Economics

CSGnet Archive CSG2001
101

[From Bill Powers (2000.09.08.0448 MDT)]

Martin Taylor 2000.09.07 20:52]

What is it that is produced, what is it that is sold, and what is
it that is bought in a transaction?

That question is critical to the truth or otherwise of Bill's comment
that a business cannot consistently sell either more or less than it
produces.

Your thoughts along these lines are relevant, but not to the circular flow
itself, which is a mundane and literal affair. When you point out that more
is sold than is produced, you speak metaphorically, for in literal truth
what is sold is an object or a service with a price tag. The producer
produces it by paying money to the people who do all the labor, from
digging raw materials to designing to assembling to transporting to
retailing the objects or services. Possession is transferred to the
consumer upon the payment of money to the producer. That is all that
happens in this economic interaction.

What this picture does not deal with, as you point out, is the meaning to
the consumer of this transaction, or for that matter to the human beings
who comprise the composite producer. To put the matter in an obvious way,
when the consumer receives a loaf of bread and pays for it, the circular
flow is completed, without any mention of the fact that the consumer needs
the nutrients in the bread in order to live. The consumer does not buy the
freshly-baked bread simply because it is there and the consumer has enough
money to buy it. There are many reasons like those you cite, such as
appearance, taste, smell, hunger or anticipated hunger, prestige,
nostalgia, and so forth.

When you say that there is more produced than is sold, you're speaking of
the values the producer may have put on the manufacture of a good or the
performance of a service which the consumer never notices or appreciates,
like the rustproofing inside a car door. And when the customer buys the
car, it may satisfy wants that are a property of the customer such as the
desire to have a newer car than a neighbor has, and which are not
properties of the thing sold. So I understand what you're saying and agree
with it. But when you model the transaction itself, particularly in the
aggregate, the reasons for its occurrance are irrelevant. Whatever a
customer may derive from the purchase of a good other than the good itself,
the inventory declines by the same amount and the producer receives the
same payment. This is true even when the good is, as you suggest, an idea
rather than a tangible thing or act of service.
Even if someone just sings a song in return for payment, the labor has been
done and the money has been transferred, and that is all the model of the
circular flow has to represent. It doesn't have to represent the fact that
you wanted to hear the song or the performer.

Your considerations become more relevant when we ask why the consumer buys
anything at all, and why the producer goes to the trouble of producing
anything. What is missing from the macroeconomic concept of a circular flow
is the battery. At best, the circular flow runs on momentum; the next cycle
takes place because the previous one occurred. But the idea of leakage
reveals the problem with this view: if any purchasing power is lost from
the circular flow each time around (although that is an incorrect image),
the flow will simply run down to zero. When you build a working model that
does what the economic transactions suggest, this weakness shows up
immediately, if only because numerical integrations inevitably contain
small inaccuracies. The system simply won't stay in the same state, even
though the balance of opposing influences appears perfect.

The "managers" Rick and I have been considering will provide part of the
needed motive power, as soon as we get the basic plant equations into
shape. But it will still be necessary to model the consumers, as Rick has
already attempted to do once. The workforce won't work and the consumers
won't consume unless they have unfulfilled wants and needs.

Modeling in terms of composite entities is the only way this can really be
done. There are simply too many motivations to be considered one at a time.
We must take as givens the fact that people want goods and services, and
that other people carry out mandates to keep inventories constant and costs
matching income. Why they do this is secondary to the fact that they do it.
In the aggregate, many of the reasons logically cancel out; doing things
for prestige, for example, is futile when everyone else can do the same
things for the same reason; prestige is a relative measure. Everyone can't
be richer than everyone else. I tend to think that in the long run,
illogical or self-cancelling goals will fade away, since they are
repeatedly demonstrated to be unreachable. Or perhaps what I mean is that
I'm interested only in modeling a viable system: if we're doomed, what's
the point of modeling anyway?

Best,

Bill P.

102

[From Bill Powers (2000.09.08.0555 MDT)]

Rick Marken (2000.09.07) --

The two equations that seem to be causing me a problem are these:

B = 1.67*w*N*dt
Q = PR*N*dt

w, or wage rate, is expressed in yearly terms, as is productivity PR.
Multiplying by dt converts to other time units: if dt is 1/365, then B and
Q are daily buying power and output.

Obviously, if N, the number of employed people, changes, buying power and
production of Q change in the same direction. The "problem" is that N
cannot, therefore, be used to balance costs against income of the producer.
Wages can be used, but wages are not very freely adjustable; it is far
easier for producers to hire or lay off workers. But let's just look at
what we have.

In order for the whole product to be purchased, the price P must be
adjusted so that

PQ = B, or

P = B/Q

The ratio B/Q is, substituting from the first two equations,

B/Q = 1.67*w/PR

This is the situation that will prevail if the inventory manager adjusts
prices to maintain a constant inventory. The result of that adjustment is
to make the buying power just enough to buy the whole product. Notice that
the wage rate (w) appears in this expression, but not the number of
workers. The wage rate per worker divided by productivity per worker is the
labor cost per unit of Q produced. Multiplying by 1.67 converts this to the
total cost, labor cost plus cost paid as capital income, per unit of Q.

I think this is interesting in that we are explicitly considering the
operation of a control system, the inventory control system, that plays a
critical part in economic relationships. This is a collective control
system, made of a large number of people who are each trying to keep
inventories of individual businesses no larger than necessary to handle
flutuations in purchases. Unless you want to believe in some mystical
"hand" that keeps prices adjusted according to buying power ("supply and
demand") there is no other way that I know of to explain prices being
adjusted in this way.

Why, one may wonder, would we require an inventory control manager when the
final result can be obtained just by calculating P = B/Q and setting prices
accordingly? The answer is that the fraction of total buying power
assignable to an individual product is unknowable, and in fact changes all
the time. All that the individual manager can do is adjust his own prices
to keep his own inventory at the lowest level he guesses will suffice. If
most managers do this, the _composite_ inventory will be kept nearly
constant, and as a result the _composite_ buying power will be kept equal
to the _composite_ Q, with the average price being adjusted to make it so.
Remember that the composite buying power includes a multiplier that
accounts for capital income as well as wages. Capital income includes all
money that goes to cover capital reserves (corporate savings), rents,
royalties, ownership fees, dividends, and interest payments. "Ownership
fees" includes what is termed profits.

