,100. So depending on what the interest rate is, this is more or less the tendency of what the time rate will be. And that is, the time rate is the interest rate, it's the basic interest rate. There are other factors going into this, the basic or pure or whatever you want to call it. It's called the basic interest rate. So in other words, interest is the price of time. It's the time market. It's exchanging present goods and future goods. So when you borrow from the American Express or whatever, or get a mortgage app, you're getting money now in exchange for which you're paying the creditor a premium for, you know, you're paying back in the future.

16:33So that's the present-future market. So, when you go to a restaurant, you buy a TV set or something, you use a credit card, what happens there is the American Express, or Masters, whatever it is, pays the guy right now, more or less right now, pays the restaurant owner of the TV owner, the store right now, in exchange for which you pay the American Express, whatever it is, 20% or 10% or whatever the rate is until you pay it off, and an interest return, annual return, let's say 20% or 15%. The metaphor also fluctuates in accordance with the basic interest rates. So in other words, the basic interest rate is the time rate, and all throughout the market you have this kind of time market going on. One of which is the credit market, the most obvious one.

17:20But also, when a businessman hires labor or buys machines, what he's doing is he's getting a future return. In other words, he's saying, okay, or rents a machine or whatever. We'll pay you now in return for which we're going to produce the product and sell it a year from now, or two years from now, and get a certain return from it. The worker and the landlord, etc., etc., don't get the full marginal revenue product. They get the marginal revenue product actually discounted by the rate of interest. In other words, they're getting a... Because if you didn't have a capitalist doing this, everybody would have to work on the equipment. They'd have to work five years on something, a computer firm, whatever, IBM, and finally they sell the product and then you get paid. So you'd have to wait two years, five years, depending on ten years, depending on what the product was, before any payment came in.

18:09Most of us can't afford to wait ten years for a paycheck. So the capitalist saves the money up, pays out the money now as a present good to workers, landlords, whatever, machine people, sell them more materials. And he then waits, then works on the product, directs the working of the product, and then gets the return in the future. And in return for this waiting, in return for this time preference, he gets the 8% or 6% of whatever the interest charge is. So interest is a general feature of production, part of the production system, long-run interest, which exists even in equilibrium when all the profits and losses are washed out, even in long final equilibrium, because as a return for hanging out money now and waiting for it late until the future. In other words, it's part of the discount of future goods against present goods.

19:01In the case of the price of the whole thing in rental charge, what you've got is, when you buy a machine and expect to get $10,000 a year for rent for 10 years, it's true you'll get it, but the price of $100,000, especially over 10 years now, is not $100,000, so you have to wait for it. It's $10,000 discounted each year by whatever the interest rate is. So in other words, if the interest rate is 10%, to make it simple, you're buying a machine which will get, everybody agrees, let's say, it will give you $10,000 rental return or productivity per year. For the first year, let's say that, well, for the first year, let's say you get the money right now, for the first year you pay $10,000, worth $10,000, the next year it's it's only worth ten percent of that, so you deduct a thousand dollars, that makes it nine thousand and then you deduct another ten percent, that makes it eighty one hundred

19:58and on into the future, so instead of instead of adding up to a hundred thousand, you add up to something, whatever, fifty three thousand, something like that, in other words, you add up because you're getting ten percent a year interest so, if it's fifty three thousand When you buy 53,000, you use it for 10 years and you get your 10% interest per year for the 10 years. So in other words, the capital, the price of the whole product on the market, whether it's a labor under slavery or a labor under slavery or whether it's a capital machine or a piece of land, the price of the whole product will tend to be, not the sum of of Future Rents, which is what we first said, the sum of future rents discounted by the rate of interest. So discounted sum, discounted future rents. We multiply i times each rental

