Tuesday, June 03, 2008

Capital

Part I: The definition of the village
Part II: Value and cost
Part III: The plow
Part IV: Material bottlenecks
Part V: Capital

Update: Fixed up the numbers

Suppose it takes 10,000 hours (~1,000 days or ~3 years) for a family to make its first plow. The family has learn how to make plows, and create specialized tools. This capital will last about 100,000 hours (~10,000 days or ~30 years), so it can be amortized over ~10,000 plows, adding ~1 hour to the cost of each plow; clearly the investment is worthwhile.

There's a problem, though. While a family can suspend growing food for nine days to create its own plow, there's simply no way for even the most productive family to suspend growing food for almost three years, even if one could store food and other life-support for so long: it would take a lifetime to accumulate that much surplus. The capital requirements for making plows creates a physical bottleneck.

Let's suppose that somehow Alice's family overcomes this physical bottleneck. She has at least three years before anyone can compete with her, which gives her at least the temporary capacity to set the price of plows well above the opportunity-adjusted cost. Since food cannot be accumulated (and, as yet, food is the only medium of exchange) Alice can realize this higher price only by working less and producing fewer plows. This strategy restricts the supply of plows, making demand in excess of supply.

But Alice cannot make this bottleneck permanent. The higher she sets the price of a plow, the more incentive there is for another family to overcome the bottleneck. Instead of amortizing the capital cost over the family's entire lifetime of plow-making, the cost can be amortized over only a portion of the production of plows. For example, if Alice sets the price of a plow at 500 pounds of food, then Bob will realize he can sell plows for 482 pounds of food as well, and amortize the 10,000 capital hours over 25 plows. Since Alice is working at about 1/5 speed, there's room for Charlie, Dave, and Erin to get into the act. Heck, even Frank, Gail, Henry and Irene might try their hands at making plows.

The only way Alice can make it economically infeasible for anyone to compete with her would be to set the price of a plow so low that others cannot recoup their capital investment. But if she does that, she can't recoup her own investment. Sooner or later, there will be too much plow-making knowledge and tools in the village, and the price will drop to the opportunity-adjusted cost, with the capital investment amortized over almost all of the plow-makers' lifetime production.

But there's another problem — a political problem — which I will address in the next installment of the series.

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