Opportunity Cost Discussion Continued
I recently defended the concept of opportunity cost, which most economists (both Austrians and non-Austrians) support, but which George Reisman rejects. That prompted well-argued and interesting, but nevertheless mistaken, replies from Reisman supporters Wladimir Kraus and Per-Olof Samuelsson. Instead of posting the very long reply in the comment section, I will present in a new post. Here are the edited (to reduce length of the post and focus on the relevant parts, the unedited comments can be seen here) comments by Wladimir and Per-Olof and my responses:
Wladimir-> "I think Stefan has missed Reisman's point. For one, Reisman explicitly says (pp. 450-460) that it is better to have a bigger financial gain than a smaller one. In that sense, Reisman would agree with Marge but still reject the concept of opportunity cost as a valid construction in economics."
Me-> Again, the point here is that even though opportunity cost is not accounting cost, it is cost in a praxeological sense. It is what you forego by making a certain choice as opposed to other possible choices. It is a necessary concept to assess whether or not a choice is beneficial or not. Because all choices have opportunity costs, it is not sufficient to simply show that a choice generates benefits in order to make it a good choice.
In the Simpson’s-example, Homer could point to how he earned a dollar through his choice, so unless take the forty dollar opportunity cost into account, it must be considered a good choice.
Wladimir argued against it by saying that if you adopt a profit maximizing rule, then you would also come to the conclusion that Homer made a bad choice. This is true but misses the point. We are analyzing the actual choice of not going to work. Was that a good or bad decision? And since it meant foregoing possible income of 40 dollars, and since costs means something that you forego when undertaking a certain action, it was from a praxeological point of view clearly a cost associated with that decision.
Perhaps now some would object that the forty dollars would have been counted as an income if you had focused on the alternative action of going to work. Well, that is true, but then we're not evaluating the same action. Whether something is revenue or cost depends on what action you focus on. There's nothing really strange about that. It is similar to how a given transaction can be counted either as revenue or cost depending on whether you analyze the action of the seller or the action of the buyer.
And just as it is objectively right to characterize the money that a buyer foregoes (and could have used for other things) when he chooses to buy something as a cost, it is objectively right to characterize as a cost the money (or other benefits) that you forego by not making the alternative choice that would have given you the money as a cost.
Wladimir-> "Economists routinely use OCs to embrace not only foregone monetary benefits, such as a foregone profit from selling a good, but also purely "psychic" costs such as the foregone pleasure of not spending one's time with friends if one chooses to work, for example."
Me-> Well, yes, and rightly so. The point is not to embrace the fallacy that working 24/7, or at least every moment you're awake, is somehow optimal. The point is to highlight to acting man that when evaluating possible actions, you choose what gives you the highest utility. Or to put it another way, whenever the amount of money you would make from working is higher than the value you perceive from doing something else instead of working, then the opportunity cost of not working is higher than the benefits of that option. This means that in a cost-benefit analysis you arrive at the conclusion that it is not a good option.
Wladimir-> "Briefly, *only* the category of productive spending, which Reisman defines as the expenditure to buy capital goods and hire labor services for the purpose of making subsequent sales, can give rise to costs of production. To see this, imagine there is no productive expenditure in the economic system. The only category of spending present is spending on consumers' goods.
What would that situation mean economically? In terms of "mere" accounting, no costs of production of account of either capital goods or labor services would be present."
Me-> Not true at all, because production of consumer's goods is associated with costs (try producing a hot dog at a hot dog stand without any cost), just as production of investment goods is. And indeed, a key cost associated with producing only consumer goods is the opportunity cost of foregone investment goods, which of course in the long term will be disastrous.
Wladimir-> "But one won't be able to recognize all that if one reasons from the point of view of opportunity cost doctrine. One will fail to recognize the pattern between low costs of production and higher profits if one reasons from the point of view of opportunity cost doctrine. One will be at a loss to understand what determines the amount and the rate of profit, how they relate to productive vs. consumptive expenditures if one reasons from the point of view of opportunity cost doctrine."