21:00return in other words. If rental return per year is a capital R, the first approximation would have been the sum of r, $10,000 a year for 10 years. Now we're saying each r is discounted by the right of interest. You multiply by the right of interest to get the actual amount. We call the price of the whole product, it's an awkward term obviously, so the term is generally used as capital value. Capital Value. So in other words, if you buy a house or if you buy a machine and you land and rent it out, the price of the whole thing to buy it is called the capital value of that good. The capital value is the sum of future rights, this capital right of interest, R divided by I. So the formula, the famous formula C equal capital R over I, this only works this way, it's only this simple if you have a permanent good, if you have a ten year life it gets more complicated. But basically, for example, land is considered a permanent

22:07good, if you buy land, if it's still going to be in use forever, let's say you buy land 50th Street and Broadway. You're buying the land forever. You're getting the use of it for all time, so to speak. If the returns weren't discounted, if the rents weren't discounted by the rate of interest, you'd never be able to buy that land because the land price would be infinite. In other words, you'd be getting, let's say, $100,000 a year, say, for valuable land, forever. So you can never sum it up. Land would be infinitely high in price. The fact that land is not infinitely high in price, which obviously isn't, since people are pretty high here, but you still can buy it, it means that it's discounted by the rate of interest. So the fact that you might get $100,000 from it 200 years from now doesn't mean a hell of a lot to you. It's almost negligible. So all these things are incorporated by being discounted into the interest return.

22:54So this formula is particularly accurate with land because it's considered to have infinite life. It's not limited. But this is a basic proportion. It demonstrates to you that the capital value of something is directly proportional to the average productivity of the rent, rental return, and inversely proportional to the rate of interest. In other words, if the rate of interest is, let's say it's 10%, so every year it's worth a sum of 10,000 plus 9,000 plus 8,100, etc., etc., the yield of final lump sum that's worth right now on the market. Well, if the rate of interest If the interest rate goes up to 20%, then it's obviously going to be worth only $10,000 plus $8,000 plus $6,400 or so. It's going to be worth a lot less. If the interest rate goes down, say, 5%, then it's worth $9,500 or so. It's going to be worth a lot more, as you sum it up.

23:47So in other words, every piece of capital means land, slaves under slavery and machines. Worth more if the rent goes up, the annual productivity or rent, and worth less if the interest rate goes up, inversely proportional to the interest rate, directly proportional to the annual rent. And this is why, by the way, the stock market has acted in a rather peculiar way for many years. The stock market, the papers have been talking a lot recently about the stock market boom. The boom is only relative. In other words, the boom is relative to what it was a year ago, but basically the stock average, the so-called Dow Jones average is the most famous one, where you take the 30 top stocks, leading stocks, and then average them into an index, you get an absolute number, which doesn't mean anything in itself, it just means it's relative to each other.

24:47The other numbers, if you go down the years, since 1920, when they first started the Dow Jones Index. In 1966, the average Dow Jones stock was $1,000, and $1,000 was the number averaging all the various stock values. Last year, 1985, it was still down to about 1200. As a matter of fact, it hadn't gone above 1000 for a long time. So this means that in 20 years, let's say, the average stock is only going up by 20% as an average number. On the other hand, prices, the price The price level has tripled since 1956. This is the price level, the consumer's price index. It's 3,000 now, so this means that the average stock value has been wiped out.

25:42In other words, the average person who held blue chip stocks or average, let's say, Dow Jones stocks, which usually are the top stocks, most of the best companies, the biggest companies in the world, But they just held on to it, they've essentially been semi-wiped out, in other words, they've not only have they not been keeping pace with the price index, it's way below it, so your capital value is going down almost by two-thirds since 1966. It's now up to about 1800, so there's been a big boom of 1700-something in last year, but it's still not that great if you consider it should be 3000 if you're really going to match what stock prices were in 1966. So the thing that just kept a damper on the stock market for a long time now, even though there's been a lot of prosperity, that even though profits are going up, in other words, the rental value of the capital equipment of these corporations is going up, interest