I believe that from the basic premise about inventory control, all the
usual "supply and demand" relationships will follow.

Enough for now. After that I deserve a nap.

Best,

Bill P.

103

[From Bill Powers (2000.09.08.1509 MDT)]

Rick Marken (2000.09.08.0920)--

Here's a couple of suggested changes to the circflow code:

1) change

if INV >= B/P then

to

if INV >= B/(P*INV) then

B is the amount of $ available to purchase inventory (INV)
and P*INV (not just P, which is a constant) is the current
$ cost of the inventory. So B/(P*INV) is the amount of
inventory purchased, in units of Q (a result of dividing
$ by $).

I think I disagree, but check me out. INV is measured in goods. B/P is also
in units of goods (dollars/(dollars/good)). Thus you can compare B/P to INV.
In your replacement, the units on the right are

dollars/[(dollars/good)*goods],

so the goods in the denominator cancel, leaving dollars/dollars, or a
dimensionless number. You can't compare a dimensionless number with a
number of goods.

2) change

   INV := INV - B/P;

to

   INV := INV - B/(P*INV);

For the same reasons as above. I think the amount of inventory
purchased on each iteration (in Q units) is B/(P*INV), not B/P.

Again, I disagree, but double-check me. B/P simply computes how many Q
units can be purchased for the amount B at price P per unit. If B is $100
and the price per good is $100, then 1 unit of goods can be purchased. So
saying

INV := INV - B/P

is only to say that the inventory is reduced by the number of goods that
can be purchased for B dollars at price P.

Have you noticed that I include dt in the definition of B and productivity?
The result is for Q and B both to be in _daily_ units (dt is 1/365 of a year).

3) change

   PS := PS + B;

to

   PS := PS + B/P;

where B/P is the $ income from the purchase of B/(P*INV) of
inventory; that is, multiply B/(P*INV) by INV to convert
the result from $ to Q:

B/(P*INV)*INV = (B*INV)/(P*INV) = B/P

Again, a units problem. PS is in units of dollars. B is in units of
dollars. Therefore you can subtract B from PS. But B/P is in units of
goods, not dollars. You can't subtract goods from dollars.

Let's try to get some control
systems in there soon.

Pretty soon, I agree. Let's be sure of the basic model first.

By the way, if there are people sans Pascal who want to
participate in this exercise, I have a version of this model
written in Excel Visual Basic which I can e-mail to you if
you want.

A helpful offer.

Best,

Bill P.

104

[From Bill Powers (2000.09.08.1610 MDT)]

Rick Marken (2000.09.08.1500)]

Never mind, Bill. Your equations are right, I think, after
all

I tried to suck my post back into the computer but it was too late.

Best,

Bill P.

105

[From Bill Powers (2000.09.09.1230 MDT)]

Rick Marken (2000.09.08)]

I've been going over TCP's chapter 2, pages 92 to 95, trying to see how to
get growth into our model. Finally realized that it's no-brain simple when
you'e doing it with a simulation.

TCP went through a long rigamarole to show that

Q/Qo = exp((z-dot + N-dot)*(t2 - t1).

where z-dot and n-dot are approximately constants.

If you backtrack this conclusion all the way to its start on p. 92, you
find this initial relationship:

P'Q' = zN (2-14)

where z is productivity and N is population (actually, as noted at the
bottom of page 92, N should be the size of the _workforce_).

PQ (dropping the primes) is the dollar value of the total production of
goods and services: that is, the GNP. It is exactly equal to the product of
z and N if z is also expressed in terms of dollar value per worker-year. If
zN increases exponentially, GNP will increase exponentially. If zN
increases as the 2/3 power of time - 25, then GNP will increase as the 2/3
power of time - 25. The derivation starting on page 93 simply asserts that
zN increases exponentially; as a result, on p. 94 it is shown that Q, with
price held constant, also increases exponentially.

In a simulation none of that complicated derivation is necessary. We start
with PQ = zN, or Q = zN/P. Reducing to constant dollars, we can then say
that if zN rises exponentially, Q will rise exponentially. And here is the
problem I started suspecting a new days ago: there's no _a priori_ basis
for assuming any particular way in which z and N will change. We can't
deduce the exponential growth curve from first principles.

All we can do is try to obtain z and N separately from the historical
record, and from them compute the GNP as a function of time. Rick, is that
information in the Statistical Abstracts?

Pause.

Best,

Bill P.

106

[From Bill Powers (2000.09.09.1910 MDT]

Rick Marken (2000.09.09.1710)--

Now I think you
can see what I was getting at; TCP didn't derive the effect of
leakage on growth rate from first principlces; he just _assumed_
that it occurs.

Yes, I do see that now.

I think TCP's major contribution was his conception of the
circular flow: the composite producer must be paying the
composite consumer enough to buy PQ and, thus, pay back the
costs of production.

Actually that's a standard diagram in macroeconomics, I think. The
principle is contained in Say's Law (see p. 87) which says "Production
creates not only the supply of goods, but also the demand for them." In
economics, Demand means, as I understand it, money spent on the goods, not
just a "desire" for goods. If the money isn't spent, there's no demand (so
Demand is a technical term and should not be confused with the
common-language term that is spelled and pronounced the same way). Say's
Law therefore says that production creates the goods and also the money
with which to buy them.

But he didn't have a model of how this
process worked. That's where we come in; we have to implement
a reasonable circular flow model and see how various composite
variables (undistributed corporate profits, savings, etc)
influence important variables in the model, like growth rate,
inflation rate, etc.

Yes. I'm beginning to get a handle on the problem with N, the size of the
workforce. If you just increase N, you increase both the payments to
workers and the amount of goods produced, by exactly the same amount. The
economy grows by the same rate of growth as N, even with constant
productivity.

What my model is missing is any limit on the _daily_ payments to labor.
This is what allows N to be increased arbitrarily -- the _daily_ payments
increase with N, but the money paid out in a single day doesn't exceed the
savings I started with, so the new workers are automatically hired on and
paid and start producing more Q (and buying it at the same time). Since
they're buying the new Q, there is enough money to pay back the producer
savings account exactly the amount spent. I don't mean there is _really_
enough money magically appearing. It's just that the way I mistakenly set
it up, this appears to be happening.

