Not sure if this belongs here, as the Pure Theory of Capital is definately not for a beginner, but in the economics questions section there seem to be few questions regarding works. So given the foregoing I thought I’d err on the side of caution and post here.
I’m working on the introductory section of this book and Hayek’s description in the first chapter of the 2 magnitudes which make up the supply of capital has me puzzled. Any help would be appreciated.
Hayek says:
“..[T]here are at least two kinds of relevant magnitudes or rather proportions which must be taken into account if we want to understand the working of the price mechanism in this field; neither of them is a simple “quantity”, and neither of them stands in a unique relationship to the rate of interest except through its relation to the other. The first is the dimensions of the real structure of productive equipment, describing how it is organized for, or capable of, yielding various quantities of final output at different dates.”
Further down the page Hayek describes this first magnitude/ratio as describing “the proportions between the existing quantities of concrete resources in terms of their relative costs.”
So, these ‘dimensions of the real structure’ of equipment simply sounds like the existing placement of producer’s goods in the economy. However, his further description adds in their relative costs. Thus, it seems as though he has in mind not only the placement of producer’s goods A, B and C, but also their costs relative to each other. In other words, he has in mind a definite ordering of goods A, B and C in the economy, and at the same time a ratio of their costs: C(A) : C(B) and C(B) : C(C) and C(A) : C(C).
Regarding the second relevant proportion:
“The second is the proportional demands, or the relative prices, which are expected to rule for these different quantities of output at different dates.”
He goes on to say that this relationship “…describes the relative demand for the two kinds of resources.”
These ‘relative prices’ sound similar to the standard step-wise graph depicted in the production chapters of MES, showing the prices of output at different steps along the structure of production. The relative prices are the ratios of prices between each step, which in the ERE corresponds to the true rate of interest. So what of the first relationship that Hayek talks about?
“But only together do these two sets of quantitative relationships or proportions determine what is usually regarded as the supply of capital in value terms.
The treatment of the capital problem in terms of the demand for and supply of one single magnitude is only possible on the assumption that the proportions just described stand in a certain equilibrium relationship to one another.”
Ok, I understand that marginal costs determine supply. But now I think that my understanding of his first quantitative relationship is a bit off. Now I think that he is saying that producer’s goods A,B and C are ordered definitely according to their marginal costs. I.e., the reason that producer’s good A is used in step 1 and not 3 is because the marginal cost of using it in 3 is greater than 1. In other words the relative marginal costs of producer’s goods not only determine how much of the goods themselves are produced but also, and perhaps more importantly to Hayek’s point, their placement in the structure of production. Still not sure if I have it right. And how does this problem go away in equilibrium as Hayek asserts? How do these 2 magnitudes become 1 in equilibrium?