26:31rates are also going up, at least until a couple years ago. So as interest rates go up, this puts a permanent damper on stocks, because even though the profits are going up, so that the value of a corporation's assets go up, interest rates You're also going up with inflation, as you see in macroeconomics. As you inflate, as people catch on to what's happening, the interest rates add on to the interest return, but the creditors get wiped out in inflation, so you add on a return. And this puts an almost permanent damper on the stock market. Stocks are a, what stocks are, they're essentially the people's evaluation of a corporate asset. The assets of each corporation, every corporation has got a certain amount of assets, expected returns on the assets, hopeful profits, current profits and hopeful future profits, and these get incorporated into the valuation of the assets that the market puts on them.

27:25This is capital equipment, buildings, goodwill and all sorts of stuff, which incorporate into the profits and the profits of the corporation. So if the profits or expected profits go up, expected future profits go up, stock prices will go up, expected return, but if interest rates go up, again this puts a damper, the price of stocks goes down. So this is basically what reason why stocks are not a good inflation hedge, and most people think, boy, why not? Why not? It heads you against inflation. If you expect future inflation, you buy a lot of stock, but the problem with that is even though profits go up, interest rates also go up, and this tends to put a ceiling on stock prices.

28:13The same way with the bond market. The bond market, which is by the way bigger than the stock market by far in overall numbers, what you have is bonds, either government bonds or corporate bonds. Corporation, let's say, issues a bond, saying, we will pay, let's say it's a thousand dollar bond. So this means the bond is a thousand dollars and it's due in 25 years, let's say, in 25 years they'll pay off the whole thousand dollars. In the meantime, they'll pay, let's say, 10 percent, 10 percent is an easy figure, 10 percent car interest. So, in other words, a corporation, General Motors or whatever, is committed to paying every year on a certain date, let's say December 1st or whatever, a hundred bucks, it's a coupon, you give a coupon to the bottom of the bond, and every year you take the coupon, there's 25 coupons, let's say, for a 25-year bond, every year you take, you clip the, you clip the tarot and send it to the corporation headquarters and they send you a hundred bucks.

29:15In other words, what a bond gives you is a right to $100 a year, over a 25-year period. It's a claim or a right to $100 a year. So the par interest isn't that important. The important thing is you have a right to $100 a year. By the way, that's why bondholders are often called coupon clippers, because they make their money by taking the coupon, clipping off an edge of it, and sending it in. Now the question is, so this is a new bond that comes on the market, it has a certain par interest rate, but the bonds are traded all the time, back and forth, there's a huge bond market, corporate and government bonds, and people buying and selling them, old bonds, all the time. And how much they buy or sell for depends on the supply and demand of the market, and basically it depends on what the interest rate is, the general interest rate, because if the general interest rate is let's say 10%,

30:08The interest rate goes up to 20%, which it was in the early 70s for a while, a couple of years. At a 20% interest rate, nobody is going to spend a thousand bucks, they're asking you here, when the bond was first issued, you pay a thousand dollars for the right to get a hundred dollars a year. This is a 10% per year return. Nobody's going to do that if they can get 20% in other places, money market funds or whatever. In order to make this attractive, to make the selling of gold bonds attractive, the bond price falls from $1,000, which it was issued at, to about $500. At $500, you're willing to buy the right to $100 a year, because then you're getting a 20% return.

30:57In other words, the 20% interest is what's known as the yield on the bond market. This is what the bond yields from moment to moment as you buy it on the market. So this is the interest yield. Even though the par interest rate is 10%, that was five years ago, ten years ago, nobody cares about that. In effect, what happens is, in order to get a claim on $100 a year, you're willing to buy it, to pay for it, only $500, because you want a 20% return, because that's what you can get at other places. This way, interest rates tend to equalize throughout the time market. Not instantaneously, but the tendency is to equalize, because if you can get 20% somewhere else, you're not going to pay 20% The bond market, you're not going to buy bonds for 10% if you can get 20% or 18% or whatever if the money market is fun.