What we need is a production _budget_, an amount of money set aside to pay
the costs of production every day. Once we have that it will no longer be
possible to add new workers arbitrarily, because unless some financial
controller changes the labor budget there will be no money to pay new workers.

This inches us toward accounting for the source of new money. The financial
controller can't budget more money for labor unless there is a source of
extra money. There may be ways to generate extra money through changes in
productivity and prices, but clearly one way would be through borrowing.
And that is a realistic way -- companies often borrow to expand production.
Once extra money is available, it can be injected into producer savings
from outside the circular flow; the financial manager can then use the
extra money to increase N, the size of the workforce. This will increase Q
and simultaneously increase the buying power by enough to buy the extra
production.

Somewhere along the way we can finally introduce leakage. Leakage will
create a shortage of money for the production budget, and it will have to
be made up somehow. Probably by borrowing.

I think that's the general direction we should take. We still lack a reason
for increasing N, B, and Q, but I think we will find that along the lines
you have already started exploring: the consumer's control systems for
obtaining Q by working.

Incidentally, CNN headline news yesterday included the observation that
consumer savings has recently been 4.4%. They didn't mention what corporate
savings were.

All we can do is try to obtain z and N separately from the
historical record, and from them compute the GNP as a function
of time. Rick, is that information in the Statistical Abstracts?

I don't believe that we should go into the model assuming that
growth in Q is determined, open loop, by zN. I think Q must
be part of a closed loop process.

I agree. But changing zN is the means by which Q can be changed. When we
get the consumer control systems into the model, we will find an error
signal, Q* minus Q, which is the basis for somehow notifying the composite
producer that it would be profitable to borrow enough new money to increase
N and thus produce more Q. The productivity, z, I assume will increase sort
of automatically, in the background, which may also make it possible to
increase N. I haven't worked that out yet.

I can't help thinking that,
if we do the model right, we should be able to predict things like
growth in Q and the effect, if any, of leakage on growth, from
first principles: the principles on which the model is built.

Right. I think we'll make some progress in that direction. Bill Williams
has promised to send me his analysis of Keynesian economics; I may help him
with modeling that, or recruit him into this effort, or both.

One step at a time, just like that other outfit.

Best,

My name is Bill and I'm a modeler.

107

[From Bill Powers (2000.09.10.0418 MDT)]

Rick Marken (2000.09.09.2000)--

I think TCP's major contribution was his conception of the
circular flow: the composite producer must be paying the
composite consumer enough to buy PQ and, thus, pay back the
costs of production.

Also, I would add the concept of composite entities, which completely
replaces any idea that a national economy is simply a scaled-up version of
a family economy (as Keynes, or his followers, thought). On the national
scale, the composite consumer does not work hard and save for old age, then
retire while using up the savings. Those processes are going on
simultaneously, all of the time, because there are people at all stages of
their economic lives at the same time. The same goes for the composite
producer: producers are at all stages of their economic existence at the
same time, issuing stock, redeeming bonds, borrowing, repaying loans,
expanding, and going bankrupt.

TCP also insisted that all parts of the circular flow are in existence at
once, though he was, I think, mistaken about insisting that effects are
transmitted instantaneously around the loop (p. 89). I believe that all
delays from a day or two to a year or two exist at the same time, so that
the transfer function around the loop would show a steeply rising wavefront
that peaks early and then tails off more slowly (the impulse response).
With simulation techniques it isn't hard to incorporate such distributed
delays into a model, though I think it's much too early to worry about that
kind of detail.

···

------------------------------------------------------
I'm concerned right now about what determines N, the size of the workforce.
It's always been a mystery to me how unemployment can exist at all without
mass starvation, bodies lying in the streets, and so on. Somehow even
people with no incomes manage to stay alive, so somebody is giving them (or
they're stealing) food and shelter and other things. Macroeconomics is not,
cannot, be concerned with distributions of wealth and other such
microeconomic matters, so the main import of this fact is that the whole
population is in one way or another supported by Q. Some people work to
produce Q; everyone in the nation consumes Q. There are really two N's to
consider: the total population, and the workforce actively involved in
producing Q. I suggest Nt and Nw to designate these populations. Maybe we
will need an Nk to designate recipients of capital income -- drones like me.

The productivity of the workforce is defined as z = PQ/Nw (OK if I drop
those pesky primes?). See page 90. Note that there are two ways to increase
productivity. One is to increase Q while maintaining the same workforce;
the other is to maintain the same Q while reducing the workforce. Either
way, the individual worker must produce more Q with no increase in cost to
the producer per unit of Q. When we model this, of course, we will find the
same problem as usual: if more Q is produced but the workforce is not paid
more, who is going to buy the product at the existing price? The only
permanent way to keep inventory constant is to reduce the price or increase
wages.

I think the next thing to do is figure out how the money supply affects
growth. If money were simply provided as needed, the producer could
increase Nw (hire a larger proportion of the population), pay them at the
going rate, and produce more in proportion to the new size of the
workforce. The only limit on Nw is the fraction of the population willing
and able to work. As I found in the simulation, the result is a perfect
compensation: the circular flow remains in balance no matter what Nw is. If
you can explain where the money comes from to pay the new hires, the
expansion of the economy follows automatically, although there is nothing
to say it has to be exponential. The workers themselves do not experience
any _per capita_ expansion from hiring more workers, since wages and per
capita consumption are unchanged, but remembering that Nw workers support
Nt consumers, we can see an improvement in the _national_ economy.

Let's assume not only that there is no leakage for the time being, but that
the composite producer can borrow money freely at no interest. This means
that the only limits to increasing Q are set by (a) how many people are
capable of working and want to work, and (b) how much Q can be produced,
which depends in large part on the amount and efficiency of production
machinery, transport, storage, and so forth. If we assume that everyone who
wants a job has a job (full employment), the only limit to growth is how
fast productivity can be increased and how fast the general population Nt
is growing, assuming that a constant proportion of Nt will want jobs (I
guess we're also ignoring the problem of limits on natural resources, for
the time being).