Me-> No, again not true at all. In fact the opposite is true. You need the opportunity cost concept to determine whether an investment is profitable or not. A key principle of (business) finance is that you can't evaluate a certain object simply by looking at whether or not it makes a profit in the pure accounting sense. You must also ensure that the return on invested capital is higher than the cost of capital (or discount rate), which is (should be) based on alternative uses if that investment capital. Cost of capital/discount rate is really the business management version of the economics concept of opportunity cost.
Per-Olof-> "I have a question for Stefan: If you disagree with Reisman's criticism of "opportunity cost", then what is your view on the preceding section (p. 459f) on "imputed income"? I ask this, because the criticism of those two doctrines is basically the same - namely that they both introduce incomes and costs that are fictitious."
Me-> See what I wrote about the praxeological nature of revenue/income and cost. Whether something is an income or cost depends on whether a certain action generated it or destroyed it. That means that what in accounting terms is an income could perhaps not really be an income in a praxeological sense (The Simpson example), and also what in accounting terms is an absence of cost is an income in praxeological terms. The most common example of "imputed income" is (I think), the imputed income of home owners from not renting. And that does make sense. Suppose we have two people both earning say 30,000 dollars (or euros or kronor or whatever) from their jobs, yet one earns 6,000 dollars per years from invested capital while paying 12,000 dollars in rent and another makes zero from investments yet only has 6,000 dollars in housing related expenditures from the home he own. Assuming that the 6,000 dollar difference in housing expenditure is related to the fact that the second person has invested his money in his house rather than in some securities, it should be clear that this difference in fact represents an income from the investment in the house, just as the 6,000 dollars that the renter earned from his investment in securities is an income.
Per-Olof-> "There's an expression in Swedish when someone is looking very frustrated: "You look like you have sold the butter and lost the money".
Well, if someone has sold his butter for x kronor and then - by having a hole in his pocket, or having been robbed at his way home, or whatever - having lost the money, he has of course suffered a loss of x kronor.
But suppose this person hasn't bothered to sell his butter at all, but has instead used it to butter his own bread. Isn't it true that according to the OC doctrine, he should still feel as frustrated, since he has obviously failed to earn those x kronor?"
Me-> No, of course not. The person who used the butter on his breads enjoyed a higher standard of living as he enjoyed that consumption. He enjoyed the "revenue" of the pleasure of consumption, while the other guy received nothing in return and so simply got screwed.
Wladimir-> "I think Stefan has missed Reisman's point. For one, Reisman explicitly says (pp. 450-460) that it is better to have a bigger financial gain than a smaller one. In that sense, Reisman would agree with Marge but still reject the concept of opportunity cost as a valid construction in economics."
Me-> Again, the point here is that even though opportunity cost is not accounting cost, it is cost in a praxeological sense. It is what you forego by making a certain choice as opposed to other possible choices. It is a necessary concept to assess whether or not a choice is beneficial or not. Because all choices have opportunity costs, it is not sufficient to simply show that a choice generates benefits in order to make it a good choice.
In the Simpson’s-example, Homer could point to how he earned a dollar through his choice, so unless take the forty dollar opportunity cost into account, it must be considered a good choice.
Wladimir argued against it by saying that if you adopt a profit maximizing rule, then you would also come to the conclusion that Homer made a bad choice. This is true but misses the point. We are analyzing the actual choice of not going to work. Was that a good or bad decision? And since it meant foregoing possible income of 40 dollars, and since costs means something that you forego when undertaking a certain action, it was from a praxeological point of view clearly a cost associated with that decision.
Perhaps now some would object that the forty dollars would have been counted as an income if you had focused on the alternative action of going to work. Well, that is true, but then we're not evaluating the same action. Whether something is revenue or cost depends on what action you focus on. There's nothing really strange about that. It is similar to how a given transaction can be counted either as revenue or cost depending on whether you analyze the action of the seller or the action of the buyer.