31:43So conversely, if the interest rates go down, let's say to 5% to make it again a simple arithmetic here. In other words, here we have our formula, if the interest rates go down, the capital value goes down. In this case, if interest rates go up to 20%, the capital value went down to 500. The rental return is the same all the time. If it's fixed in a bond, it's fixed at $100 a year forever, because that's the way it was issued. If the interest rate goes down to 5%, however, this means that now people are willing to pay more for $100 a year. And so, the bond price is bid up to $2,000. At $2,000, then, you pay $2,000 to get $100 a year, you're paying 5%. In other words, as the interest rate falls, in this case, to 5%, the capital value is up to $2,000. So, in other words, the bond yield, interest yield on bonds is exactly inverse proportion to the interest rate, excuse me, to the price

32:55of the bond. If the bond price increases, it means the interest return has fallen, if the bond price goes down, the interest return goes up. So this is why during an inflation, during the later stages of inflation, when people catch on with what's going on, only there's constant inflation, interest rates keep going up because the value of the dollar is worth less when you pay back the debt than when In other words, if you've charged 10% interest on a loan and two years from now you get the loan back but now the dollar is only worth half of what it was before, it means you're getting virtually wiped out. You're getting only 5%. So as the creditors and debtors are going to wake up to the permanent inflation as it existed in the 70s, the interest rate and inflation premium gets tacked on the interest rate. As the interest rate goes up, the bond The bond prices fall. The bond prices start collapsing. So if you have a really severe

33:48inflation, the bond market collapses, as it did in Britain and any other country with hyperinflation. The first thing that collapses is the bond market. Nobody's going to buy the right to $100 a year or $1,000 a year. They know that $100 or $1,000 would be worth peanuts in a year and a half or something. So when inflation was moderated, it was not The bond market has revived. Before that, the bond market was a point of cracking altogether. In Britain, when Britain had a severe inflation, which is still more or less still going on to some extent, the bond market was the first thing to collapse. Nobody would buy bonds, nobody would invest in it. So if you think there's going to be inflation, if you're anticipating higher inflation, don't buy bonds of any sort. It's the first thing not If you're expecting to try to get rid of it some day, sell it, it's the worst thing to buy.

34:48The first people who wiped out the United States inflation were the guys who bought savings bonds, those days like 3% or something, you hold on to a savings bond for 20-25 years and you find out the money you get is worth about half of what it was when you first invested in it because of inflation. So that's the last thing to get. The, okay, see now we see that the interest rate, or the term is actually interest rate is the time market and time preferences and plus or minus inflation premium, that's really a macro question. But anyway, that's the basic cause of it. And I'd say the time market permeates both for rental, the relationship between rent and capital value for interest rates in general. So what you're doing is the capital value of anything, whether it's a bond or stocks or a house or a machine or factories or whatever, is determined by the discounted sum of expected future rents or expected future returns on whatever the product is.

35:49and so the capital value is determined by two things, the expected rents, the expected future rents or returns from the product and the interest rate, the discount rate which you use to apply to it and this is again why when interest rates go up, future investments become less profitable, investment in long term future construction projects, things like that become much less profitable When interest rates go down, they become much more profitable. When the government's trying to evaluate, for example, whether or not a certain future dam or any other long-range project is profitable or not, it much depends on what interest rate they consider the correct interest rate to charge. The government always likes to give itself a low interest rate and make whatever does seem profitable.

36:39If you take the market interest rate, most of the government projects are uneconomic So we then have a relationship between capital value now, we determine what the capital value of everything is or the price of the whole product, namely the sum of future rents or expected future rents, discounted by the interest rate, interest rate is determined by the time Market, plus inflation premiums when there's inflation, time preferences. Time preferences can change according to lots of things, cultural points, risk of being confiscated.