Suddenly I find myself right back with TCP, because these must have been
his basic assumptions whether he said so or not. I have forgotten many of
the stepping-stones that led to PCT; I am sure that TCP forgot how he
arrived at many, if not most, of his insights, by the time he was in his
90s and working on the last draft of _Leakage_. He assumed that the money
required would simply show up. I now see that this is because he was first
treating the case in which there were no monetary restrictions. If you
wanted to expand production by hiring more people and acquiring more
machinery, you just borrowed the money and did it: borrowing the money
costs nothing if there are no monetary restrictions at all. There is
nothing to limit expansion, then, but the speed with which the composite
producer can learn to produce more Q per worker and get it to the consumers.

And that is very much higher than the rate at which the economy normally
expands -- from the data, TCP estimated it at over 13 percent per year. Why
doesn't it expand that fast? Because (1) money is not free, (2) some money
is lost from the circular flow, and (3) there are limits on the rate at
which new workers can be brought into the workforce.

So I think we're closing in on the basic "plant" model. As I said, the next
step is to see how adding a cost of new money interferes with increasing
the size of the workforce. It might also interfere with spending money to
increase productivity, for productivity isn't only a matter of getting new
ideas; it's also a matter of building and putting into service the tools
that enable either the same or an expanded workforce to produce more Q per
worker. I'm beginning to think we will not end up straying too far from
TCP's conclusions. But the difference will be that we will record all of
our assumptions and how we got to them!

Best,

Bill P.

108

[From Bill Powers (2000.09.10.2033 MDT)]

Rick Marken (2000.09.10.1920)--

I would also add (4) there are limits to the rate at which the
desire for more Q can increase. I don't believe Q would grow
at an arbitrarily high rate if money were free, no money were
lost from the circular flow and you could increase the workforce
arbitrarily. As you've noted yourself, people only want so many
goods and services: toasters, ovens, cars, houses, massages. If
the economy were producing so that Q consisted of 1000 of each of
these goods and services per capita and there were enough demand
to buy all of Q (B = PQ) I don't believe that all of Q would be
bought (too bad we can't run the experiment). I can't think of a
way (off the top of my head) to test to determine whether Q
is controlled; buy I think it must be.

I think there's something called the "marginal propensity to consume,"
which expresses the fact that demand falls off at high rates of
consumption. We would take that as an indication that Q is approaching a
reference level. But Q, we have to remember, consists of _all_ products,
and people want different amounts of different products. Also, the
distribution of income is such that while a few people actually have as
much as they want of many different kinds of Q, a great many people never
get even as much as they need.

On the average, which is what we have to deal with in macroeconomics, we
live in a scarcity economy. Many people find it difficult to get basic
things like tolerable housing, nutritious and sufficient meals, health care
when they're sick or hurt, warm clothes for themselves and their children,
and so on down a long list of things that we privileged few take for
granted because they absorb so little of our income. To those basic things
we have to add the products that people like to buy because they're
interesting, or fun, or symbolic of belonging to a group, or useful for
escaping from long boring hours with nothing to do, even though they
contribute little or nothing to survival.

So it isn't surprising that it may seem that people would want an unlimited
amount of goods and services. That impression is an exaggeration, of
course, but if you've never seen the population in a state where it
actually had close to what it wanted, it might seem that way. What we can
say is that by and large, people want considerably more than that have.
When we model the Q control system in the composite consumer, we're going
to have to set Qref a lot higher than Q has ever been, at least for some
kinds of products.

As you indicate, desires for new things increase with time, but for many
specific things (like Cabbage Patch dolls) the desire also wanes. I think
it wanes not just because the reference signal relates to newness per se,
but because what people thought they might get from the new Q is not
actually obtained. People try many new Qs because they are looking for
things like respect, love, peace of mind, confidence, and security that
salesman say these things will provide. Of course the chances are not very
great that a new good or service will provide such things, so when the new
Q fails to achieve the purpose, it is discarded or not replaced when it is
used up or wears out.
And the poor consumer goes on looking for the magic good that will make him
happy.

Because of these and other considerations, I'm not sure we can have a
wholly sucessful model based on a sort of average Q. We could construct
one, of course, and it would do some realistic things, but human behavior
will be very different in relation to different kinds of Qs such as food,
which is mandatory, aand movies, which are optional. What I see down the
road is a model involving fairly large arrays of consumers with a range of
reference signals relating to a range of different kinds of Q, It's really
no harder to model 1000 control systems than it is to model one. And of
course we would need arrays of producers, too, involved with different Qs.

But I'll be happy to leave that to others. The most interesting part of
this for me is getting the basic concepts worked out -- laying out the
field of study and the approach, as it were (although I expect that the
existing field of study contains a lot that a modeler needs to pay
attention to).

Best,

Bill P.

109

[From Bill Powers (2000.09.11.1248 MDT)]

Rick Marken (2000.09.11.0840)--

On the average, which is what we have to deal with in
macroeconomics, we live in a scarcity economy.

All I was pointing out was that the model must have a reference
for Q; Q (or some function of Q, like PQ in my model) must be
a controlled variable, not an output that is generated open loop.

I agree that the consumer must have a reference for Q. What, however, is
the composite consumer's means of affecting Q? The immediate means is to
spend money, but to get that money the CC must devote a certain number of
hours of work to producing Q -- or at least, some fraction of the CC must
do this, the fraction that does not live on capital income. As I've been
setting up the situation, the Q that is produced is strictly a function of
the size of the workforce, Nw, and the productivity, z (to adopt TCP's
symbol for it). Q as plant output can't be altered directly; it can be
altered only through changing Nw or z or both. If we take TCP's assumption
for now, productivity simply increases exponentially with time, so it's not
a function of other system variables. That leaves Nw, the size of the
workforce, as the only means of deliberately altering Q. So which is it, CC
or CP, who can alter Nw at will? I'm still mulling that over. CP can
obviously do it by hiring more workers, but at the same time there have to
be potential workers willing to be hired at the going wage. And there is a
limit on the number of workers available to be hired: some fraction of the
total population, probably between 20 and 50 percent.

