A Short Course in Economics
3. Crusoe Economics
Austrian economics builds up
from the economics of the individual. Typically,
the individual is called Crusoe, a man stranded alone on a desert island after
a shipwreck. He represents a man with
only land (the natural resources) and labor (his time and energy); no capital
goods.
At the top of Crusoe’s value
scale will be finding food to eat now and a reliable source of food for the
future. With no capital goods, he has
only what nature provides. Suppose he
finds some berry bushes which he can pick to provide him with sustenance. The picking of the berries is a simple act of
production: he uses his labor and what nature provides (the berry bush) to
transform them into a consumers’ good, the berries.
Time is limited, and time
for rest and leisure is essential. Let
us suppose that Crusoe decides that he will spend 10 hours per day producing
berries, with 14 hours for leisure.
Suppose that he can produce 20 berries per hour and requires 200 berries
per day for sustenance.
In this situation, it is clear
that Crusoe will be consuming 100% of the berries he produces; none are
saved. He will be able to satisfy only
his most valued end, the consumption of berries. There is no time left for other activities.
As a human being, Crusoe
seeks to produce the maximum product he can with his available means. Man is always looking for ways to become more
productive, so that he can either reduce his labor costs or increase his
consumption.
Suppose that Crusoe has an
idea that if he were to use a stick to shake the branches of the berry bush, he
could increase his productivity. But
first he needs to find/make an appropriate stick. Assuming that he does not want to reduce his
leisure time, in order to make the stick Crusoe will need to temporarily
restrict his consumption, since he will not have time to produce the same
number of berries (200).
What are the considerations
that Crusoe will make when deciding whether it is worth diverting his labor into
make the stick?
- Expected increase in productivity – how many
berries per hour will he be able to produce with the stick?
- Durability – how long will the stick last?
He calculates, or forecasts, that it will take 10 hours
to find and make an appropriate stick. Therefore
he must forgo 200 berries, because for 10 hours his labor will be diverted
from berry production to stick-making.
He estimates that with a stick, he will be able to produce 50 berries
per hour. The stick will last for 10
days before it will need to be replaced.
So for this example, Crusoe
must weigh the following alternatives:
a) Continue producing and consuming 200 berries per day
for the next 10 days (2000 berries).
b) Restrict his consumption (by 200 berries), while the
stick is produced. Then produce 500
berries per day for 10 days (5000 berries).
The restriction of
consumption is called saving and the transfer of labour
and land to the formation of capital goods is called investment.
Which is the best alternative
for Crusoe? It all depends on his value
scale. Which one of these options will
be ranked the highest for Crusoe will depend on a number of other factors:
i.
Time preference – Crusoe may strongly prefer present satisfactions to future
satisfactions, and would consider the dissatisfaction of giving up of 50
berries today too great to warrant
having additional berries later.
ii.
Risk/uncertainty – Crusoe may expect to stumble upon a bountiful orchard very soon,
where he will be able to increase his berry productivity without needing the
stick. This would make him less likely
to produce the stick. Alternatively, he
may expect that soon the berries will become inedible due to colder weather, in
which case he would want to quickly maximize his production ready for winter by
producing the stick. Additionally Crusoe
must consider the risk that his forecasts are inaccurate.
Forecasting of future
conditions is involved in every action.
The process of forecasting is called the act of entrepreneurship. The
successful entrepreneur is someone who is accurately able to predict future
conditions. Successful entrepreneurs
make a psychic profit while unsuccessful entrepreneurs make a psychic loss.
The stick is a capital good,
or, producers’ good, because it is not directly useful for satisfying
ends. It must be combined with a
nature-given element, the berry bush, in order to produce the consumers’ good,
the berries. Once it is produced, we say
that the capital structure has been
improved.
The decision to choose
whether to increase capital is a choice between consumption, and
saving/investing. Crusoe had to choose
whether to forgo consumption of berries in order to invest his labor in
making the stick.
Suppose that Crusoe has made
the stick and can now produce 50 berries per hour. By reducing consumption (i.e. saving) and
investing in capital goods, Crusoe has increased his productivity of berries
and can now seek to satisfy additional ends.
He can now choose between:
- Increasing his consumption (to 500 berries per
day)
- Increasing his leisure time (to 19 hours per
day)
- Applying his labor to other tasks (for 5 hours
per day)
- Some combination of the above.
What he chooses will depend
entirely on his value scale, and the means-ends calculations he makes. With his “freed-up” time, he may choose to
hunt game, or catch fish, or build himself a shelter, or simply explore more of
the island. Some choices, like hunting
game, may require an initial investment; labor will need to be applied to
produce a spear or bow-and-arrow, a capital good, before the consumers’ good,
dead game, can be produced. By saving
and investing, more complex production processes, possibly involving several
stages of production, become possible.
All capital goods are
perishable. Crusoe’s stick has a
durability of 10 days before it needs to be replaced. After that, Crusoe will have to go back to
producing berries at 20 per hour. During
the 10 days while Crusoe is using the stick, we say that capital is being consumed. In order to maintain the capital structure,
and continue producing berries at 50 per hour, Crusoe must make a further act
of saving/investment. If he invests 1
hour per day in the making of a new stick (giving up 50 berries per day in doing
so), so that the new stick is ready for use as soon as the original stick is
worn out, then the capital structure is maintained
intact.
An actor’s decision to a) add to his capital structure, b) maintain it, or c) consume capital, will depend primarily on the actor’s time preferences. A forward-thinking individual (low time preference) is likely to restrict present consumption and instead save and invest, adding to his capital structure, and thus becoming more productive.
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