Friday, October 29, 2010

Keynes - The General Theory - Chapter VI

In Chapter VI Keynes attempts to define income, saving and investment in order to further develop his general theory. Keynes' discussion of income involves the different costs which affect income, so I will break up my analysis of his writings according to each different cost.

User cost: Keynes defines user cost as the "sacrifice of value involved in the production of A" (finished output sold to consumers). This cost is made up of the value foregone by choosing to produce and sell A, as well as any output purchased from other entrepreneurs. He does not specify whether this "finished output" is higher order goods which the entrepreneur will use to produce lower order goods, or if these are consumption purchases by the entrepreneur. I do not see why Keynes includes a discussion of user cost, for it has little use to economic analysis. Whatever higher order goods an entrepreneur purchases he will combine with his labor and capital to create a lower order good. Also, the value forgone when producing output only matters to each individual entrepreneur when making a decision on what and how much to produce. Economists can say little if anything more on the matter.

Factor cost: Keynes defines the factor cost of A as "the amount paid out by the entrepreneur to the other factors of production in return for their services." These other factors of service not being specified, but assumed to be the owners of land and labor. Keynes goes on to say the difference between output and factor costs is equal to aggregate income. Keynes calls this difference the entrepreneur's profit, but he neglects to adjust for interest and the entrepreneur's own wage. Profits and losses are the markets way of informing people which businesses are best satisfying consumer desires, but only if profits are properly define. Keynes prefers to equate profit to income, when profits are really an excess over what the entrepreneur makes due to a wage and interest. Only under this Austrian definition of profits can they be useful in guiding firms to swiftly satisfy consumer desires.

Supplementary cost: Keynes writes that a change in market values, wastage due to time, or destruction due to a catastrophe are supplementary costs. I do not see the significance of these costs, changes in market values and wastage due to time should be anticipated by entrepreneurs, that is part of what makes them entrepreneurs. Catastrophes are insurable risks, and as such should not affect output - and employment because that is Keynes' focus - because the cost is covered by insurance.

Windfall loss: Keynes defines windfall loss as supplementary costs which are unforeseen. For example, a particularly exceptional catastrophe would be considered a windfall loss. The main point Keynes makes is that "although the windfall loss (or gain) enters into his decisions, it does enter into them on the same scale - a given windfall loss does not have the same effect as an equal supplementary cost." I found myself wondering why Keynes believed these similar costs affected someone differently, but he never explained it further. I do not think that this fact could be empirically or theoretically proven, but I may be wrong.

Keynes ends his discussion on income by stating this definition of income is different that his definition in his Treatise on Money. He then goes on to take a quick look at saving and investment, concluding that saving is equal to investment. From that he makes the argument that the propensity to consume is essentially the inverse of the propensity to save, and he will use the former in all further discussions. Since we already discussed propensity to consume, and its inherent flaws, I will end the discussion here.

This chapter was by far the most confusing yet, and it appears he is simply defining income, saving and investment in a manner that best fits his general theory. As opposed to Rothbard's Man, Economy, and State which starts from a simple axiom and proceeds to develop theory from there, it almost seems as if Keynes has his theory already in mind and uses these chapters to make it viable.

2 comments:

A Wiser Man Than I said...

Also, the value forgone when producing output only matters to each individual entrepreneur when making a decision on what and how much to produce.

There's also the fact that at least one component of this "user cost" is highly speculative. I suppose the entrepreneur could have made widgets instead of gadgets, but it's unclear how that helps us as economists.

Only under this Austrian definition of profits can they be useful in guiding firms to swiftly satisfy consumer desires.

It's not as if the entrepreneur would count it all profit, anyway. He might take home 10K in "profit", but if it's accounted in the manner Keynes supposes, he may not feel his venture is very profitable.

I do not see the significance of these costs, changes in market values and wastage due to time should be anticipated by entrepreneurs, that is part of what makes them entrepreneurs.

In addition to the problem that the reader encounters because Keynes chooses to deal with seemingly arbitrary terms, there is also the ambiguity of what he is proposing to track. An entrepreneur may wish to keep track of something, but if there is no way for him to calculate it, he will simply have to act without this information.

All these terms are supposed to add up to something, eventually; but it tallies to little more than that the entrepreneur acts with a good deal of uncertainty.

He then goes on to take a quick look at saving and investment, concluding that saving is equal to investment.

Keep an eye on this. I have a feeling he's going to postulate something later which may contradict this statement.

This chapter was by far the most confusing yet...

It certainly was. The bar has now been set.

Sergio Ferri said...

Windfall loss: "...it does NOT enter into them on the same scale"