Just at the moment, I'm looking at the constraints on CP's hiring of more
workers. If money is freely available (it can be borrowed at 0% interest),
CP can hire more workers right up to the number available, borrowing the
money necessary to meet the first expanded payroll and expanding the
physical plant to support their work, and then circulating that money
through the workforce and capital income recipients back to itself via the
selling of the increased Q. Through the route of capital income, which
includes profits, this raises the managers' income as much as possible. In
the background there is a continuing conflict over the relative size of
wages and capital income, but we can just assume the ration after
government redistribution that TCP observed: 40 for K, 60 for W.

Looking ahead a little, if the interest rate is not 0%, then a cost is
incurred by borrowing to hire more workers, and that cost is paid to
repicients of capital income (in this case, interest) but _not_ to wage
earners. So interest on borrowed money can't be used to increase
production. I don't know where that fragmentary idea leads, yet.

If you want to work on the Q control system, the question that needs an
answer is how an error in Q gets converted into an increase or decrease in
Q. The answer isn't obvious -- how does a CC who wants more Q get the CP to
produce more Q? This boils down to asking how CC can influence the number
of workers that CP hires, or the productivity of CP's physical plant. Do we
assume some information channel here whereby the CP can learn that the CC
would or would not buy more Q if more were produced? Can this be signaled
by the CC doing something that runs the inventory of Q down to zero? And
just what, under the current conditions, would that be? CC can't buy more
unless CC is paid more; CC can't be paid more unless the workforce is
increased.

There seem to be some missing relationships here.

By the way (another fragmentary thought), the amount of money actually
circulating can be quite small in comparison with the amount that changes
hands in, say, a year. I think there's a term for this: "velocity." It's
how long it takes money to make its way all around the circular flow. In
our model, we can pick dt to have any size we want -- for example, one
second. Just on the face of it, the money would then seem to circulate
around the loop every second. If we set dt to one day, it would circulate
once a day -- and 86,400 times as much money would be required, the number
of seconds in a day. So we must look for the physical constraint on the
flow and incorporate that into the model in such a way that the amount of
money required to be in circulation becomes independent of our choice of
dt. The way to do this may be to set a fixed number of transactions that
can happen in a day (or any standard time period). Then if we choose a
smaller dt, the number of transactions that occur during dt becomes
correspondingly smaller. I don't see how to do this yet.

Your reaction that a scarcity economy is dysfunctional is sort of beside
the point if the economy we're modeling is actually of that kind. Why
should the economy keep growing? The apparent tendency to grow without
limit may be dysfunctional in itself; when cells do that we call them
cancerous. I was trying to point out that "without limit" may simply be a
misinterpretation, since we have never observed the real system except in a
state of large error. If the errors ever came close to zero, we would have
a steady-state economy, which would grow in the sense of becoming more
satisfactory, but probably not in the sense in simply getting bigger,
faster, and more frantic. In fact true "growth" (of satisfaction) would
involve increasing productivity and decreasing time spent "working" (doing
things you don't like in order to get money).

However, the model itself isn't affected by the size of the error. If you
set the reference Q lower, the error will be smaller or zero, or even
negative -- pick the value that fits the data.

I don't know about you, but with respect to this model I'm still in a state
of reorganization, with more problems than answers.

Best,

Bill P.

110

[Martin Taylor 2000.09.07 20:52]

[From Bill Powers (2000.09.05.0810 MDT)]

It is the axiomatic requirement that the producer sell all that is produced
that makes this control system a necessary property of the composite
producer. There is no viable business that _consistently_ sells either more
or less than it produces. But neither is it a law of nature that
businesses, even in the aggregate, be viable. In fact, there can be a
difference between the amount sold and the amount produced only as long as
inventory is increasing or decreasing, neither of which is a long-term
option for a composite producer that can survive.

I've been lurking on this thread very occasionally, and I can't
comment on the equations. But this statement seems to illustrate what
seems to me to be a fundamental problem with the approach. Maybe my
skimming has been too superficial and I'm way off base. But here's
what seems to me to be a crucial question:

   What is it that is produced, what is it that is sold, and what is
it that is bought in a transaction?

That question is critical to the truth or otherwise of Bill's comment
that a business cannot consistently sell either more or less than it
produces.

It's a more subtle question than appears on the surface. If one
thinks of physical objects, it is true that inventory cannot go to
infinity or below zero. But are physical objects what is produced,
sold, and bought? Usually not. What is produced is some kind of
structure--perhaps a physical arrangement of metals, ceramics, holes,
gears, wires, and links, perhaps a set of words in a particular
arrangement, perhaps an idea for how to manage a business. What is
sold is a related structure, but not the same. The physical object
may be the same, but whereas a car producer produces an object with
certain horsepoer and cylinder displacement, the car sold may be a
car with a certain colour scheme and upholstery. And the car bought
may be an indicator of wealth and status. These are not the same
thing at all. All the care that the engineer puts into designing the
car (and for which he, as part of the composite producer, is paid) is
of little consequence to the seller who shows the customer the
comfortable upholstery and the elegant colours, and neither is what
is bought.

The point is that there is usually more produced than is sold, and
more sold than is bought, but there may be elements of what is bought
that were not part of the _structure_ that was produced. On average,
however, less is bought than was produced.

What is the inventory of saleable ideas, that cannot increase or
decrease in the long term? There are more ideas all the time, but
usually the monetary value of an idea tends to decline over time. One
can't deal only in a circular flow of money. One has to deal with the
counter-flow of produced, sold, and bought structure, and one has to
recognize that there is a major non-monetary input to the system in
the form of raw mineral and energy resources, without which both the
circular flow of money and the counter-flow of structure would stop.

Maybe all these considerations have been taken into account, but I
don't remember seeing them in the discussion.

Martin

111

[Martin Taylor 2000.09.08 11.11]

[From Bill Powers (2000.09.08.0448 MDT)]

in response to Martin Taylor 2000.09.07 20:52]

... Whatever a
customer may derive from the purchase of a good other than the good itself,
the inventory declines by the same amount and the producer receives the
same payment. This is true even when the good is, as you suggest, an idea
rather than a tangible thing or act of service.

I don't see the inventory of "idea" declining when the creator of the
idea has been paid. That was one of the points I intended to make.
Another customer can also pay for the same idea, without extra
creative effort on the part of the idea-maker (see "management
consultant").