And just as it is objectively right to characterize the money that a buyer foregoes (and could have used for other things) when he chooses to buy something as a cost, it is objectively right to characterize as a cost the money (or other benefits) that you forego by not making the alternative choice that would have given you the money as a cost.
Wladimir-> "Economists routinely use OCs to embrace not only foregone monetary benefits, such as a foregone profit from selling a good, but also purely "psychic" costs such as the foregone pleasure of not spending one's time with friends if one chooses to work, for example."
Me-> Well, yes, and rightly so. The point is not to embrace the fallacy that working 24/7, or at least every moment you're awake, is somehow optimal. The point is to highlight to acting man that when evaluating possible actions, you choose what gives you the highest utility. Or to put it another way, whenever the amount of money you would make from working is higher than the value you perceive from doing something else instead of working, then the opportunity cost of not working is higher than the benefits of that option. This means that in a cost-benefit analysis you arrive at the conclusion that it is not a good option.
Wladimir-> "Briefly, *only* the category of productive spending, which Reisman defines as the expenditure to buy capital goods and hire labor services for the purpose of making subsequent sales, can give rise to costs of production. To see this, imagine there is no productive expenditure in the economic system. The only category of spending present is spending on consumers' goods.
What would that situation mean economically? In terms of "mere" accounting, no costs of production of account of either capital goods or labor services would be present."
Me-> Not true at all, because production of consumer's goods is associated with costs (try producing a hot dog at a hot dog stand without any cost), just as production of investment goods is. And indeed, a key cost associated with producing only consumer goods is the opportunity cost of foregone investment goods, which of course in the long term will be disastrous.
Wladimir-> "But one won't be able to recognize all that if one reasons from the point of view of opportunity cost doctrine. One will fail to recognize the pattern between low costs of production and higher profits if one reasons from the point of view of opportunity cost doctrine. One will be at a loss to understand what determines the amount and the rate of profit, how they relate to productive vs. consumptive expenditures if one reasons from the point of view of opportunity cost doctrine."
Me-> No, again not true at all. In fact the opposite is true. You need the opportunity cost concept to determine whether an investment is profitable or not. A key principle of (business) finance is that you can't evaluate a certain object simply by looking at whether or not it makes a profit in the pure accounting sense. You must also ensure that the return on invested capital is higher than the cost of capital (or discount rate), which is (should be) based on alternative uses if that investment capital. Cost of capital/discount rate is really the business management version of the economics concept of opportunity cost.
Per-Olof-> "I have a question for Stefan: If you disagree with Reisman's criticism of "opportunity cost", then what is your view on the preceding section (p. 459f) on "imputed income"? I ask this, because the criticism of those two doctrines is basically the same - namely that they both introduce incomes and costs that are fictitious."
Me-> See what I wrote about the praxeological nature of revenue/income and cost. Whether something is an income or cost depends on whether a certain action generated it or destroyed it. That means that what in accounting terms is an income could perhaps not really be an income in a praxeological sense (The Simpson example), and also what in accounting terms is an absence of cost is an income in praxeological terms. The most common example of "imputed income" is (I think), the imputed income of home owners from not renting. And that does make sense. Suppose we have two people both earning say 30,000 dollars (or euros or kronor or whatever) from their jobs, yet one earns 6,000 dollars per years from invested capital while paying 12,000 dollars in rent and another makes zero from investments yet only has 6,000 dollars in housing related expenditures from the home he own. Assuming that the 6,000 dollar difference in housing expenditure is related to the fact that the second person has invested his money in his house rather than in some securities, it should be clear that this difference in fact represents an income from the investment in the house, just as the 6,000 dollars that the renter earned from his investment in securities is an income.
Per-Olof-> "There's an expression in Swedish when someone is looking very frustrated: "You look like you have sold the butter and lost the money".
Well, if someone has sold his butter for x kronor and then - by having a hole in his pocket, or having been robbed at his way home, or whatever - having lost the money, he has of course suffered a loss of x kronor.
