I just finished the lecture course by Peter Klein and Joe Salerno, the Causal-Realist Approach to Economics, and the last lecture on banking and the business cycle was very fascinating. However, I was confused when Mr. Salerno said that the costs go up in the capital goods industry. Firstly, bank reserves go up, interest rates go down, investments increase in the capital goods industry, prices and therefore profits go up, the industry expands, demand for labor goes up, wages go up, capital goods increase and then costs start going up, profits are lost, etc…and I was wondering why the costs start going up. After the wages are increased, workers leave the consumer good industry, but they spend their wages in the consumer good industry still. The only thing I could figure was that costs (not prices) rise in the capital goods industry because of the higher wages. Is that correct?
And also, in the consumer good industry, as workers leave leave and join the capital goods industry, prices go up and profits fall in the consumer good industry…can you perhaps elaborate on the connection between the labor falling, prices rising, and profits decreasing?
Higher time preference which means that consumers are consuming now rather then later and since there is a finite supply of resources, costs go up as a sign of weaning resources.
But the consumer goods are coming from capital goods, right? That’s another thing that I am confused about, maybe I don’t understand the relationship between capital goods and consumer goods, but if there’s a demand for consumer goods, doesn’t that affect the capital goods industry as well because you need capital goods to produce consumer goods? And what defines a capital good and consumer good?
Costs don’t go up in the capital goods industry because of the higher wages paid?
You’re entirely correct. In the long run a shift in time preference towards the future will mean that more consumer goods are produced due to the greater productivity of capital goods. But, in the short run, when the shift in preferences occurs there will be a temporary reduction in the flow of consumer goods. Now, this is fully justified due to the lower time preference.
Depends, there is high order capital which takes time to empower.
A capital good is something that produces consumer goods or is apart of consumer goods production. Think of it like a donut machine. That is what a capital good is, while a donut itself is a consumer good.
If time preference goes up and all things being equal, costs and prices go up.
Profits don’t decrease in the consumers goods industry, in fact, rising profits in the consumer goods industry is what can cause the boom to end.
Essentially what’s happening is that the lower interest rates and excess credit are going to the capital goods industries. They’re going to use this money to bid for the factors of production, in particular labour. What’s important to keep in mind is that the workers haven’t changed their discount rate (if they had changed in corresponding to the increase in credit, the business cycle wouldn’t happen). Now, with the lower interest rates and money they’re receiving, they’re going to be buying more consumer goods.
So what’s happening is that the lower interest rates and excess credit is telling entrepreneurs to spend money investing in capital goods, at the same time, the increased spending on consumers goods is telling other entrepreneurs to spend their money producing consumer goods. Of course, this means that both sets of entrepeneurs are going to bidding for labour, causing the prices to increase. In the long run, only the producers of consumer goods will be warranted in expanding production and these people will make profits. As profits are made in these sectors, the producers of capital goods will shift towards the production of consumer goods and the bust will occur.
“In the long run a shift in time preference towards the future will mean that more consumer goods are produced due to the greater productivity of capital goods. But, in the short run, when the shift in preferences occurs there will be a temporary reduction in the flow of consumer goods. Now, this is fully justified due to the lower time preference.”
So if people demand consumer goods, don’t capital goods have to be produced in order to create consumer goods? Don’t consumer goods come from capital goods?
If consumer goods come from capital goods like donuts come from donut machines, then why wouldn’t the capital goods industry increase and make money as the consumer industry makes money from the higher wages being spent by the workers in the capital goods industry.
And are we assuming that the workers will spend their higher wages in the consumer good industry, and not reinvest it into the capital goods industry?
I feel like I need to know this subject inside out, and answer all objections for myself because this is an issue I am constantly having to debate with friends, and I don’t think I understand this entirely yet.
“In the long run, only the producers of consumer goods will be warranted in expanding production and these people will make profits. As profits are made in these sectors, the producers of capital goods will shift towards the production of consumer goods and the bust will occur.”
Why will only the consumer goods industry be warranted in expanding production?
And why will the capital goods industry not make profits over the long run?
While time preference is high, so is the cost of borrowing; capital purchases are delayed and made with larger down payments.
maybe take a time out and read this:-
But the Fed has increased the money supply and made it cheaper to borrow money…is that what you’re talking about?
I still don’t see how that answers my questions.
And to clarify, I totally agree with the Austrian theory of economics, I just need to know the in’s and out’s of it, so to speak, because I know people are going to ask me these questions, and I need to have the answers, or they’ll never respect my opinion, much less be persuaded by it.
Thanks, I’ll take a look at it. I started Human Action, I don’t think I got that far though.
Its the relevant chapter for you 