I appreciate the point that numeric dollars paid by the customer
equals numeric dollars received by the seller, and that sellers of
one good are customers of another. But it seems to me that value has
to enter the equations somewhere. There are customers who receive
value for no money (nobody pays the Earth cash for the privilege of
acquiring raw materials from it, or the Sun cash for acquiring
energy). Likewise there are sellers who have paid for value that no
longer exists--a rusted out car, for example. And, as I said and you
agreed, the value the producer puts into something is rarely the
value the customer is paying for. (I argue also that the value the
customer pays for averages less than the value the producer puts into
a concret or abstract structure).

If I read you correctly, you are saying that these statements are
true but irrelevant to the analysis you and Rick are doing. Unless I
take the trouble to go over your analyses, I must take your word on
that. But just from a first-principles point of view, it does seem to
me that economics should be an issue of the creation and destruction
of value, at least as much as it is a question of the transmission,
circular or otherwise, of money.

To me, the circulation of money is to the economy much as the
circulation of working fluid in a refrigerator is to the operation of
the fridge--it's a critical part of the engine, but it isn't the
whole works. The fridge needs a motor with energy supplied from
somewhere, and that energy is what allows the energy to be extracted
from the air and perishables being stored in the fridge. You can't
analyze the fridge without considering the circulation of the fluid,
but there's more to it than that.

Anyway, I'll probably bow out of the discussion again right here.
It's just a thought I wanted to get niggling at the back of some
minds. And maybe it isn't really relevant at all.

Martin

112

[Martin Taylor 2000.09.10 13.42]

[From Rick Marken (2000.09.09.1710)]

I think TCP's major contribution was his conception of the
circular flow: the composite producer must be paying the
composite consumer enough to buy PQ and, thus, pay back the
costs of production.

TCP may have come to this notion independently, but it was hardly
novel. It was implicit throughout Bagno's 1955 IRE paper, and
explicit in my Bachelor's essay of 1956 that was based largely on
Bagno. You can see both of them at
<http://www.mmtaylor.net/Economics/index.html&gt;\. I think you will find
also, if you go through Bagno's paper, that he explains where leakage
comes from, though it is in a language of which you seldom approve.

Martin

113

[From Rick Marken (2000.09.13.1100)]

Me:

I think this is where we have to remember that the composite
consumer and producer are really the same entity; a composite
controller.

Bill Powers (2000.09.12.DTR)--

I think I'll put off adopting that idea. They may contain
many of the same people, but they aren't performing the same
functions. The CP is engaged in taking in raw materials and
generating goods and services, for the purpose of creating
capital income (i.e., profit). The CC consists of all people
with income of any kind, who use that income to purchase
goods and services for their own benefit, survival, and
pleasure. The CC consists mostly of non-owners; the CP
consists mainly of non-workers. Each has to contain some
of the other, but the interests of the two groups are
different, and to a large extent they conflict. Corporate
reference levels are different from consumer reference
levels.

I think you are getting into micro economic issues here. In fact,
the CP includes everyone contributing in any way to production of
GNP; and that's nearly everyone (profit is just wages for rich
people remember). The CC does include many people who are not
directly contributing to production of GNP (housewives, retirees,
etc) but the overlap (of CP and CC) is significant and, more
important, the stuff produced by the CP is produced for the CC

The relevant part of the CC is those who Consume GNP. So I don't
thinK the interests of the CC and CP are different; that may be
true at the microeconomic level where the "CP" is owners of
industry who have more interest in making megabucks than in doing
what is best for the consumer ("CC"). But at the macro level,
this conflict is just an invisible part of how the CP/CC produces
GNP for itself.

But we can worry about this stuff later. I now think that your idea
of having the CP add Q to a pool (INV) that is bought down by the
CC will be a significant improvement over the TCP model. I think
your current "plant" equations are on the right track. I think we
might also consider having CP add B to a pool (SAV) that is drawn
down by the CC to purchase INV. The amount of INV bought down should
depend on the amount available in SAV and how much of INV the CC
wants.

Anyway, I'll try to work on something this weekend.

Best

Rick

···

---
Richard S. Marken Phone or Fax: 310 474-0313
MindReadings.com mailto: marken@mindreadings.com
www.mindreadings.com

114

[From Bill Powers (2000.09.13.1310 MDT)]

Rick Marken (2000.09.13.1100)--

But we can worry about this stuff later. I now think that your idea
of having the CP add Q to a pool (INV) that is bought down by the
CC will be a significant improvement over the TCP model. I think
your current "plant" equations are on the right track. I think we
might also consider having CP add B to a pool (SAV) that is drawn
down by the CC to purchase INV. The amount of INV bought down should
depend on the amount available in SAV and how much of INV the CC
wants.

That's my man. Appended is the source code tending toward this end. It even
includes an inventory controller; also both population and productivity
increase slowly but exponentially over time. I'm using new numbers, such as
1000 workers each making $25,000 per year, and new prices and
productivities that give ball-park realistic numbers. I don't know what to
make of the results -- this is strictly a stab at moving on by a small
step. There's no reference Q in it yet, either. I don't know why the
numbers settle down, or why there's a negative PS, or anything else, yet.
I'm still at the stage of running the model over and over and trying to see
what's going on.

Best,

Bill P.