37:26Obviously, if your investment is going to be confiscated, you're not going to invest very much. You might spend more currently, figuring what the heck, tomorrow the money is going to be confiscated anyway, maybe we'll spend it now, things of that sort. Usually, as the economy gets more affluent, people have lower and lower time preference rates, usually. They're willing then to invest more in the future and consume less now because they're more affluent now. So usually, as a long-run proposition, interest rates will fall over time, but this is not necessarily true. It's just a general tendency, and also interest rates differ. Time preferences differ over cultures. Some cultures, people are much more thrifty, save a lot for the future, they have a low time preference. and other cultures are going to spend money right now and they have a high time preference rate.

38:13And over the market, of course, all these things balance out into a general overall interest rate. We've now really mopped up, we've finally concluded the analysis of the market and market pricing. We've now got consumer goods prices, producer's goods prices, wage rates, rental prices of and all sorts, and finally the relationship between that and the interest rate and capital value, capital goods, capital values in general. It's called capitalization, by the way, this process of arriving at capital price, it's called capitalization, capitalization of future rents. And now we can finally conclude our analysis of things like taxi medallions. Remember we talked about taxi medallions, tobacco rights, rights to grow tobacco, things of that sort.

39:04Of course they're determined by supply and demand, but also in addition to that, supply and demand basically is the value of this monopoly privilege, the taxi medallion, will be, the capital value, will be determined by the sum of future rents, discounted by interest rate. So as the profits on the taxi business go up, the capital value of the medallion tends to go up, and on the other hand, if interest rates go up, it tends to lower the capital value. One of the reasons why the medallion was about $60,000, I think, when Miller wrote his book, it's now about $105,000. One of the reasons for that is the drop in interest rates in the last four or five years. It dropped from about 12% to about 80% or something like that. Anyway, it's an argument. Yeah. Yeah, it's divided, yeah.

39:49Line by is better. I don't want to be looking at it. So, yeah. Yeah, it's basically, I mean, you're multiplying by a percentage, you're dividing by a percentage. So at any rate, so as the interest rates have fallen in the last few years, because inflation has fallen, the value of capital assets like that, in that case the right to operate, to run a cab, or drive a cab, own a cab, I should say, has gone way up. So it's been a reflection of what these medallions are, their rights to monopoly privilege or monopoly rights to this restricted entry into a restricted profession of operating a cab.

40:36And the same way with tobacco rights and rights of tobacco growing plantations, oil import rights at the time we had oil import quotas, only certain people can, those who own the right to have a tobacco farm, those who only like to import oil, these fluctuate in accordance with Supply and Demand, indeed, but Supply and Demand depends on people's estimates of future rents, of future returns, and the rate of interest in weighing the two against each other. So, I guess that really completes our discussion on the market. The next hour, we'll sum up the course and have questions and whatever and talk a little bit about the exam. Ten minute break. I was going to be an all objective answer, in other words, multiple, as I said last time, multiple choice, some multiple choice in a good old manner you're now accustomed to, some fill in the blanks, and some fill in the blanks with multiple choice, which is really the same thing as another form of multiple choice.

41:32So the purpose of this review is to help you out here, so if you want to start asking questions any time, break in, because that's the whole point, whatever is fuzzy, to be clarified. We started with the law of diminishing marginal utility, the basic form of action, analysis of action, applied to anything, any consumer goods in particular, if for any, the supply of any good increases, the value would catch any one unit or decline and because your most important use comes first and your next important use is separate, separate, so the greater The lower the supply of a product, the lower the value of each unit of the product.

