Lesson 3 of 8
More now against more later
The trade-off drawn once. An economy on its frontier can only get more later by taking less now, and the whole disagreement is about what happens off it.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- With resources fully employed, more consumption goods this period means fewer resources going into things that mature later, and the reverse.
- The trade-off is the reason the theory starts from full employment rather than from idle capacity, which is a deliberate and contested choice.
- Off the frontier, with resources idle, the trade-off weakens, and that is where this tradition and the demand-side account of the cycle disagree most sharply.
Everything in the previous two lessons assumed the resources were already doing something. That assumption is doing more work than it looks, and it is worth stating on its own.
Three positions on the same resources
On the frontier
- Consumption-heavy: 80 to consumption, 20 to the earlier stages.
- Investment-heavy: 60 to consumption, 40 to the earlier stages.
- Both use all 100 of available labour and land.
- Moving between them requires somebody to give something up.
Off the frontier
- 60 to consumption, 20 to the earlier stages, 20 idle.
- More of both is available without anyone giving anything up.
- The trade-off this course is built on is slack here.
- Explaining how an economy got here is the task, not assuming it.
The first two are choices. The third is a different problem.
Why the theory starts at full employment
Hayek states the methodological choice in the first pages of his second lecture, and it is one of the sharpest things in the book. He rejects explaining a rise in output by saying more idle factors were brought into use, on the ground that this is no explanation at all: the existence of idle resources is itself the fact that needs explaining.
He therefore insists on starting from a situation general economic theory already accounts for, which is one in which all available resources are employed, and treats unused resources as the thing to be explained rather than the premise.
That is why the whole apparatus is a trade-off. If resources are committed, committing them differently has a cost.
What the trade-off is between
Not between goods and money, and not between spending and saving as such. Between the flow of consumable output now and the flow available later.
A period spent building a machine is a period in which the labour that built it made nothing anyone can eat. The machine is worth having if what it eventually produces is worth more than what was given up while it was being built, which is the arithmetic of the whole tradition in one sentence.
Where the disagreement lives
Take the third column of the figure. If an economy has idle labour and idle plant, then more consumption and more investment are both available without a trade-off, and the cost of getting them is not a real cost.
That possibility is the centre of the demand-side account of the cycle, and it is why Keynes and Hayek talked past each other for a decade. It is taken up properly in the last course of this track, where the rival accounts are set beside each other.
The honest statement here: this tradition has an answer, which is that idle resources are themselves a consequence of an earlier mismatch, and that answer is a claim rather than a demonstration.
What to carry into the next lesson
That a change in the split is a real change, not an accounting one. When the next lesson shows the structure lengthening, the resources that go into the new stages came from somewhere, and the frontier is the reminder of that.
Check yourself
Why does Hayek refuse to start from idle resources?
- Because idle resources do not exist
- Because their existence is the thing that needs explaining, so assuming it explains nothing
- Because they cannot be measured
Show the answer
Answer: B.
He argues in lecture II that theory must start where general economic theory stops, at a state with no unused resources, and treat unemployment as the main object of the explanation.What is the trade-off actually between?
- Money saved and money spent
- Consumable output now and the flow of output available later
- Wages and profits
Show the answer
Answer: B.
A period spent building capacity is a period whose labour produced nothing consumable, and the machine is worth it only if what it later yields exceeds what was given up.Where is the disagreement with the demand-side account sharpest?
- On whether interest exists
- On what happens off the frontier, where more of both is available and the trade-off is slack
- On the definition of a consumer good
Show the answer
Answer: B.
This tradition holds that idle resources follow from an earlier mismatch. That is a claim rather than a demonstration, and the rival accounts course takes it up.Sources
- Hayek, Prices and Production, first published 1931, second revised edition 1935, lecture II, sections 2 to 4, for the rejection of an explanation that starts from unused resources, the insistence on beginning from a state of full employment, and the statement that the existence of unused resources is itself a main object of the explanation.
- Garrison, Time and Money: The Macroeconomics of Capital Structure, 2001, chapter 1, for the production possibilities frontier as one of the diagrams of the capital-based framework alongside the triangle, the loanable funds market and markets for labour.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- All the numbers here are invented round figures chosen to show a split. They are not measurements, and no economy is described.
- The claim that idle resources are themselves a consequence of an earlier mismatch is the tradition's position, not a settled result. The demand-side account holds the opposite and is given its own hearing in the course on the Great Depression.