···

==============================================================================
program circfl2;

uses dos, crt;
var P, P0, Q, B, BD, PS, CS, M,
    w, INV, t, dt, debt, interest,
    z,popgrowth, prodgrowth, Nt, Nw, Nwmax, dNw,dNt: real;
    tt: integer;
    ch: char;

begin {"kb" = kilobucks}
clrscr;
t := 0.0;
tt := 0;
dt := 1.0/365.0; { Iteration time is one day}
PopGrowth := exp(dt*ln(1.02)); {daily growth rate}
ProdGrowth := exp(dt*ln(1.03)); {daily productivity growth}
CS := 1e5; { initial consumer savings}
PS := 1e5; { initial producer savings}
INV := 1e5; { Initial inventory}
Nw := 1000.0; { Number of workers}
Nt := 5*Nw; { Total population }
w := 25000.0; { Yearly wage per worker, kb}
P := 10.0; { Price per good, kb}
P0 := 10.0;
z := 4.175e3; { Productivity, goods/worker-year}
Debt := 0.0;
t := 0.0; { time counter}

while not keypressed do
begin
  B := 1.67*w*Nw; {Yearly cost of labor}
  PS := PS - B*dt; {Decrease producer savings by daily prod. cost}
  CS := CS + B*dt; {Increase consumer savings by daily prod. cost}
  Q := z*Nw; {Yearly production rate}
  INV := INV + Q*dt; {Add daily production to inventory}
  if INV > B*dt/P then {If surplus in inventory,}
   begin
    PS := PS + B*dt; { Add B/P*P (= B) to producer savings}
    CS := CS - B*dt; { Decrease consumer savings by purchases}
    INV := INV - B*dt/P; { Reduce inventory by purchases}
   end
  else { else shortage of inventory}
   begin
    PS := PS + INV*P; { Sell all that is left at price P}
    CS := CS - INV*P; { Deduct purchase from consumer savings}
    INV := 0.0; { Set inventory to zero}
   end;
  if CS < 0.0
   then CS := 0.0; { No consumer debt yet}
  {---------------------------------}
  z := ProdGrowth*z; {change in productivity per day}
  Nt := PopGrowth*Nt; {Change in total population per day}
  Nw := 0.2 * Nt;
  if t = 0.0 then
  begin
   gotoxy(1,1);
   write('Initial std of living = ',Q/Nt:8:4);
  end;
  gotoxy(1,2); writeln(' t = ',t:8:3, ' years');
  t := t + dt;
  inc(tt);
  if (tt >= round(1.0/dt)) then
  begin
   gotoxy(1,3);
   writeln(' P = $',P:8:3,' per Q');
   writeln(' Q = ',Q*1e-6:8:3, ' millions');
   writeln(' B = $',B*1e-6:8:3,' millions');
   writeln('Nw = ',Nw:8:3,' workers');
   writeln('PS = $',PS*1e-6:8:3,' millions');
   writeln('CS = $',CS*1e-6:8:3,' millions');
   writeln('IN = ',INV:8:0,' units of Q');
   writeln('Std of living = ',B/P/Nt:8:4,' Q per capita');
   tt := 0;
  end;
  P := P + 1e-8*(10.0 - INV); { control of inventory via price}
  delay(2);
end;
ch := readkey;
gotoxy(1,20);
writeln('Press key to exit');
ch := readkey;
end.

115

[From Kenny Kitzke (2000.10.10)]

Rick, I have not seen too much lately from you on your composite economy
model. Are you still working on it?

As I have previously indicated, I think it is an effort in futility. And, I
do not want to debate that with you. However, for those who may want to
pursue this, or for your own understanding and challenge, I have observed a
number of interesting phenomena that I would think your model would address
and hopefully explain. If you have already addressed these issues, I am
sorry. I generally give this thread a "delete."

1) In 2Q 2000, American worker productivity rose at 5.7%, making the annual
gain of 5.2% the fastest annual rate in 17 years. How does this remarkable
fact relate to other economic factors such as capital investment and interest
rates according to your model of the macro economy?

2) This strong 5.7% gain in 2Q 2000 productivity pushed unit labor cost down
0.4%. What would your model predict? Is this a clear sign of greater
profitability and a higher living standard for those in this economy?

3) The Federal Reserve has raised interest rates six times since June, 1999,
supposedly to slow economic growth. The opposite seems to be happening.
What does your model predict and explain about this phenomenon?

4) The Administration claims that the rise in productivity has come because
of elimination of budget deficits and lower interest rates which has allowed
businesses to invest in productivity enhancing equipment. Does your model
either confirm or deny this contention?

5) As big as the US economy is, it is still the tail on the global economy.
Why do you think you can accurately model the US economy independent of this
global economic reality?

6) The US is running the greatest trade deficits in history? How is this
reflected in the model?

7) When the US gives foreign aid (loans or gifts) to other countries, is
this leakage until and unless repaid?

8) A retired man grows his own vegetables, and even gives his excess away
free to his neighbors. How would this affect the model when millions of
Americans do this?

9) Some people give as much as 25% of their income away to charities. How
would this impact the macro model?

10) Many people provide labor and expertise to the unfortunate at no charge.
How do such activities impact the model as compared to charging them?

I have a bunch more, including on record unemployment levels. I will defer
that waiting for answers to these questions. If you already have any
comments regarding unemployment levels and how they fit into the model,
please advise.

kenny

116

[From Rick Marken (2000.10.10.1812)]

Kenny Kitzke (2000.10.10)

Rick, I have not seen too much lately from you on your
composite economy model. Are you still working on it?

Yes, indeed. But I have been sidetracked on another project.
I'll be back.

As I have previously indicated, I think it is an effort
in futility.

It's getting to seem that way to me too.

However, for those who may want to pursue this, or for
your own understanding and challenge, I have observed a
number of interesting phenomena that I would think your
model would address and hopefully explain.

I think these are very interesting observations and I'll try to
address them all. But be aware that the model is in process so
it's not exactly the same as the model I presented at the meeting.
The basic circular flow concept remains but there will be some
important changes in the "environmental" side of the model.

Anyway, here's my take on your questions based on my current
understanding of the circular flow model and the US economic
data.

1) In 2Q 2000, American worker productivity rose at 5.7%,
making the annual gain of 5.2% the fastest annual rate in
17 years. How does this remarkable fact relate to other
economic factors such as capital investment and interest
rates according to your model of the macro economy?

According to the model and the data, the _amount_ of capital
investment (which is empirically a constant proportion of GNP)
has nothing to do with productivity. Worker productivity probably
depends on _qualitative_ aspects of capital investment; the quality
of the training and technology that workers use to produce Q. There
is currently no connection between worker productivity and interest
rates in the model.

By the way, if productivity is Q/N (output/size of workforce) then
annual growth in GNP (dQ/dt, which was 5.2% in 2Q 2000) must
be largely the result of increased productivity if the workforce
(N) is relatively constant (which it has been for the last 3
months). If this is true, then what seems remarkable to me is the
fact that growth in GNP (5.2%) was _less than_ the growth in worker
productivity (5.7%) over those three months. Or is the measure of
productivity to which you refer something other than Q/N?

