Production, Capital, and Income Maximization

foundationsofeconomicsIn Chapter 7 of Foundations of Economics, Shawn Ritenour gets into capital theory and explains how entrepreneurs try to maximize their income once they have forecast demand for their products.

One of the questions I had before reading this book was whether Ritenour would use the Christian perspective simply as “bookends” to his treatment of economic concepts or whether it would reappear throughout the book. At the beginning of this chapter he “touches base” with the doctrine of the cultural mandate, noting that it necessitates economic production to fulfill. An understanding of production is thus very useful to any Christian interested in living out this doctrine.

Capital goods increase efficiency of production, but in order to reap those fruits in the form of more produced goods or more leisure time, the structure of production must be “lengthened” to account for the time it takes to produce the capital goods themselves. To illustrate the process of capital formation, Ritenour uses an example very similar to one that I’ve employed in classes to explain capitalism to undergraduate students: Groucho is on a desert island and “saves” by using some of his time to fashion a stick that will help him gather food. No immediate benefit accrues to him during the period in which he fashions the stick, but once it’s completed, his food gathering proceeds in a much more efficient manner.

Ritenour takes this opportunity to explain the cost of maintaining capital as well; if Groucho doesn’t spend some time keeping his stick in good repair, eventually it will break, and he’ll be back where he started. Groucho’s time preference at any given point will determine how much current consumption (in food or leisure) he’s willing to forego in order to accumulate and maintain his capital. If his time preference is relatively low, he’ll sacrifice fewer goods in the present for more goods in the future. We’re also reminded at this point that capital accumulation, like all action, is entrepreneurial and involves uncertainty.

At this point in the chapter, Ritenour transitions into a discussion of income allocation. When people receive income, they have three choices about what to do with it: spend it on consumption, save it to spend on investment, or add it to their cash balances (allowing them to cope with uncertainty better). Using the example of a student trying to work his way through college, Ritenour shows how someone might do all three things with a given sum.

Other things being equal, every individual wishes to maximize his income. Is this simply a manifestation of greed and something Christians should condemn? Not at all, says Ritenour: “Increasing their monetary income simply enables people to increase their ability to achieve their ends.” The hypothetical college student mentioned above seeks to increase his income by starting a business selling hot dogs. We see how an entrepreneur (if he acts rationally) will charge a price for his goods that will maximize his income taking into account both fixed and unit costs of production.

Ritenour points out the many difficulties involved in entrepreneurial activity and notes that entrepreneurs ought to be accorded some respect for taking risks that in the aggregate benefit everyone in the economy. Next stop: profit and interest!

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About Dr. J

I am Professor of Humanities at Faulkner University, where I chair the Department of Humanities and direct online M.A. and Ph.D. programs based on the Great Books of Western Civilization. I am also Associate Editor of the Journal of Faith and the Academy and a member of the faculty at Liberty Classroom.
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