42:19This solves the so-called paradox of value or value paradox of the diamond bread or diamond water paradox. Namely, how come bread, which is very important, or water, which is very important, or staff of life, how come they're worth very little on the market? Their prices are very cheap. On the other hand, diamonds, which are mere frippery and luxury, are very expensive. So there seems to be a contradiction between use value and exchange value or prices. And the law of diminishing marginal utility clears that up, namely that in real life we choose and buy stuff, or not buy stuff, not on the basis of the philosophic value of the whole, of a class of goods, but on the basis of each unit, we buy units, we buy loaves of of Bread or TV sets or diamond, carats of diamond or whatever, and we buy them in relation to the supply that's available, so that because bread and water have a huge supply, huge stock available, the value of each unit is low, whereas diamonds are quite rare and therefore

43:25and limit very small supply and therefore the value of each unit is higher. So this clears up the alleged paradox or conflict between use value and exchange value. From the law of diminishing margin utility we arrive at the falling demand curve, our basic curve in microeconomics, the prices on the y-axis and the quantities on the x-axis we get a demand curve, falling in other words the higher the price the less will be purchased either for each individual or even more for the market as a whole. So this gives you in other words the locus of how many units will be purchased given the different prices and the intersection of the demand curve and the existing supply line will give the market price and we saw why this is true because if the price is higher than the market price you get a surplus, an unsold surplus means the supply is greater than the demand at that price and the unsold surplus, in order to sell the surplus, businessmen who want to increase their profits

44:30decrease their losses cut the price and as they do that, the surplus is eliminated. Similarly, if the price is below the market price, more people want to buy it than there is available. Demand is greater than supply as a shortage and the stuff disappears from the shelf very quickly and then in response to that, businessmen raise their prices and see that they may as well charge more since the stuff is disappearing quickly and as they do that, the shortage is eliminated. So we're back again to the equilibrium point. At the equilibrium point, and only at that point, is the supply and demand equal. The market is, in other words, cleared. There's no shortage, there's no surplus. And that, offered, is exactly how much the people want to buy.

45:16So this is our fundamental analysis of market prices and market in general, that it's responding to the demand curve, the values of consumers, which in turn determine the demand curve, which in turn determine the price given whatever supply is available. And then if the demand increases, the demand curve goes up for any reason, price will go up, and then more supply will be brought forth, profits will go up, and therefore people will produce more of it over time. So over time, the supply curve will keep increasing, say to here, you'll get a larger, in response to the higher demand, you'll get eventually a larger, and the higher price, you'll get eventually a larger production. And conversely, if the demand curve falls for whatever reason, let's say that people shift their pace from bourbon to vodka, the demand curve for vodka goes up, the demand curve for bourbon goes down, as that happens the price falls and losses are made, are incurred, and business spends supply less bourbon over time, and the supply goes down and the price goes up a bit.

46:26Let's see, what you have then, in other words, is in response to the long-term change in demand, in this case a fall, less bourbon is produced ten years from now than it would be now because of this long-term shift. So in other words, resources are determined over time on the basis of land, labor and capital, how much is being produced in responding to consumer demand and how much they're willing to pay for the different products. So at any given time, the market price is determined by the intersection of supply and demand, and in the long run, supply is influenced or determined by long-run demand. Then we went through the various applications of this and why prices change, and then what happens is that there's a price control by government which messes things up.

47:14In other words, the maximum price control creates a permanent shortage, which gets worse over time, doesn't allow the market to clear the market, creates a permanent shortage and lowers supply over time, which makes the shortage even worse, and various other effects, black markets and rationing through lining up, queuing up and all that sort of stuff, decline in quality, all these things are a product of maximum price control. And with minimum price control, where the government keeps up, keeps the price above the free market level, then the supply is greater than the demand permanently, in other words, the permanent surplus, which increases over time as the people will produce more of it at a higher or greater profit.

48:00So you have a problem of a surplus which gets worse. This is particularly true in two areas, historically. Farm price supports, which of course are getting worse all the time, and minimum wage laws, similarly, which create unemployment or surplus labor looking for jobs that are not available. And so we still have that farm price support, one intervention leads to more interventions to try to solve these. In other words, one intervention trying to cure a problem doesn't cure it, it creates problems which cause more interventions as a supply, as surpluses go up and they try We try to make the farmers cut their production. If they do it by making them cut their acreage, the farmers will cut the acreage and then produce more in each acre. So you wind up with even more surplus and you try to force them to cut the production.