But suppose this person hasn't bothered to sell his butter at all, but has instead used it to butter his own bread. Isn't it true that according to the OC doctrine, he should still feel as frustrated, since he has obviously failed to earn those x kronor?"
Me-> No, of course not. The person who used the butter on his breads enjoyed a higher standard of living as he enjoyed that consumption. He enjoyed the "revenue" of the pleasure of consumption, while the other guy received nothing in return and so simply got screwed.
posted by stefankarlsson at 10:26 AM
16 Comments:
Stefan,
I did not know the "opportunity cost" concept was such a difficult thing to understand - apparently to some people it is. While I have no idea what book Wladimir is referencing, it sounds like he or Reisman are trying to be revisionists of opportunity cost. It is either that, or they are just plain confused. How can a PhD like Reisman think opportunity cost is only "accounting cost"? Does he think that "all costs" are somehow synthesized/reflected in money? If that's the case, I would like to hear the theory on that.
Oh yeah, interestingly enough... if you drop "opportunity" off of "opportunity cost" and just type "Cost" into Princetons WordNet Dictionary one gets:
"Cost: Value measured by what must be given or done or undergone to obtain something."
Perhaps it would behoove Reisman and his "opportunity cost interpretation supporters" to know the literal meaning of words.
Perhaps as a follow-up post you will re-emphasize "subjective valuation theory" so Reisman & et al, know that profit or loss is all relative to the individual.
Tu ne cede malis Stefan!
-Austrian Neophyte
Anyone who doesn't believe in opportunity cost should have no problem with their government forcing them to lend 25% of their income to the national government for a year in return for an interest free note. This is in addition to the taxes they must pay.
They should also have no problem with the government forcing them to do 40 hours of labor each week for the government without pay.
After all, if opportunity costs aren't real, where is the loss?
I thank Stefan for his lengthy and thoughtful reply.
Let me deal in this comment with the main argument which I think Stefan simply dodged.
Wladimir-> "Briefly, *only* the category of productive spending, which Reisman defines as the expenditure to buy capital goods and hire labor services for the purpose of making subsequent sales, can give rise to costs of production. To see this, imagine there is no productive expenditure in the economic system. The only category of spending present is spending on consumers' goods.
What would that situation mean economically? In terms of "mere" accounting, no costs of production of account of either capital goods or labor services would be present."
Stefan-> Not true at all, because production of consumer's goods is associated with costs (try producing a hot dog at a hot dog stand without any cost), just as production of investment goods is. And indeed, a key cost associated with producing only consumer goods is the opportunity cost of foregone investment goods, which of course in the long term will be disastrous.
(Reply)Wladimir->
I want to see your calculation of "opportunity cost" of investment goods in the case, as I assumed, where there is no spending for capital goods and labor anywhere in the economic system and thus no *market* prices for both capital goods and labor services.
How would you calculate the amount of cost of production, the amount of profit, the amount of capital invested and consequently the rate of profit on the capital invested?
Show me your method of calculation using a hypothetical example involving some hypothetical numbers for "opportunity cost" of any kind you want.
How can anyone not argue against the concept of opportunity cost? It is of particular importance in relation to imputed rental income. I got a friend to retire aged 35 by suggesting that he charged imputed rent against his moribund menswear shop, of which he was the owner of the freehold. As a consequence of this exercise, he realised it would be more profitable to let the shop instead of trying to run his own business there.
Needless to say, having released himself from the opportunity cost in lost rental income, he was very pleased with his new lifestyle and went on to run a rock band and then develop a career as a stand-up comedian.
The late Charles Clore made his fortune that way - every shop had to meet its rental target.
A short reply to commentators who apparently think that the one and only use of the concept is to make people aware that there may be more attractive course of actions. It may be news to some here but in economics the opportunity cost doctrine is one of the buildings blocks of the theory of cost and consequently plays a major role in the theory of prices.
