WorldSys: Austrian Home Study Course, Week 8

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

READINGS: Chapter 8 of Gene Callahan’s Economics for Real People

1 What is capital?

Capital has had many definitions throughout the history of economics, but I like Israel Kirzner’s view of capital as being like a way station on the path to producing a consumer good. Capital is any higher-order good, like a robotic assembly line or a harvester, which allows for the production of a consumer good.

2 In what sense is the classification of capital goods a subjective enterprise?

It is subjective in the same way that classification of all goods is subjective: a given capital good matters only insofar as it can be used to produce a good that is ranked in someone’s ordinal scale of values. This kind of ranking percolates upward through the structure of production and gives a capital good its value.

3 Why did [economist Gene] Callahan [from whose book “Economics for Real People this week’s reading was taken] choose the title, “Make a New Plan, Stan”?

Much of the chapter is about the relationship between capital goods and planning. Specifically, whether or not a given item even counts as a capital good hinges on the role it plays in someone’s plan.

4 Give an example of a first-order good and a corresponding higher-order good.

Beets are a first-order good meant to be consumed directly. Everything in the production process upstream of beets — whatever machinery is used to till the soil, plant beet seed, fertilize and water the beets, harvest them, process them, package them, transport them, would be higher-order goods.

5 Why are market prices necessary to compute a firm’s total capital?

Market prices are required to estimate the value of the capital goods on hand. Whatever another farm would pay for your beet-harvesting equipment is its approximate value. It is worth pointing out, however, that this is not always a clear indication of value; if the world of beet farming is undergoing a quiet revolution that is soon to make all of your current capital stock obsolete, then merely adding up that capital’s current selling price on the market is not going to tell you what it’s truly worth.

6 Is there a such thing as “social capital”?

The textbook author says no, but he’s using the term to mean “the physical capital of society as a whole”. The only way in which I personally have heard the phrase “social capital” used is in referencing the social assets of a firm. Clearly the analogy between social and physical capital isn’t perfect, but I don’t think conceptualizing things like brand recognition and product popularity as a kind of capital is nonsensical or foolish. As long as one doesn’t take one’s own analogy too literally it can function as a useful shorthand in conversations and thinking.

7 What is meant by the term, “structure of production”?

The structure of production is the sum total of all the interlocking plans to create goods, together with the capital required to see these plans through.

8 How do Austrians differ from mainstream economists in their views on capital?

The neoclassical and Keynesian economists tend to view capital as a big, undifferentiated lump which can be summed up in a few numbers that are then plowed into mathematical equations. One of the key differences between the Austrian school and competing outlooks is that the former recognize the profound heterogeneity of the capital structure. Indeed, this insight is one of the pillars of the Austrian critique of the interventionist remedies proposed by Keynesians.

9 How do people benefit from the capital structure?

The capital structure is part of what makes dollars go so far. Capital goods make labor more productive, make resources cheaper, make distribution easier, etc. This savings is passed on to individuals who are able to get everything from toothpaste to transmission fluid much more cheaply than they could if they were making it themselves.

10 What is consumer sovereignty?

Consumer sovereignty refers to the fact that the ultimate configuration of capital is driven by consumer demand. When people began to demand cars over horses, truly titanic reconfigurations of the capital structure took place as hay production decreased in favor of oil refining, blacksmiths lost work and assembly line personnel gained it, and money accrued to those who had correctly predicted the future.

11 What was Alfred Marshall’s objection to Menger’s order of production?

Marshall asserted that Menger’s conception of goods as belonging to various ‘orders’ in a hierarchy was unhelpful because any good could belong to several different orders simultaneously, depending upon who’s vantage point was taken.

A car can be a consumer good to me, a second-order good to a traveling salesman, and a much higher-order good if used to drive to meetings at which the construction of a new beet processing plant is discussed.

12 How does Callahan answer this objection?

By asking: who gives a damn? The position of a good in the structure of production depends upon the plan of the person utilizing it. So yes, a good can be a first-, second-, third-, on n-ordered good, depending upon the use to which it is being put. This isn’t an issue, it’s a straightforward consequence of founding our economic analysis on subjective valuations.

13 Why did Böhm-Bawerk claim that “roundabout” processes were more productive?

The most straightforward way of planting beet seed is to walk out the front door and plant them in the ground by hand. A more roundabout way is to first spend three days building a tool to till the soil, then another two days building a little machine that plants and buries the seeds all at once.

This circuitous method is slower at first but will increase productivity in the long run by saving you a good deal of manual labor.

Most of the modern economy works in this way. Instead of machining a car’s parts at one location a good deal of the work is outsourced, sometimes to a firm all the way across the world.

Complex supply lines, specialized production processes, and intricate structures of capital goods all contribute greatly to an increased standard of living despite being less direct than they otherwise could be.

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