Capital Based Macroeconomics
Posted at 7 October 2007 21:28
The inter temporal structure of capital
Economy’s production as a sequence of inputs and a pint of output.
Width: increments of production time
Length: value of consumable output.
Hayekian Triangle
Ten stages of production:
The output of one stage is used as an input to subsequent stage.
Saving and Economic Growth
A possible temporal pattern of consumable output
Consumable output grows, declines and stay constant depends on the relationship between savings and capital depreciation.
If savings is in excess of capital depreciation, the economy grows.
Assumption: no change in technology and availability of resource
People’s inter temporal preferences change which favour of future consumption
People willing to forgo current and near-by consumption to enjoy increasing future consumption
Inter temporal capital restructuring
If people’s inter temporal preferences changed at the second stage, the output of consumption goods during near by stages will be reduced. The freed-up resources can be allocated in the early production stages, enhance the ability of economy to produce consumable output in the future.
The altered capital structure will yield consumables at an increased rate by matching the initial output level and exceed it.
Derived demand and time discount
An increase in savings sends tow market signals:
changes in output prices and
changes in interest rate.
The interplay of derived demand and time discount accounts for the change in the allocation of resources brought by an increase in saving.
Increased savings means reduced current demand for consumer goods.
Menger’s Law: Derived demand
The decreased demand for goods of the first order has straightforward implications for the demand for goods of the second order. The demand of goods of second order is derived demand.
More favourable credit condition brought by the increase in saving. Time discount effect reduces the cost of carrying inventories.
Time discount effect draws resources into early stages of production.
Quantity theory of money:
MV = P (Qc + Q2 + Q3 + Q4 + Q5 + Q6 + Q7 + Q8 + Q9 +Q10)
Derived-demand effect Time-discount effect
dominates in the late stages dominates in the early stages
The reduction in the output of first order goods (Qc) is echoed with the second order goods (Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10) the magnitude of the reduction reduced by the time discount effect for the higher orders of goods.
There are increased in output levels of second order goods (Q6 Q7 Q8 Q9 Q10), time discount effect becomes more dominant with increasingly high order goods.
The freed up resources which are allocated to different stages of production are in a pattern of favourable credit. The investment rises as the current demand falls.
The Market for Loanable Funds
The supply of funds is saving out of current income. Current output not consumed.
The demand of funds is the eagerness of the business to use saving or unconsumed resources.
Loanable funds theory shows how much resource available for investment.
Interest rate governs the investable resources and allocation of resources.
A decreased interest rate by an increased interest rate reflects the increased availability of invested resources. The reduced interest rate will stimulate early stage investment activities. Resources for expansion of long term projects come from unconsumed resources.
Sustainable Economic Growth
When people change inter temporal preference in favour of future consumption by trade-off current and nearby consumption. They start to save. The increased savings reflect in the loanable funds theory which shifts the supply curve of loanable funds right with downward pressure on the interest rate. The loanable funds market is brought back in to equilibrium. The natural interest rate is falling from ieq to ieq. The reduced cost of borrowing motivates business to expand investment activities. The increased saving reduces current and nearby consumption. But the reduced consumption is offset by the increased investment allowing the economy stay on the production possibility frontier.
The clockwise movement along the PPF with increased investment and reduced consumption.
The changes on the Heyekian triangle followed the reduced consumable output and altered capital structure.
The derived demand effect: the decreased demand of consumable output at the first order, and the increased demand of consumable goods at the second order. The time discount effect is the reduced cost of carrying inventories.
The derived demand effect dominates on the late stage of production; the time discount effect dominates on early stage of production.
Input prices are bid down on the late stage of production and bid up on the early stage of production.
Quantity theory of money:
MV = P (Qc + Q2 + Q3 + Q4 + Q5 + Q6 + Q7 + Q8 + Q9 +Q10)
Derived-demand effect Time-discount effect
dominates in the late stages dominates in the early stages
The reduction in the output of first order goods (Qc) is echoed with the second order goods (Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10) the magnitude of the reduction reduced by the time discount effect for the higher orders of goods.
There are increased in output levels of second order goods (Q6 Q7 Q8 Q9 Q10), time discount effect becomes more dominant with increasingly high order goods.
The freed up resources which are allocated to different stages of production are in a pattern of favourable credit.
The altered capital structure will yield consumables at an increased rate by matching the initial output level and exceed it.
Typically, capital depreciation will be less than gross investment, and the economy will enjoy a positive growth rate, the PPF expand period from period.
Unsustainable Economic Growth----- Boom and bust
The initial rate of interest qualifies as the natural rate of interest. An artificial boom is initiated by the injection of new money through credit markets.
Credit expansion creates double disequilibrium at a sub-natural interest rate.
Savers save less while borrowers borrow more. The horizontal distance between the supply and demand represents a frustrated demand of credit which is filled with central bank’s injection of new credit but not genuine savings.
The double disequilibrium has counterpart on the PPF. Saving less means consumption more, so it moves counterclockwise on PPF. Favorable credit conditions suggest a clockwise movement along the PPF. Investment and consumption is tug of war between the consumers and investors. Credit expansion pushes the economy toward a point that lies beyond the PPF.
The Hayekian triangle is being pulled at both sides against the middle.
The production activities are divided into three categories:
Current production of consumables (late stage)
Capital maintenance (early stage)
New ventures (early stage)
The unemployment rate can fall below full employment. Equipment can be kept in usage by delaying normal maintenance. The under maintenance of existing capital impinge negatively on consumable output. The reduction of consumable outputs is dubbed “forced saving.” The push beyond PPF towards the virtual disequilibrium point is cut short by the lack of genuine saving.
The labors are laid off and early economic activities are now unprofitable. As boom turns to bust, unemployment associated with liquidations.
The temporally structure of production eventually turns boom into bust, and the economy goes into recession—and possibly into deep depression.
The low interest rate, consistent with a future orientation, stimulates investment activities in the early stages. But without sufficient resources being freed up elsewhere, many of these investment projects will never be completed.
Increased consumer demand draws some resources toward the late stages, further reducing the prospects for completing a new capital structure.
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