I ask you to look past that initial stage and try to think and understand how that concept helps or hinders our grasp of various economic phenomena interacting with each other.
And also please read what Reisman actually wrote -- it's not much, only a few pages. You may learn something in the process.
Wladimir-> "I want to see your calculation of "opportunity cost" of investment goods in the case, as I assumed, where there is no spending for capital goods and labor anywhere in the economic system and thus no *market* prices for both capital goods and labor services.
How would you calculate the amount of cost of production, the amount of profit, the amount of capital invested and consequently the rate of profit on the capital invested?
Show me your method of calculation using a hypothetical example involving some hypothetical numbers for "opportunity cost" of any kind you want."
Me-> Wladimir, if capital goods production would cease, it would indeed be nearly impossible to calculate the potential value of such production. However, that would be more of an epistemological rather than ontological problem.
Stefan-> Wladimir, if capital goods production would cease, it would indeed be nearly impossible to calculate the potential value of such production. However, that would be more of an epistemological rather than ontological problem.
Wladimir-> Stefan, your position is ambivalent even in the case where things are absolutely crystal clear. I don't know what solution you have in mind to the "epistemological" problem for the present case, but this is how I think, following Reisman, things work.
Under primitive conditions of NO OUTLAYS for capital goods and labor (productive expenditure), i.e NO markets for factors of production, no costs on account of those purchased factors would exist. Yet to the extent people use money to facilitate the exchange of whatever consumers' goods they might be able to produce using home/tribal-made capital goods such as primitive knives, spears,fishnets, boats etc. etc., no outlays for factors of production means they've sales revenues but no cost of production, thus the amount of profit they earn corresponds to the penny their sales receipts. Since capital invested is zero, the rate of profit is infinite. That's how one would calculate cost of production in such an economy even though capital goods are produced and used within the confines of the household/tribe.
In the absence of markets for factors of production, the level of production must be at best stagnant. From that point on, only after markets for factors of production have developed, the deepening and widening of the division of labor can take place. But how would that reflect our relation between sales revenues, costs, profits? Markets for factors of production presuppose productive expenditure. Productive expenditure lead to cost of production. Cost of production are deducted from sales revenues, thereby lowering the amount of profit. Productive expenditure means capital invested. A given amount of profit relative to a given amount of capital invested brought about by productive expenditure gives rise to a rate of profit which is the lower the greater are productive expenditure relative to sales.
I can calculate all the items for any imaginable proportion of productive expenditure relative to sales revenues. Just give me the figures for sales, which reflects the quantity of money and the determinants of how much people choose to invest rather than consume (time-preference), and I can provide precise quantitative figures of a model economy. No recourse to epistemology and the like is needed.
I hope you see what I'm getting at. If one wants to understands the workings of a monetary economy, it is absolutely essential to be clear about the nature of entities one employs in the analysis. Moreover, a monetary economy functions on the basis of monetary calculation. It's the relation between sales and outlays that determines which business and industries will continue to produce and which will file for bankruptcy or not even enter the business in the first place. It's money prices and money incomes which build the indispensable basis even for consumer valuation of goods! But if one introduces "opportunity costs" and the like one introduces elements that render a coherent analysis simply impossible. It's the same if one tries to add apples with oranges.
I suspect, though I am no expert on these things, that several confusions are coming in here.
There is the usual one regarding the definition of "Capital", which is variously taken to mean
Land ie the surface of the earth and its natural contents eg fish in the sea,
Physical capital, that is things produced by human labour for the purpose of producing end products eg the fishing boat and fishing tackle, and
Credit, which is payments advanced to support production and producers from the time it commmences until the product is sold eg the fisherman must buy the boat and tackle but receives nothing until the fish has been landed and sold.
There is a general problem caused by looking at money flows and their connection with value, which tend to obscure the underlying physical reality of the economic process, whereby human labour, working on the surface of the earth, is applied to natural products to produce that which people desire, those products then being exchanged.
