Question for economists

[Nesh]

there is this question messing with my head recently I ve made lots of thoughts about it and I ve came up with many conclusiosn. The problem is although it seems logical whenever I talk about it with my proffessors I get mixed answers and they usually deny it and tell me its wrong.

Each of them deny it for different reasons but I dont quite get it. I still see a hole. Perhaps I am wrong perhaps they dont quite get my point because they have formed already an impression of how economy works that isnt letting for a different approach that could be right, or perhaps I am not good at explaining what's bothering me.

Today I was even being told by a proffesor of mine that I am using Marxist theory when I didnt base it at all on it.

Now for the basic question from which it all begun.

We know that every product developed for consummption includes in its price the cost of labor and the cost of capital. With other words Labor wages and Capital revenues or profit.

The total value of total product equals the marginal product of Labor and marginal product of Capital.

TP=w*L+ r*K

Important notes and assumptions:
1)With capital I dont mean human capital.
2)In labor I include the wages of highly paid participants like the owner of the firm.
3)To make things simpler lets assume that we live in a society where we have only one firm that produces for example one product like cheese in which only and all of its residents work there


Now if the total product in the market whether it is a service or a good includes in its market price both the value of productivity of labor and capital then the question is how are all goods and services (in this case all the cheese) going to be bought, to pay back fully both capital and labor when the only consumer of cheese are the residents of that country?

The firm in other words produced a bigger value of total cheese but less can be bought to pay back fully capital and labor.
Now whats wrong here?

Today the proffesor told me that the capital also consumes cheese. When I asked how he told me about rents. I didnt get the connection. How does capital consumes through rent?

If capital is being rent from the firm then the firm must have enough returns from sales to pay back the renter. If the firm rents capital to someone else, then that someone else must have the income to pay both for cheese and the rent.

 

[Frank]

You have one basic assumption wrong (for the most part): the price of (mass-produced) goods is not decided by the associated costs. The price is based on what the market will pay. And if those costs are too high, that simply means it isn't produced at that location. When the costs are low, you make a lot of profit.

 

[MfA]

Now if the total product in the market whether it is a service or a good includes in its market price both the value of productivity of labor and capital then the question is how are all goods and services (in this case all the cheese) going to be bought, to pay back fully both capital and labor when the only consumer of cheese are the residents of that country?

The capital is also supplied by residents, since they spend their money on cheese (there is nothing else to buy) we have a nice zero sum game.

 

[MfA]

Now if the total product in the market whether it is a service or a good includes in its market price both the value of productivity of labor and capital then the question is how are all goods and services (in this case all the cheese) going to be bought, to pay back fully both capital and labor when the only consumer of cheese are the residents of that country?

The capital is also supplied by residents, since they spend their dividends on cheese (there is nothing else to buy) we have a nice zero sum game.

Money doesn't get lost at any point in your example, it just gets pumped around.

 

[Nesh]

You have one basic assumption wrong (for the most part): the price of (mass-produced) goods is not decided by the associated costs. The price is based on what the market will pay. And if those costs are too high, that simply means it isn't produced at that location. When the costs are low, you make a lot of profit.

hehe yours is yet another different approach on whats wrong with my thought. But there is no correlation between any of the answers I got.

You mean that TP=w*L+ r*K is wrong? Because thats the equation that he has shown me to discuss on and thats the same I was going to show him.

This is the value of total productivity in the market I assume when market price represents total cost=zero profits.

Your example confuses me even more if we put profit in there for the following reason.

Lest say the previous assumptions remain with a few differences and the market in that society seems willing to pay $2000 because thats how much they were willing to pay last time with zero profits

So lets say that company decides to sell at $2000 again.

Even if we assume that capital as well as other resources used, also consume cheese and they produce a product that costs $1500 to make due to a better planned productivity chain that lowers costs, this total cost which represents the payment of all resources together is lower than $2000.

Only $1500 can be spent for cheese since thats the payment the resources got. Which means $500 are missing from that economy to be spent. They will consume cheese worth $1500 because thats all they can buy and a volume of cheese vlaued at $500 will be left on the shelves. Which is still zero profits but with some extra cheese thrown in the trash.
Who's going to buy the remaining cheese?

For these to get sold someone else or more must also be in the picture that own $500. But how? If some own $500 that means there is another firm (perhaps making chocolates) that payied them. But if they spend all that $500 on cheese, who's gonna buy the chocolate?
Unless that $500 appear out of nowhere



Ouch my head.

 

[Frank]

I think I understand the basic misconceptions.

Fist, the formule and examples given are meant to explain basic, economical principles. What would happen in a closed society when you only have a single product. And in that case, you are right.

But, in reality, economics isn't anything like that. It's a global thing nowadays, for starters. And there are very many different products and other things that "consume" money. And even things that create potential money. (Non zero-sum.)

The main thing is competition. If you take that into account at all times, you're most likely to get to the best answer.

For bread and other daily basics, that competition is smaller than with the very high volume consumer products. But even there, you have to see if you can produce a product that costs less to make than what you can afford to ask for it.

With bread again, you might want to advertise with slogans like "home baked", "speciality", "known source", etc. Which might increase the perceived value of your product. Which is really the most important thing.


Edit: another extremely important thing is your location. "Location! Location! Location!". Make it easy and convenient for people to buy your stuff.

