Chapter 6
INCOME
The income generated by an entrepreneur can be given by A+G-A1 where A is the output for the period and A1 is the purchases for the period. G then is the value of capital equipment and finished stocks at the end of the period. Confusion arises over the value of G as some is derived from equipment held from previous periods. Once this can be deduced a clear definition of income arises.
There are two methods of deriving G, the production method and the consumption method. During the period the value of G is affected by maintenance and improvements carried out by the entrepreneur and by depreciation as a result of producing output.
The production method takes maintenance and improvement (B’) into account, by subtracting it from G, giving maximum net value (G’). Under the production method income is defined as the excess of the value of finished output sold during the period over prime cost. Prime cost is the sum of user cost (U) and factor costs (F). U is the maximum net value minus the excess potential value of equipment over G – A1 of what has been sacrificed to produce A. Factor costs are what the entrepreneurs pays other factors of production for their services.
The consumption method takes into account the involuntary loss (or gain) in the value of his capital equipment. Some of these losses are involuntary but not unexpected and are known as supplementary costs (V). Aggregate net income is then equal to A – U – V. Supplementary costs are those deductions from income which a typical entrepreneur makes before reckoning what he considers to be his income. Supplementary costs are important as they affect everyone’s consumption not just entrepreneurs. Unforeseen changes are known as windfall losses; however these losses have a less fundamental effect and are therefore less significant.
Income can then be defined as the excess value of finished output sold during the period over his prime cost. This definition of income is similar to that of Marshall’s. However, Professor Hayek suggested that it is a mistake to put all the emphasis on net income which only refers to consumption aspects as opposed to income proper which includes production issues.
SAVING AND INVESTMENT
Saving is said to equal excess income over consumption and therefore doubts about the definition of saving must arise from doubts about the meaning of these two terms. Income is already defined. Consumption is simply the value of goods sold to consumers, but who is a consumer? Is there a difference between a consumer-purchaser and an investor-purchaser? We need to draw the line between consumers and entrepreneurs and defining A1 (i.e. what one entrepreneur buys from another) allows us to do this. As consumption is defined as A-A1 and income as A-U, it follows that saving is equal to A1-U and net saving (i.e. net income minus consumption) to A1-U-V.
Investment refers additions to the value of capital equipment resulting from activity during the period i.e. the part of income that hasn’t yet been consumed and therefore equal to what has previously been defined as saving. Net investment is therefore equal to A1-U-V. While saving results from consumer behaviour and investment from entrepreneurial behaviour, both are equal to excess income over consumption and therefore to each other. Equivalence arises from the bilateral character of transactions between producers and consumers i.e. aggregate amount individuals decide to save is equal to aggregate amount individuals invest and occurs because psychological habits allow the market to settle at an equilibrium level where readiness to buy equals readiness to sell.
INCOME
The income generated by an entrepreneur can be given by A+G-A1 where A is the output for the period and A1 is the purchases for the period. G then is the value of capital equipment and finished stocks at the end of the period. Confusion arises over the value of G as some is derived from equipment held from previous periods. Once this can be deduced a clear definition of income arises.
There are two methods of deriving G, the production method and the consumption method. During the period the value of G is affected by maintenance and improvements carried out by the entrepreneur and by depreciation as a result of producing output.
The production method takes maintenance and improvement (B’) into account, by subtracting it from G, giving maximum net value (G’). Under the production method income is defined as the excess of the value of finished output sold during the period over prime cost. Prime cost is the sum of user cost (U) and factor costs (F). U is the maximum net value minus the excess potential value of equipment over G – A1 of what has been sacrificed to produce A. Factor costs are what the entrepreneurs pays other factors of production for their services.
The consumption method takes into account the involuntary loss (or gain) in the value of his capital equipment. Some of these losses are involuntary but not unexpected and are known as supplementary costs (V). Aggregate net income is then equal to A – U – V. Supplementary costs are those deductions from income which a typical entrepreneur makes before reckoning what he considers to be his income. Supplementary costs are important as they affect everyone’s consumption not just entrepreneurs. Unforeseen changes are known as windfall losses; however these losses have a less fundamental effect and are therefore less significant.
Income can then be defined as the excess value of finished output sold during the period over his prime cost. This definition of income is similar to that of Marshall’s. However, Professor Hayek suggested that it is a mistake to put all the emphasis on net income which only refers to consumption aspects as opposed to income proper which includes production issues.
SAVING AND INVESTMENT
Saving is said to equal excess income over consumption and therefore doubts about the definition of saving must arise from doubts about the meaning of these two terms. Income is already defined. Consumption is simply the value of goods sold to consumers, but who is a consumer? Is there a difference between a consumer-purchaser and an investor-purchaser? We need to draw the line between consumers and entrepreneurs and defining A1 (i.e. what one entrepreneur buys from another) allows us to do this. As consumption is defined as A-A1 and income as A-U, it follows that saving is equal to A1-U and net saving (i.e. net income minus consumption) to A1-U-V.
Investment refers additions to the value of capital equipment resulting from activity during the period i.e. the part of income that hasn’t yet been consumed and therefore equal to what has previously been defined as saving. Net investment is therefore equal to A1-U-V. While saving results from consumer behaviour and investment from entrepreneurial behaviour, both are equal to excess income over consumption and therefore to each other. Equivalence arises from the bilateral character of transactions between producers and consumers i.e. aggregate amount individuals decide to save is equal to aggregate amount individuals invest and occurs because psychological habits allow the market to settle at an equilibrium level where readiness to buy equals readiness to sell.
1 comment:
Chapter 6 Comments
Again, very good summary. Important to define variable names when you first see them.
"Income can then be defined as the excess value of finished output sold during the period over his prime cost. "
So is this a markup theory of investment that Keynes is developing?
"Consumption is simply the value of goods sold to consumers, but who is a consumer?"
Excellent point.
I really liked this summary, but it could have gone into a bit more detail. Well done though.
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