The models generally fail to assign a value to the surface of the earth, which is strange considering the importance of the land (property) market and its role in the ongoing economic crisis.
A further confusion is related to the definition of value, which surely must be related ultimately to the labour that someone is prepared to give in order to acquire the thing.
@Henry:
You're correct about confusions. I don't think I won't be terribly off the target if I just state that you, wittingly or unwittingly, argue from the neoclassical/orthodox Austrian standpoint here.
Let me say this, as someone who spent a great deal examining the development history of those doctrines and is in position to compare Reisman's views with all others, you invariably will arrive at a dead-end in your analysis of such phenomena as money cost, money wages, real wages, money income etc. etc. if you proceed from the concept "Capital" as a sum of physical things.
Reisman deals with those things in his book. He not only provides, in my view, a correct definition of capital etc. but also makes clear, in a truly integrated fashion, how indeed the process of physical capital accumulation takes place withing the conditions of a monetary economy where calculation and valuation in terms of money are the motive force that guides and regulates production.
If you're interested, I'll gladly refer you to corresponding passages in Reisman's book.
Wladimir, I'm afraid you really don't understand. If capital investment simply stopped for whatever reason there would still be factors of production capable of producing them. If no market for them exists then it will be nearly impossible to estimate their current opportunity cost when employed in production of consumer goods. But there is still an opportunity cost of using all factors of production to produce consumer goods, only we can't know what it is, which is why I said the problem was epistemological, not ontological. But that goes for any kind of cost estimate, so that is not really relevant.
And it would certainly be possible to estimate the opportunity cost of again using some factors of production to produce capital goods. That would be the value foregone by not using all of them to produce consumer goods.
And after these markets have developed, you can with equal ease estimate opportunity cost as any other cost. You're making an unwarranted leap from a situation where no information exist to one where information exists, and tries to attribute the former to opportunity cost and the latter to other cost, even though both suffer the same epistemological problem in the former scenario, and neither suffer it in the latter.
And you are wrong BTW to say that the rate of return would be infinite. Any profits existing after investments had stopped would of course not be attributable to non-existing investment, which means you would divide zero with zero.....
Stefan,
you are right, I really don't understand how anyone can say the following and think there is no contradiction in it:
"If no market for them [factors of production] exists then it will be nearly impossible to estimate their current opportunity cost when employed in production of consumer goods. But there is still an opportunity cost of using all factors of production to produce consumer goods, only we can't know what it is, which is why I said the problem was epistemological, not ontological."
The contradiction you may perhaps want to resolve: no markets for factors of production --> no factor prices --> no costs on account of purchases of factors of production.
Yet you still claim there would be cost in that economic system, not in terms of money or anything else "ontological" but, apparently, in terms of something entirely imaginary, the determination of which becomes an "epistemological problem" vis-a-vis an "ontological problem", i.e. dealing with entities that exist in reality. I hope you'll excuse me but this obscurantism in its purest form, bordering on solipsism, which, astonishingly enough, you seem to be perfectly OK with!
And with all due respect, the rate of profit would be infinite not "zero/zero" (sic), which BTW means "nothing/nothing". In my view, infinite rate of profit = ("profit =sales revenues")/("zero capital invested"). Or do you think that those sales revenues constitute wages? Or if not wages, what is it that you would call those sales revenues? Do they constitute an income category? If yes, which one?
"The contradiction you may perhaps want to resolve: no markets for factors of production --> no factor prices --> no costs on account of purchases of factors of production.
Yet you still claim there would be cost in that economic system, not in terms of money or anything else "ontological" but, apparently, in terms of something entirely imaginary, the determination of which becomes an "epistemological problem" vis-a-vis an "ontological problem", i.e. dealing with entities that exist in reality. I hope you'll excuse me but this obscurantism in its purest form, bordering on solipsism, which, astonishingly enough, you seem to be perfectly OK with!"
