What is interest? Its existence is part of the structure of reality: we live in a world in which time is scarce. The law of marginal utility is not only instrumental in establishing the prices of present goods but also in establishing the rate of exchange between present and future goods. The essence of the phenomenon of interest is the cost that a lender or an investor endures. This cost stems from the fact that the lender or the investor has given up some present benefit. The cost is the value of the least important end adjusted for the time factor that the lender or investor must give up in order to secure benefits from future goods. FULL ARTICLE
Source link: http://archive.mises.org/6803/marginal-utility-and-interest-formation/
Marginal Utility and Interest Formation
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When acting, people always attempt to substitute a more for a less satisfactory state of affairs. In doing so, they betray a preference for more over fewer goods and better over worse goods. To pursue ends, people necessarily employ means. Such an action reveals a preference for the ends to the means. If one did not prefer the end to the means expended in pursuit of that end, one would not so act. An end must therefore always be valued over the means. Interest is a manifestation of a spread between the end and the means, and occurs in instances other than money-now to money-later.
“Observe that without the existence of money — the medium of exchange — the baker isn’t able to establish how much of future goods he must be paid for his loaf of bread that would comply with the rate of return of 20%.”
Why would the baker CARE what would equal 20% – that rate and the baker’s “indifference” rate of 15% are entirely artificial in the first place. The baker KNOWS how much of future goods would make him (ex ante) satisfied to part with his loaf for a year. If it happens to be the SAME (fungible) good, he could even calculate a percentage, but who (still) would CARE?
And when the baker decides how much of whatever it would take to compensate him for the loan, he will perforce take into account whether the per-unit value of the compensating medium (potatoes, money) will increase or decrease during the term of the loan. This consideration is (usually unconsciously) incorporated in the decision as to what QUANTITY of the compensating good suffices to incent the loan.
Rates are for beancounters.
Mr Potts,
read Frank Shostak’s other artiles – read his interviews too. I think that of all the people who visit this site, he understands the Austrian theory the best. Also, he is an arbitrageur/entrepreneur at heart, which is refreshing given that so much that is discussed here is about ideology as opposed to Mr Market.
Do your homework before giving your two wooden pennies.
N. Joseph: “The baker KNOWS how much of future goods would make him (ex ante) satisfied to part with his loaf for a year.”
Maybe Mr. Shostak should have written that “the baker would find it more difficutl to establish how much of future goods he must be paid for his loaf of bread that would comply with the rate of return of 20%.” For he answers your question in the next paragraph:
“In a world without money, all that one would have are the rates of exchanges between various present and future real goods. For instance, one present apple is exchanged for two potatoes in a one year’s time. Or, one present shirt is exchanged for three tomatoes a year. Again all that we have here are various ratios.”
In other words, without money, calculations are much more difficult.
N. Joseph: “And when the baker decides how much of whatever it would take to compensate him for the loan, he will perforce take into account whether the per-unit value of the compensating medium (potatoes, money) will increase or decrease during the term of the loan.”
That might not be so difficult for one year, but say the loan was for 20 years. Does the baker want to lock himself into taking just potatoes as payment in 20 years? Or just apples? The baker could draw up a schedule of items that he might want in 20 years and calculate the return he would require, but money makes it much easier. And if we’re talking about real money, gold, then he won’t have to worry about its value changing much. Whereas with any other commodity, especially potatoes and apples, he’ll have to worry a great deal about changes in value in 20 years. The complexity and uncertainty involved in lending via barter is the reason people chose gold as the medium of exchange thousands of years ago. They weren’t as ignorant as we like to portray them.
RogerM:
You are “sort of” correct in your statement (preceding) but almost as certainly partially incorrect.
In essence, you ascribe peoples’ choosing of gold
as a medium of exchange to an expectation of its enduring (over time) value. Essentially, the process is almost the direct reverse: the enduring, less-fluctuating value over time is a RESULT of its frequent CHOICE as a medium for the facilitation of exchange. Media of exchange arise through the experiential process in which trading individuals observe and internalize the reality that direct barter is (for several simple reasons I won’t enumerate here) impractical but that each trade enabling closer approach to whatever are their goals is desirable. Certain of the characteristics by means of which such intermediate goods achieve preference as such lead to their increasing employment in just such manner–and to concomitant enhancement of their previous value. In time (whether short or long), the widespread perception of this use with respect to a certain few commodities leads to their very stable valuation.
So far (as I’m sure you’ll recognize), what I’ve explained is strictly Austrian/Misesian–explanations with which I absolutely concur. But I’m going to go “out on a limb” here and describe (although only in part) my own theory, quite as “Austrian” as any other but in a direction completely overlooked by Mises or any other.
The “market” is comprised of two essentially dissimilar parts or phases but which are inseparable in operation. One is an external reality: the entire complex of goods (including services) vendible or potentially vendible. The other is internal–within the individual minds of market participants and potential market participants, comprising, for all practical purposes, virtually everyone. The first is potential SUPPLY, the second potential DEMAND. No participant knows anything about the totality or quantity of either magnitude but is yet enabled to understand everything needed about both through the communication system of PRICES expressed on the market.
Things are EXACTLY as they’d be if the human race were a single organism connected by a neural network whose function it were to maximize the peaceful satisfaction of all portions (individual persons) of the organism, i.e., to assure that each participant enjoyed the greatest possible satisfaction made possible by his own contribution to the satisfaction of others.
I don’t maintain that there is such a mental network but that the market works like one. Moreover, that its working is as close to perfect as is possible for humans to approach and that EVERY ATTEMPT TO CIRCUMVENT THE PROCESS BY INTERVENTION IN ITS OPERATION OR MANIPULATION OF THE QUANTITATIVE BASIS OF COMMUNICATION SIGNALS MUST IMPAIR ACHIEVEMENT OF THE UNDERLYING GOAL (BY SUBSTITUTING LESS FOR MORE, WORSE FOR BETTER, AND, MOST IMPORTANTLY, COERCIVE AND DEADLY FOR PEACEFUL AND FRIENDLY).
That’s the first part. The second–prescriptive–I’ve got to keep under my hat for yet awhile.
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