 

[Blitzkrieg]

That $500 you have left over would be company profits which would be distributed through to the owner(which are also the workers in your firm, since this is a closed simple model, who could then buy more cheese with that added income) and also for reinvestment in replacing and mainting capital for continuous production.
The company could not sell for $2000 if their was not $2000 to buy it. Remember production=expenditure=income.

 

[DudeMiester]

I could see such principals being useful in determining what you should charge for a good, but if the market will not bear that price then you are screwed.

 

[PurplePigeon]

I'm probably not completely understanding the question, but I think others are on the right track when they talk about the system being described as too limited to be realistic.

If we extended the system to include:

a) a central bank which has the ability to create money (as opposed to "value" or "wealth", which is created by your cheese company)

and/or

b) a second manufacturer to faciliate trade

it might be enough. (Sorry, I am improvising off the cuff here and don't have time to think things through completely.)

 

[Nesh]

The capital is also supplied by residents, since they spend their dividends on cheese (there is nothing else to buy) we have a nice zero sum game.

Money doesn't get lost at any point in your example, it just gets pumped around.

Very true. I ve thought about it last night again and I am making a revision of the question.

I think I understand the basic misconceptions.

Fist, the formule and examples given are meant to explain basic, economical principles. What would happen in a closed society when you only have a single product. And in that case, you are right.

But, in reality, economics isn't anything like that. It's a global thing nowadays, for starters. And there are very many different products and other things that "consume" money. And even things that create potential money. (Non zero-sum.)

The main thing is competition. If you take that into account at all times, you're most likely to get to the best answer.

For bread and other daily basics, that competition is smaller than with the very high volume consumer products. But even there, you have to see if you can produce a product that costs less to make than what you can afford to ask for it.

With bread again, you might want to advertise with slogans like "home baked", "speciality", "known source", etc. Which might increase the perceived value of your product. Which is really the most important thing.


Edit: another extremely important thing is your location. "Location! Location! Location!". Make it easy and convenient for people to buy your stuff.

Yes. I was going to evolve my observations later on a global scale and explain why the economy doesnt collapse, because if we take the above example I mention as an absolute reality that what was going to happen.

This question is merely just a starting point on which I will get more in depth.

Despite that I made a revision of the question because my proffesors tend to refer to the total product produced in terms of total cost of production instead of correcting me by telling me "you are actually refering to total market price".

I ll make some adjustments to the "problem" because the misconception is something else.

Competition according to my observation tends to have a certain behaviour we all know about of recycling due to that "problem".

Location wasnt an issue in my question because the assumption was that people could easily and directly buy the product. Despite that the location wasnt going to be out of the picture in my later in-depth development of my thought. I would have used it under a different importance. The ability of firms to move, or allocate labor (Example industrial firms tend to move to third world countries because there are lots of unexploited resources as well as cheap labor).

That $500 you have left over would be company profits which would be distributed through to the owner(which are also the workers in your firm, since this is a closed simple model, who could then buy more cheese with that added income) and also for reinvestment in replacing and mainting capital for continuous production.
The company could not sell for $2000 if their was not $2000 to buy it. Remember production=expenditure=income.

Yeah but you forgot one thing. The chocolate firm just made losses , Ofcourse it doesnt end here. I was going to extend the economy later step by step to explain what happens in the economy and thus doesnt collapse. The problem is my proffesors think I am implying that the economic system is self killing itself thus reject the first step without letting me build the whole picture.

PurplePigeon mentioned the other players that come into the picture to fix the otherwise collapse of the economy and he rightfully did so

I'm probably not completely understanding the question, but I think others are on the right track when they talk about the system being described as too limited to be realistic.

If we extended the system to include:

a) a central bank which has the ability to create money (as opposed to "value" or "wealth", which is created by your cheese company)

and/or

b) a second manufacturer to faciliate trade

it might be enough. (Sorry, I am improvising off the cuff here and don't have time to think things through completely.)

No no you are right.

I ll sum up where I am getting it to.


If we were in a confined economy like my example it would have been like a glass of water with a hole. Slowly leaks water until its empty and nobody can drink it. Economy collapses. That hole exists in our conomy as well.

But our real economy is like a glass of water than can get bigger in size, but at the same the hole can also change sizes under different rates, but nobody has control over that hole.

So what happens all individuals that form our economy struggle to make the glass bigger and pour enough water in it according to how fast the hole grows so it will always remain full(equilibrium) and never get empty (one of the reasons why competition is so fierce).
Some times there is more water being poured than necessary so some is spilled out (economic boom). Some other times the hole grows so fast comparatively to the growth of the glass and the quantity of water that ihe glass gets partially empty until the economy adjusts itself(recession).

That hole is what keeps the economy continuously struggling and growing.

Because of that hole, wealth grows continuously fast and previous products get cheaper and recycled to newer more advanced producs. But we work as many hours (and sometimes more) as we used to work in an economy for example lets say 20 years ago, and we still get the same satisfuction as we used to get back then(example :today I am as excited with my PS2 as much as I was with a Super Nintendo in 1994 ) unless we were in an economy of a third world country thus outside of the global economic system of the developed countries and entered it later.

I kind of summed it up now, BUT I WANT TO STUDY THIS WITH A PROFFESOR IN GREATER DETAIL BECAUSE THEY HAVE THE SOURCES AND THE MATHEMATICAL KNOWLEDGE TO PUT THIS IN A MORE PRACTICAL STUDY!