Just what is so hard for you to understand? I pointed out that factors of production can be used to produce capital goods even if they're not currently doing so. And since they have that capability, that means that employing them for other purposes are associated with opportunity costs (namely the products they would have produced if they actually had been used to produce capital goods).
What you're really saying is that considerations of something which could happen, but hasn't happened, is "obscurantism" (?!?) and "solipsism"(?!?). Actually, you're the one guilty of it as you try to deny the knowledge of the effects of alternative actions (obscurantism) and you are the one that tries to claim that something we haven't experienced really don't exist (solipsism). Which would mean that until 1492, America didn't exist for Europeans. But just as America existed even though most Europeans didn't know about it, so do the opportunity cost of consumer goods production exist even if we don't know how high it is.
"And with all due respect, the rate of profit would be infinite not "zero/zero" (sic), which BTW means "nothing/nothing". In my view, infinite rate of profit = ("profit =sales revenues")/("zero capital invested"). Or do you think that those sales revenues constitute wages? Or if not wages, what is it that you would call those sales revenues? Do they constitute an income category? If yes, which one?"
Yes, wages and remaining profits constitute income, but they're not attributable to non-existent investments, which is the point you fail to grasp. When you calculate rate of return you link effect (return) with cause (investment). If investments aren't made they can't be described as cause, and since effect presuppose cause, then no cause means no effect. Really quite basic and simple.
Stefan,
I think now we're getting to the real difference between us.
You ask: "What you're (Wladimir) really saying is that considerations of something which could happen, but hasn't happened, is "obscurantism" (?!?) and "solipsism"(?!?)."
Oh, yes, of course! Don't you that you putting "something which could happen, but hasn't happen" on a par with something that did in fact happen! Don't you see that THIS is a problem?! Reisman has very nice examples to highlight the absurdity of putting together imaginary and actual things in his criticism of OC. You've married a very good looking women, but you could have married a very pretty women, but in fact didn't, does it mean that you've married an ugly women? According to the logic of OC, there is no other conclusion, for "very good looking" -"very pretty" = "ugly". But how do you reconcile the fact that your wife is in fact very good looking? Or, of you like working with numbers. You've earned $100,000 but could have earned 1 million, does it mean you suffered a loss? The logic of OC dictates that you did. But how to reconcile that conclusion with the fact that your net-worth is up by 100,000?
Again, I'm NOT disputing the fact that those situations are not equilibrium states and that people tend to adjust their actions to the payoffs available to them. But this fact does not permit one proceeding counting "what could have been" as something that in fact happened!!! Now, as a heuristic method it is fine but don't you see that it at least confuses things? If you do, then we might after all find common ground here.
You also write:
"Yes, wages and remaining profits constitute income, but they're not attributable to non-existent investments, which is the point you fail to grasp."
By how those sales revenues could be wages if there is no demand for labor, i.e. no external market for labor??? Who paid those wages? Wages, remember, are paid out of productive expenditure. Their amount varies with the size of the demand for labor. But if there is no productive expenditure either for capital goods nor for labor services then, again, there can be no prices for capital goods and no prices for labor, i.e. wages.
Also you write in the same paragraph:
"When you calculate rate of return you link effect (return) with cause (investment). If investments aren't made they can't be described as cause, and since effect presuppose cause, then no cause means no effect. Really quite basic and simple."
In other words, profit, in your view, is not the difference between sales and costs of production? Is then your definition of profit as something resulting from investment, i.e. capital, only? Investment in capital goods? Would you count investment, i.e. spending for labor, as part of business investment too? If so, what is the source of the AMOUNT of profit? What begets profit then, in your model? The "excess" product resulting from investment in capital goods, or in capital goods plus labor? Just checking what theory of profit/interest you're having in mind here.
"Oh, yes, of course! Don't you that you putting "something which could happen, but hasn't happen" on a par with something that did in fact happen! Don't you see that THIS is a problem?!"
No, and in your previous comments you haven't seen it as a problem either, since you too endorsed the notion that Homer made a mistake in failing to show up at work.
