Wednesday, August 11, 2010

If the Capital Stock decreases (and it is), then your future prospects and standard of living do too...How do I know? Why the Production Possibilities Frontier, of course.

     In order to have healthy economic growth in the short run and long run, it is vital that a nation builds upon its Capital Stock.  Capital Stock is, well, the Stock of Capital a nation has available to make goods (stuff).  It is includes everything from basic tools to heavy machinery; from the quality of its public infrastructure (roads, water, power, schools, etc) to the quality of its private infrastructure, such as commercial buildings, factories, skills of the workforce, etc.  This article has a nice graph showing the US is not increasing its capital stock, but is only maintaining and/or replacing its current stock of capital.  If fact, we have experienced an overall DECREASE in national capital stock (you can see it on the FAR right side--the line dips below 0). 

""Companies in the U.S. are stepping up purchases of equipment and software at the fastest pace since the late 1990s. But much of the spending is aimed at replacing older equipment after recession-related postponements or to improve efficiency—not to raise production or boost hiring...""
"...Companies may keep increasing spending on equipment, computers and software even if they don't add capacity. Nomura Securities economist David Resler calculates that businesses didn't spend enough in 2009 on new equipment to offset the wear and tear on their existing equipment. As a result, the capital stock—the inflation-adjusted value of all business equipment and software in place in the U.S.—dropped 0.9% from 2008—its first decline since World War II...."
    A basic concept in economics, usually the first model encountered in an introductory class, is the Production Possibilities Frontier (PPF).  The PPF gives a graphical representation of how a society is doing in terms of utilizing its productive resources.  Societies produce goods that can be put into two specific categories, but the goods with-in those categories are very broad. The two categories are Capital Goods and Consumer Goods.  Capital Goods are goods produced that don't give immediate satisfaction (can't eat it, play with it, or be entertained by it--These would be categorized as Consumer Goods.) Among them are the items mentioned in the discussion on Capital Stock in a previous paragraph.  Producing and investing in Capital Goods is vital, because it allows a society to ensure future production capacity to satisfy future needs and wants.  This is what the PPF looks like in graphical form:
     Point "B" ON the PPF represents the economy at Full-Employment of resources (including people). This point on the PPF is highly desirable and expected to be a point (not necessarily THE point) the economy should be at more often than not. However, currently we have LOTS of unemployed resources, most importantly people, so we are performing at a point inside our PPF---we simply are not doing as well as what we COULD be doing with our available resources.  In other words, our POTENTIAL production should be Point "B" but our ACTUAL production is at Point "A". 
   Ok, fine, all we have to do is get things moving again and we can put those unemployed resources to work and get BACK to Point "B", right??? Not so fast, considering the state that Capital Stock is in now.
   The article says we are in a period of DECREASING (slight, yet decreasing none the less) Capital Stock.  Graphically, this is what is happening:
     We are moving from KG* to KG1 (Point "C") in terms of Capital Goods production and employment, hence available Capital Stock is decreasing. What are the ramifications of this?
    Fewer Capital Goods means less production of other capital goods AND less production of many Consumer Goods (how are they going to be made with a lack of Capital Goods?). A highly undesirable thing may happen---the PPF, or our potential to produce goods now and in the future, is going to diminish. Graphically, it looks like this:
     The WHOLE PPF shifts to the LEFT. Relative to the PPF before, we have permanently reduced our current productive capacity and greatly reduced our future ability to produce Capital and Consumer goods ("Stuff").  This will not bode well for the next generation, who may see fewer opportunities and a reduced standard of living.
  As I say in class ALL THE TIME: If our politicians, business leaders, and other policy makers DO NOT make the correct investment decisions today, then students will have fewer opportunities down the road.  Let's get to investin' and-a-shiftin' the PPF to the RIGHT!
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