2) This strong 5.7% gain in 2Q 2000 productivity pushed unit
labor cost down 0.4%. What would your model predict?

About what?

Is this a clear sign of greater profitability and a higher
living standard for those in this economy?

Not really. If unit labor cost is really down, then workers are
paid less (as proportion of GNP) and, thus, are able to buy less
of what is produced (as proportion of GNP); this would then be
decreasing their standard of living. If profits as a result of
lowered unit labor cost, then the only standard of living being
increased is that of the small portion (1% ?) of the population
that gets most (50% ?) of this profit.

3) The Federal Reserve has raised interest rates six times
since June, 1999, supposedly to slow economic growth. The
opposite seems to be happening. What does your model predict
and explain about this phenomenon?

The Fed is not the only source of leakage; the model says that
there are two sources of leakage; the Fed (rho leakage) and unspent
income (alpha leakage). So if Fed activity increased rho leakage,
a large offsetting decrease in alpha leakage could keep growth
increasing at a good clip.

4) The Administration claims that the rise in productivity
has come because of elimination of budget deficits and lower
interest rates which has allowed businesses to invest in
productivity enhancing equipment. Does your model either
confirm or deny this contention?

No. The model doesn't really deal with worker productivity yet.
But I don't believe elimination of budget deficits or lower
interest rates would affect productivity. These variables _might_
have an effect on economic growth, however, to the extent that
they reduce leakage.

5) As big as the US economy is, it is still the tail on the
global economy. Why do you think you can accurately model the
US economy independent of this global economic reality?

I don't think I can. Eventually, the global economy will have to
be taken into consideration. But the fact is that less than 5%
of the US economy is global; the Japanese economy is a different
story; global trade is probably as much as 50% of their GNP.

6) The US is running the greatest trade deficits in history?
How is this reflected in the model?

It's not reflected at all at the moment. These trade deficits are
big in an absolute sense but relative to GNP they are pretty small.
But I agree, they must eventually be taken into account.

7) When the US gives foreign aid (loans or gifts) to other
countries, is this leakage until and unless repaid?

Yes.

8) A retired man grows his own vegetables, and even gives
his excess away free to his neighbors. How would this affect
the model when millions of Americans do this?

It would have no effect at all on the model; the model deals
only with the _legal_ money economy. To the extent that free
giveaways make up a significant portion of Q then that would
affect the fit of the model to the data.

9) Some people give as much as 25% of their income away to
charities. How would this impact the macro model?

It reduces leakage. But this kind of charitable giving makes
up a _very_ small portion of GNP -- much less than 1%, I think.
So it's not going to make a big difference in the amount leaked.

10) Many people provide labor and expertise to the
unfortunate at no charge. How do such activities impact
the model as compared to charging them?

Such labor increases Q without increasing P. Since the economic
measure of production is PQ, if free labor is a big contributor
to Q then our estimates of Q based on PQ will be off, and this
will reduce the accuracy of the model.

I have a bunch more, including on record unemployment levels.
I will defer that waiting for answers to these questions.
If you already have any comments regarding unemployment
levels and how they fit into the model, please advise.

In the model, unemployment, like growth, depends on leakage.
According to the model, unemployment is relatively high now for
the same reason that growth is relatively high: low leakage. Rho
leakage is low because the Fed has kept reserves pretty low since
about 1993. I don't know why alpha leakage is low but there is
record low "personal savings", which is one component of alpha
leakage, according to TCP; so that's part of the reason. I have
no idea why personal savings have been decreasing.

Best

Rick

···

--
Richard S. Marken Phone or Fax: 310 474-0313
Life Learning Associates e-mail: marken@mindreadings.com
mindreadings.com

117

[From Rick Marken (2000.10.10.2200)]

Me:

the fact is that less than 5% of the US economy is global;
the Japanese economy is a different story; global trade is
probably as much as 50% of their GNP.

Bruce Nevin (2000.10.10.2342 EST) --

Does that include producers of Q in the US economy who
reside outside the US, associated (relatively low) costs
of production, etc.?

I think those producers are included in GNP, not in GDP.

Looking at the data, however, I see that one's estimate of the
proportion of the US economy (GNP) that is "global" depends on how
one defines the global part of economy. If one counts "total imports
and exports" as the global economy, then the proportion of the
economy that is global is considerably more than 5%. In 1960, total
imports and exports were 9% of the economy (GNP); in 1998 they were
23%. So, given this measure of the global part of the economy, Kenny
is right: the global economy is a large part of the US economy and
it has become a very large part in the last 30 years.

What I was thinking of when I guessed that only 5% of the US
economy is global was the _trade deficit_ (or surplus), which is
simply $ value of exports - $ values of imports. In 1960 we had
a trade _surplus_ ($ exports > $ imports) which was only 0.5% of
the economy. In 1998 we had a trade _deficit_ which was 2% of
the economy.

I think the trade surplus/deficit is what makes a difference to
the economy. If the deficit/surplus is 0 (perfect balance of trade)
then its as though whatever is imported was made in the US because
the exported part of GNP was used to "produce" it (in the sense that
the same proportion of GNP arrived at US docks as left those same
docks).

So assuming that the trade deficit/surplus is the "global" part
of the economy that matters to the behavior of the US economy, the
global economy represents only about 2% of the US economy. That
doesn't mean that this aspect of the global economy is economically
unimportant, especially when a 2% difference in growth rate
(3% vs 5%, say) is considered economically significant. The trade
deficit/surplus should be included in the model, and it will.

Best

Rick

···

---
Richard S. Marken Phone or Fax: 310 474-0313
Life Learning Associates e-mail: marken@mindreadings.com
mindreadings.com

118

[From Bruce Nevin (2000.10.10.2342 EST)]

Rick Marken (2000.10.10.1812)--

···

At 07:19 PM 10/10/2000 -0800, Rick Marken wrote:

the fact is that less than 5%
of the US economy is global; the Japanese economy is a different
story; global trade is probably as much as 50% of their GNP.

Does that include producers of Q in the US economy who reside outside the US, associated (relatively low) costs of production, etc.?