48:46It's an endless chain of events brought about by the initial bad premise and then continuing on the same path. So we went through a lot of that, what the effects of maximum price control and minimum price control are. That was about the first half of the term, dealing with that. Then we went on to the theory of the firm and the firm tries to maximize its profits and what exactly that meant. And so then we had dollars on the y-axis, quantity of production on the x-axis, then total revenue, which is equal to price times quantity, and total cost, which is un-purchased, not spent.

49:41and then total revenue, something like this and we can either go up or go down since price and quantity are moved inversely. In other words, if the price goes up, quantity so will go down and vice versa. As we saw from the demand curve, total cost is always rising. This is the minimum total cost, providing that firms have the incentive to keep the total cost to the minimum. If I don't have cost plus pricing and defense contract and and all that, where the cost will balloon upward, because the government, the taxpayers paying them back, recompensing them, plus the guarantee rate of profit, guarantee markup. So in this case, the maximum profit will be the maximum distance between the two, say here, be the production point, and this will tend to be the, also be the, the slope of the tangents are equal, the marginal revenue is equal to marginal cost.

50:36marginal being the change in total revenue divided by delta Q and marginal cost being the change in total cost for each new unit so this is, but marginal revenue and marginal, equaling marginal cost is a necessary but not sufficient condition of maximizing total profit because it could be in a minimum zone here too, in other words the two things are, the tangents are also equal at a minimum And the only way you can tell whether the maximum minimum is a look at the total Unless, as the textbooks do, you implicitly assume only one peak I mean, if you assume only... if you cut the thing off here, then of course it's easy Then you say, well, whenever the marginals are equal, then it's maximum profit That's because you're conveniently forgetting about the other possible troughs and peaks in the production schedule Okay, this is an area So in other words, the maximum profit point will be at a point where the demand curve for the firm is elastic.

51:37This is the elastic zone. The demand curve for the firm will never be an inelastic zone. It means any business firm, regardless of the size or whatever, will always be producing, if it has any smarts at all, will always be producing an area where the demand for its product is elastic. Transposing that into the other diagram for this is the average and marginal diagrams. This is the total revenue and total curve. If we assume only one peak and no trough, if we cut this off here, because the textbook is always doing to make life easier for them. Then we have total revenue will be since the man curve is always falling, that's the same thing as the average revenue curve. Marginal revenue will always be falling below it and falling more sharply. It's mathematically the way it works out. This is marginal revenue. The cost curve as we've seen is more or less If it's U-shaped, although not precisely that, anyway, if it's U-shaped, something like that, it decreases the average total cost, decreases over product number produced until it reaches some kind of trough and goes up again.

53:01So marginal cost in something like this will intersect at the trough point. and a usual marginal average relationship. Namely, whenever an average of anything is falling and the marginal is below it, whenever the average of anything is rising and the marginal is above it, and therefore whenever the average of anything is at a trough or a peak, it intersects the marginal. And so, the maximum profit point then, given all the assumptions, given that there's only one peak and no trough point, will be wherever these to intersect, marginal revenue and marginal cost intersect, in other words, if you only have this diagram, you don't have that one, so this will be here, and then the total profits will then be, at that point, let's say it's a thousand units or whatever you're producing, at that thousand units, this is average revenue and this is average cost, so the total profits And we go average revenue minus average cost times quantity, and in other words, this follows

54:04from that, profits equal total revenue minus total cost, so profits are also equal to total revenue divided by quantity, which is average cost, average revenue, minus total revenue divided by cost, average cost, times quantity, like this, these drop out, so in other words, the total profits will be this area here, this minus that, times that, this will be the total profits, at the maximum profit point, where production is a thousand, let's say, the maximum profit point Average costs are falling, are U-shaped because they're indivisible, even though the production function is such, you might think that it should be a constant average cost, because same causes always yield the same effects.