"Reisman has very nice examples to highlight the absurdity of putting together imaginary and actual things in his criticism of OC. You've married a very good looking women, but you could have married a very pretty women, but in fact didn't, does it mean that you've married an ugly women? According to the logic of OC, there is no other conclusion, for "very good looking" -"very pretty" = "ugly". But how do you reconcile the fact that your wife is in fact very good looking? Or, of you like working with numbers. You've earned $100,000 but could have earned 1 million, does it mean you suffered a loss? The logic of OC dictates that you did. But how to reconcile that conclusion with the fact that your net-worth is up by 100,000?"
Again, I'm NOT disputing the fact that those situations are not equilibrium states and that people tend to adjust their actions to the payoffs available to them. But this fact does not permit one proceeding counting "what could have been" as something that in fact happened!!! Now, as a heuristic method it is fine but don't you see that it at least confuses things? If you do, then we might after all find common ground here."
No, I do not see any confusion here. If you had a chance of getting a better woman than you actually got, or earned an additional $900,000, because of some mistake you made, then you should see *the action* as being loss-making.
As Mises pointed out, economics is (or should be) about human action, and once you use the Misesian paradigm of analyzing economic events from the perspective from its causal factor, which is to say human actions, and more specifically here the motivating effects of human actions, the logic of opportunity cost should be apparent.
(Comment divided in two parts because of the 4,096 character upper limit in blogger.com to comments)
"In other words, profit, in your view, is not the difference between sales and costs of production? Is then your definition of profit as something resulting from investment, i.e. capital, only? Investment in capital goods? Would you count investment, i.e. spending for labor, as part of business investment too? If so, what is the source of the AMOUNT of profit? What begets profit then, in your model? The "excess" product resulting from investment in capital goods, or in capital goods plus labor? Just checking what theory of profit/interest you're having in mind here."
This is really simple. Again, try to understand the Misesian cause and effect analysis of additional actions. We look at the effects of human action. Accounting profits that are caused by previous investments should be attributed to those previous investments. Labor income resulting from additional work efforts should be attributed to those additional work efforts. If no additional investments are made, than no profits can be attributed to these non-existent investments.
"By how those sales revenues could be wages if there is no demand for labor, i.e. no external market for labor??? Who paid those wages?"
If say a supermarket has already been build then these wages could be financed by the sale of good from that supermarket. Since the investment had already been made, no additional investments will be needed (at least not until the inevitable capital consumption makes the building unusable).
"Wages, remember, are paid out of productive expenditure. Their amount varies with the size of the demand for labor. But if there is no productive expenditure either for capital goods nor for labor services then, again, there can be no prices for capital goods and no prices for labor, i.e. wages."
No, wages are paid for by company revenues, which may be the causal result of past investments, new investments or additional work efforts.
"In other words, profit, in your view, is not the difference between sales and costs of production? Is then your definition of profit as something resulting from investment, i.e. capital, only? Investment in capital goods? Would you count investment, i.e. spending for labor, as part of business investment too? If so, what is the source of the AMOUNT of profit? What begets profit then, in your model? The "excess" product resulting from investment in capital goods, or in capital goods plus labor? Just checking what theory of profit/interest you're having in mind here."
Profit is the difference between revenues and costs, of course (assuming revenues are larger, otherwise it would be called loss). But rate of return is the extra profits resulting from additional investments relative to the amount of these additional investments. If no additional investments were made and profits still arose, then the concept of rate of return would not be applicable to those numbers since non-existent investments can't cause any profits.
I don't do abstract economic theory but there are numerous vacant sites in the town where I live. Some of them have been empty for 20 years or more, despite planning consent for development.
There are all sorts of opportunity costs there. Lost rent. Lost employment, housing and business opportunities. Lost tax revenue. But because they are not featured on anyone's balance sheet, the only opportunity is for the buddleias which have taken root there.
Why does this happen? Because the owners are land speculators and can trade and borrow on paper values.
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