Praxeology - Episode 16

Translations of this material:

into Russian: Праксиология Эпизод 16 — Экономический расчёт. Translated in draft, editing and proof-reading required.
Submitted for translation by IrinaChernykh 22.06.2015

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Why is Capitalism called Capitalism?

Hi Guys, Praxgirl here.

In our last lesson we learned that direct exchange has inherent problems that can only be solved through indirect exchange. We found that there is a quick tendency in society for goods that are highly valued to become the predominant medium of exchange and this is called money.

In this lesson we will look closer at the qualities and implications of money, and how and why money allows an economy to grow past the limitations that are inherent to direct exchange.

THE IMPLICATIONS OF MONEY: THE COMMON DENOMINATOR

Money opens to a market the ability to enormously expand the scope for specialization and the division of labor. Now, people no longer have to worry about the problems of divisibility or double coincidence of wants. What this means is that a blacksmith can now trade his swords for money, rather than having to find someone who wants to accept swords as an exchange and has exactly what he wants in return. A teacher in a school is now able to teach for money, rather than trading for specific goods which he must evaluate before he trades. A man can produce a machine (a capital good) and exchange it for money, and he can trade money for food at the supermarket.

Modern society is thus built on the use of money. And the establishment of prices now has a common denominator. It’s important now to explain what having a common denominator and prices in term of one common good really means in order to avoid misinterpretations and fallacious thinking.

PRICES

What do money prices really mean? First let look at how prices are determined in direct exchange. Prices are nothing but exchange ratios between two goods. When two individuals engage in an exchange, the price of a good in terms of another is simply the number of units of the first party’s good that must be offered in order to receive one unit of the second party’s good in exchange.

For example, suppose a baker wants to trade with a blacksmith. They reach an agreement and trade 4 pies for 1 sword. The price of a sword in this case is 4 pies. If we want to find the price of one unit, we simply look at the ratio, and divide one unit of a good against the trading ratio of the other. In this case, the price of one pie would be one fourth of a sword.

It’s important to note that prices are nothing but historical facts; they are the exchange ratios between two goods at the instant of transaction in the given historical conditions. They can tell us nothing about how people will assess the value of the respective goods they want to trade in the future. They simply tell us that at one time, a baker valued a sword more than the 4 pies he was willing to give up in exchange. And vice verse, the blacksmith valued 4 pies more than the sword he gave up.

MONEY PRICES AND ECONOMIC CALCULATION

Prices are merely exchange ratios between two goods. Therefore a money price means the unit of the good “money” was exchanged for some other good. The only change with money prices is that now one good can serve as the common denominator against all other exchangeable goods. In our first example, the pie price of one sword was 4 pies. If the baker trades a pie for 1 ounce of gold, then the money price of a pie is 1 ounce of gold. What this means is that money prices consist of what they are traded against some good, rather than a measurement of their objective value.

Having a common denominator in a market opens to man the ability to perform Economic Calculation. A man can quantify the units of money in his stock and know his ability to acquire goods and services very quickly. His method of calculation follows from observing money prices. Since we now understand what prices really are--the number of goods exchanged for another good--it’s easy to transfer this idea to money prices.

Economic calculation means that a man can compute his successes and failures, or how close or far he is in achieving his desires in terms of a single good he has in his possession.

Economic calculation can comprehend everything that is exchanged against money. To fully grasp what I mean by calculation, take this example: if a computer is sold on the market for 1 ounce of gold, and a car is sold for 5 ounces of gold, everyone can now understand. very quickly, that a car’s market worth is 5 computers.

Computing with a common denominator allows men to keep balance sheets. Using their knowledge of day-to-day prices, businessmen can appraise and estimate the price at which their current stock of goods or services will sell on the market. This clearly helps a businessman to perform his operations with much more efficiency and avoid wasting resources.

