Saturday, January 14, 2012

Real Microeconomics (supply shocks)

Part 1: What is "real"? (commentary)
Part 2a: Real microeconomics (demand shocks)
Part 2b: Real microeconomics (supply shocks)

In the last post, I talked about real "demand shocks", when we want a lot more of something than we can presently produce. There are also real "supply shocks". A supply shock happens when something becomes considerably more expensive: given some set of resources, we can produce less of something we want or need than we could yesterday, with no compensation in the production of other things.

But what do I mean by "more expensive"? I'm talking about real economics, economics without money. The only resource we can arbitrarily change is how we spend our time. We cannot just arbitrarily make decide to have more iron: if we want more iron, human beings have to spend time digging it out of the ground. (We might also spend time creating machines to dig it out of the ground, or we might choose to use up some of the labor "embodied" in an already created digging machine to dig up iron instead of copper or uranium). So, by more expensive, I mean producing something requires more labor* than before, labor that has an opportunity cost, that could have been used to produce something else.

*Strictly speaking, socially necessary abstract labor time.

Real supply shocks tend to "creep"; in this sense, "shock" is kind of a misnomer. (In economics, "shock" just means something exogenous, i.e. in some sense outside the normal economic system.) We don't wake up one morning to find that hats suddenly take twice as much labor to make as yesterday. Rather, the real cost — the labor — tends to inexorably increase over a long period of time.

Oil is a good example of a supply shock. We believe (IIRC) we have in the last century extracted about half the oil that's in the ground. The problem is that we've already extracted the oil that's "easy" to get to, and increases in our productivity are starting to fall behind the increase in difficulty in extracting the rest of the oil. We're not going to "run out" of oil; oil will just take more and more labor time to extract, until the oil that's left is so expensive it will be used only for those things we really really want.

In a similar sense, agriculture before the industrial revolution was in a state of creeping supply shock. As the population grew, more and more land had to be put into food production. The problem is that we used the most productive and fertile land first; additional land was less productive than new land. This caused the average labor time for a given quantity of food to rise over time. Improvements in technology and the production of capital could not keep up with the loss of productivity, to the point where food production was a severe constraint on population growth. This sort of constraint is not pretty: people tend to actually starve to death.

Of course, supply "shocks" don't have to be crisis producing. As we create more capital, which makes labor more productive, and as technology improves, it requires less labor time to make most goods and services, which reduces the opportunity cost in terms of making goods and services that cannot have improvements in productivity. (One cannot, for example, greatly improve the productivity of live performances of classical symphonies.)

One interesting comparison of real economics vs. financial economics is that "positive" supply shocks (which can be abrupt), where the labor cost of something decreases, cannot produce a crisis in real economics, but can produce a crisis in financial economics. Curious.

2 comments:

  1. A niggling detail related to one of your examples:

    Agriculture before the industrial revolution in the west (I can say nothing about Asia) was also suffering from the fact that western knowledge about agriculture was... well, it was on a par with what your average modern person knows without doing any research.

    That is, knowledge of soil chemistry was effectively nil, crop rotation was still a rare thing, people knew about the idea of fertilizer but everyone had their own idea of what made a good one (reportedly, there was even a British farmer who thought SALT was a good fertilizer -- must have been a real peach), and so on ad infinitum. And farmers reacted to early scientific advice with active hostility. (The father of the author of "The Scarlet Pimpernel", for example, was an eastern European rural nobleman who got run off his land by the farmer tenants because he tried to force them to use scientific farming methods.)

    As a result of all this, agricultural yields were regularly terrible before the industrial revolution, and heavily-used land tended to lose its fertility over time. (Before crop rotation came in, the practice was to allow land to lie fallow to recharge, but not everyone could afford to do this, or cared about whether their fields would still be capable of growing crops in future years.)

    The point being: supply shock in this area was not merely because of growing demand, it was also because of poor management which was actively reducing (usually unwittingly) the supply. For this reason, I suspect that this example is not a very good one.

    P.S. I hadn't posted a comment here recently. I like the new posting rules.

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  2. The point being: supply shock in this area was not merely because of growing demand

    Growing demand creates a demand shock. Increasing real cost of production (in labor hours) causes a supply shock.

    Do you mean, perhaps that agricultural supply shocks were not only because of decreasing marginal utility of production from using decreasingly fertile land, but also because of static or regressing technology?

    I'm an economist, not an agronomist. I was simply recapping Malthus' argument, as best I recall it.

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