55:06The average cost curve is falling for a long time because, or for a short time, whatever, of Indivisibility. Factors of production cannot all be multiplied to the same extent. So since you can't, you can multiply the number of shipments, freight car shipments by 20% You can't multiply a number of tracks by 20%. You can only either double them or leave them the same amount. They have these indivisibilities, and therefore, as you keep increasing in production, you use up more of this fixed cost, more of these big indivisible factors of production.

55:52And I finally get to the point where all of them are being used up and beginning to be overused until the average costs start going up. In real life, the average cost curve usually goes, instead of going to a fixed one point or one trough point, it usually goes down like that, reaches a plateau and then goes up again. So there's a whole area here, a zone in which businessmen are interested in, where average cost is constant, marginal cost is the same as average cost, and it goes up for that length of time. Which is why businessmen don't understand what economists are talking about. Economists are talking about average and marginal, for them, the businessmen, of course, are always constant.

56:39And the reason is they're dealing with this zone, and they're not interested in a hypothetical zone when they're never actually functioning. And then we went on to pricing of factors of production and we're going through a long elaborate process of showing how factors of production are, the man curve of factors of production is determined. It turns out the man curve will be the marginal revenue product curve, which will be falling We're falling for two reasons. One, because marginal physical product is falling. And two, because demand curve is falling, or marginal revenue is falling.

57:24So when you multiply marginal physical product times marginal revenue, you get a fully marginal revenue product. Yes, sir? This is the demand curve for the firm, for the product of the firm. The demand curve for, wonder about it, this is the demand curve of the firm for factors of production, wages, labor, land and capital. This is the demand curve for the factor. And this is the demand curve for the product. The product of the firm. So this is the man curve for factors of production, and then the supply of factors of production is whatever it is, whatever the stock of labor, land and capitalism, it will give them the yield of wage rate or the price of the factors or whatever, intersection of these two things.

58:15And the supply of labor, particularly of course largely determined by population, we went Contrast the Malthusian Doctrine, which is that people always breed down to subsistence level, so to speak. And today, of course, we talk about interest rate and the capitalization and how capitalization is determined by the expected future returns or rents from a product or equipment or whatever, and the interactions between that and the interest rate, which is the time preference rate. Okay, are there any questions on any of this stuff? We have a whole, let's summarize the whole term now, about a half hour, so is there any, yeah.

59:19Most of the blanks, we'll cover the whole term, but we'll cover the major stuff. There'll be no trick questions about obscure areas. Basically, we'll cover these major things The final will be, in other words, I'm leaning over backward to help the students. If you do better on the final than on the midterm, I figure you've increased in stature, you've learned, etc., so it'll be worth more than 50%. If on the other hand you do worse on the final, I'll give it 50%. So I'll try my best to, it's not mechanistic. So there'll There'll be multiple choice, there'll also be fill-in-the-blanks, which is multiple choice, where you have a blank, it's either increased, decreased, remains the same or indeterminate And as a real fill-in-the-blank, you put your own word in, however, don't worry about the grammar, the key thing is to forget about the grammar Don't worry about the sentence structure and whether plural or singular or anything like that, just put in what you think is right

1:00:36and this is not an English course, you don't have to worry about that and of course, I should mention that the union stuff will be covered as far as the impact of unions on the wage rate, craft union versus industrial union, the Wagner Act is changing the whole labor market structure Well, the Wagner Act was 1935, you know that, that's about it The Wagner Act came in 1935. That's the only date you have to know. 1935 was the Wagner Act.

1:01:22Once again, there'll be nothing. You should read the chapters that are indicated in the outline, but there won't be anything on exam that I haven't talked about in class. and a lot of stuff, which of course the book has that I don't talk about and that's not being included. That's it? Anything else? Okay, God bless you, good luck.