This does not mean that money is a unit for the measurement of value. It is not possible to measure value and the science of Praxeology would never contend to do so. A process of measurement consists in establishing the numerical relationship of an object with regards to another object of the same kind. There is no such fixed unit for value. Value is a subjective concept. Therefore, it would be a mistake to try and relate the number of units of money to the numerical calculations of technology and the natural sciences. The natural sciences have the ability to measure with precision and thus predict with relative accuracy the outcome of a definite action. But as far as the concept of value is involved, there is no such standard.

Let me illustrate this difference with an example.

Suppose that Matt wanted to build a bridge. By using his knowledge of engineering he can establish how a bridge must be built on a river to carry definite loads. But engineering cannot answer the question of whether or not the construction of such a bridge would take away material factors of production and labor from a task where they could satisfy more urgently felt needs. For instance, without money Matt cannot figure out if his construction of bridge is taking away labor and goods from construction of a school, or building houses. It also cannot tell Matt whether or not the bridge should be built at all, where it should be built, what capacity for bearing burdens it should have, and which of the many possibilities for its construction should be chosen. Money solves this problem. Money, as the common denominator and primary medium of exchange in a society transmits the information of all the transactions that are being engaged in through money as to where the most profitable place to build a bridge will be. “Most profitable” means the best and most efficient use of resources in order to satisfy the highest and most urgent desires.

THE LIMITS OF ECONOMIC CALCULATION

Economic calculation has its own limitations. It cannot comprehend things which are not sold and bought against money. There are things in this world which cannot be bought and sold using money. Self-worth, vigor, life itself. These things play an important role in society, yet they are not part of economic activity.

However, this isn’t a problem for economic calculation because these things do not require calculation. Things that cannot enter into accountancy are either ends themselves or simply nonexchangeable consumer goods. No economic calculation is needed to determine their value by an actor. A man merely has to choose.

For example: suppose a boxer named Butch is asked by his manager to “throw a fight” for money. Butch is an aging boxer and is in desperate need from the money to get out of debt. But Butch also has a lot of pride as a formerly successful boxer. Pride is something that cannot be put into money terms. On the night of the fight, all that Butch needs to consider is whether to purposefully lose or not, whether to value his pride over the money. Things that cannot be put into money terms are actually put in a particular position that makes decisions rather easier. It would be a gross mistake to complain that money somehow affects society’s morality or aesthetic values. They do no suffer from the fact of money.

Money is merely a good which has emerged as the common media of exchange in a society. It is therefore not the fault of money that it is profitable for businesses to make a Twilight movie series or that people prefer to listen to Lady Gaga over Beethoven symphonies. Money prices merely communicate information for those things that are bought and sold against it. It is neither more complicated nor simpler than this. And as a matter of fact, Praxeology finds that the existence of money has the complete reverse effect. Money as a tool for better planning, greatly increases the supply of material goods. It therefore allows for men to spend more time enjoying their nonexchangeable goods. To put it simply, the less time you have to worry about feeding yourself, the more time you can focus on aesthetics, virtue and love.

CONCLUSION

In conclusion, what we have learned is that money is a commonly exchanged good which facilitates indirect exchange. It serves as a common denominator to all economic transactions, which allows economic computations or calculations.

The importance of money will be emphasized again and again in our lessons. Economic calculation is the guiding principle of action in any society with a division of labor and this only becomes possible when money emerges. Potential actions are evaluated on the basis of expected costs and revenues, and past actions are evaluated with the accounting of profit and loss.

It should start to become clear why money allows a society to prosper. Because it best serves to communicate whether capital is being preserved or consumed. Someone building a bridge is not engaging in a production process that will satisfy his ends immediately but after a lengthy process and they need a device to transmit information to them, through each step of the process, whether they will be able to achieve their end. We can call those who engage in producing or acquiring capital goods, Capitalists. This structure of society has been labelled Capitalism as a smear in the past. But we can now see, it’s actually a very appropriate term. It emphasizes the importance of the role the Capitalists--those who save more than they could consume--have in the prosperity of mankind.

I’ll see you guys in next lesson.