2. Income and Expenditure

In a money economy, an individual sells the goods and services he owns for money, which he then uses to buy other goods and services.  By selling goods and services for money, he buys money and this money forms part of his money income. 

Money income could come from selling capital goods, consumers goods or land.  It can also come from land, labor, capital goods or durable consumers’ goods being rented out rather than sold.  Another source of money income is a gift.  An individual can also receive money income by actually producing the money commodity, in the case of gold, by mining it from the ground.

Since for any given exchange, sellers will tend to obtain the highest price possible, it follows that men will strive to earn as much money income as they can for a given good or service.  This is provided that there are no “psychic factors” in play, in other words that the money from two different offers is considered homogeneous (equally serviceable).  This is usually the case when selling or renting consumers’ goods, capital goods and land, but it may well not be the case in renting labor services, for example, where the “conditions of labor” can often induce individuals to not maximize their money income.  Labor services must also be weighed against the utility of leisure foregone. 

Money is acquired in order to exchange for desired goods.  For every exchange, one party buys money – money income – and the other party sells money – money expenditures. 

Each person may make a record of his monetary exchanges – income and expenditures – over a given period of time.  Such a record may be called a balance of payments.  Income and expenditures can also be called exports and imports of goods.  If an individual’s income in a given period is more than his expenditures, then there is a net increase to his cash balance.  If an individual’s expenditures in a given period are more than his income, then there is a net decrease to his cash balance. 

Each actor must allocate his money resources among:

1. Consumption spending
2. Investment expenditure
3. Additions to his cash balance

All individuals spend money on consumers’ goods to use directly.  Additionally, individuals can invest in goods of higher orders.  These individuals are called capitalists.  As with the example of Crusoe investing his resources in building a stick to increase his berry productivity, investment in producers’ goods requires refraining from consumption.

Above is a diagram of the structure of production.  Solid lines represent the movement of goods; dashed lines represent the movement of money.  Each capitalist (owner of a capital good) hires labor and nature-given factors to produce a lower-order capital good, which is then sold on to another capitalist, or ultimately to the consumer.  Note that all money ends up with either labor or nature (landowners). 

Clearly, the capitalists must hire land and labor services in anticipation of the future sale of the product.  And in order to own the capital good, they must first save money and invest it into the capital good. 

Money is a good and is therefore subject to the law of marginal utility; as an individual’s cash balance increases, the marginal utility of each additional unit of money will be worth less to him.  Individuals will tend to hold a certain cash balance, and as the cash balances increases, they are more likely to spend the “excess money” on buying goods – either consumers’ goods (consumption) or producers’ goods (investment).  Individuals freely choose to hold a certain cash balance, and increase and decrease it as they see fit.  The average cash balance a person holds is likely to be influenced by institutional factors such as the regularity of payments for labor.  An individual’s demand for money is his reservation demand (his desire to hold on to the money he already has) plus his desire to increase his cash balance (or minus his desire to decrease his cash balance).

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