In Chapter 11 of Foundations of Economics, Shawn Ritenour makes the transition from what is often called “microeconomics” to what is often called “macroeconomics,” where the discussion centers on “big stuff” like business cycles, inflation, and unemployment. He disapproves of this terminology: “At most any division between microeconomics and macroeconomics is topical. The same principles of human action to develop principles of exchange and price determination are the same we use to examine the determination of the purchasing power of money and cause of recession.”
After a review of some key characteristics of the market economy, Ritenour moves into the chapter’s main topic: the production structure. Whereas production effort runs down the structure of production–higher-order goods must be produced before they can be used in lower-order processes–income runs up the structure of production, beginning with the consumers who demand the end product and moving from lower-order producers to higher-order producers.
Monetary income in production is allocated to owners of land, labor, and capital. With the first two groups, what you see is what you get; their gross and net incomes are identical. But the owners of capital goods had to expend money to produce them, so their net income differs from their gross income. The net income of the owner of a capital good is interest, reflecting the social time preference.
The key to the structure of production is saving, which must take place continuously to create the capital goods used in the higher orders of production. Contra those who claim that consumer spending drives the economy, Ritenour states the following:
All of the exchanging of present money for future money that takes place at every stage of production in the entire economy points to one inescapable fact: the amount of money spent at any time on capital goods is much larger than the amount spent during the same period on consumer goods. The production of consumer goods is an must be supported by a vast, complex capital structure. The entire structure of production is supported by saving and investment.
Rates of interest at each stage of the structure of production tend to even out over time, just as the rates of interest in different industries tends to do. The income an owner of capital receives tends to equal DMRP (see the post on Ch. 9) of the capital good, and this form of income is usually called “rent.” The overall value of a capital good (or “capital value”) is based on the discounted amount of all future rent payments the capitalist expects to receive.
Entrepreneurs can acquire capital for their ventures from their own savings, by borrowing from other savers, or by pooling their savings with other investors and sharing ownership in the venture. The shares of ownership under the latter arrangement are called “stock,” and it’s these shares of ownership in businesses that are traded daily in the stock market. Owners of stock hope to receive not only interest but also entrepreneurial profits (many of them, of course end up receiving entrepreneurial losses). Savers who lend to a business by buying a bond, by contrast, expect to receive only interest, not profit.
Capital values change along with changes in the social time preference. If the latter rises, capital values will decline because a more interest is demanded by savers, leading to a fall in the DMRP of capital goods. On the other hand, if social time preference falls, capital values will rise to reflect the higher DMRP of capital goods. Ritenour argues that the lowering of the social time preference leads to economic progress as more savings increase the capital stock, thus lengthening the structure of production. When the social time preference rises, the opposite occurs, and the economy regresses.
The chapter’s final section discusses the Gross Domestic Product (GDP) a statistic that attempts to measure the overall size (and presumably health) of the economy. Ritenour points out many problems involved with trying to calculate GDP; in fact, some eminent economists have argued that the margin of error in the number is so wide that it can often indicate a growing economy when the economy is actually shrinking and vice versa. That policymakers normally invoke this number as a primary piece of evidence when arguing for or against a particular agenda is evidence of a broken system (my view, not Ritenour’s, although he might agree with me).
Ritenour concludes the chapter by arguing that it’s essential for the different stages of the production structure to be coordinated in a peaceful and productive way to avoid surpluses and shortages. Interest rates make this intertemporal coordination possible. (I smell a critique of the Federal Reserve coming soon.)