Models of production
The function of the investment of capital is to solve mismatches of supply and demand and this process simultaneously creates employment. The section starts with an introduction to a model of the firm, classification of types of services and forms of capital, and then an introduction to measures important for households - wages, productivity and labor hours.
The table below clarifies the intended meaning of firm and investment used in this section.
Term | Description |
Firm | Any entity that employs a combination of capital, land, and labor to solve an unmet need in the market |
Investment | Committing upfront resources with the intention of having an expected benefit later in the future |
The firm
To connect the aggregate outcomes of national GDP with the dynamics of individual behavior, a general firm is illustrated in Figure A.1. Firms are the smallest unit of a capitalist system.
Firms meet unmet needs in the market through the process of economizing, investment of capital and catalysis of the entrepreneur. The function of a firm is to solve an unmet need in the market, whether it is to provide essential services such as food, energy, housing, education or some other want or desire such as music or personal electronic devices. This unmet need is the demand. To meet this demand the firm employs a combination of land, labor and the investment of capital. It is this deployment of capital that economizes on the limited resources of land, labor, raw materials and energy. The concept of substitution is that it is possible to economize on one limited resource at the expense of the other. Sustained labor productivity can be achieved either at the expense of the other limited resources via substitution or through general “total factor productivity”. The behavior of entrepreneurs is to act as problem solvers in the market by identifying unmet needs and resolving them by employing capital between firms and creation of new firms. Entrepreneurs can exist either within firms or outside firms in other institutions such as finance (private capital firms), academia, government institutions or social entrepreneurs attached to non-government (non profit) organizations (NGOs).
Types of services
There are four general classes of services based on whether they are excludable and/or rival. If a person could be excluded from using the service at a reasonable enforcement cost, the service is considered excludable. If a person’s consumption of the service necessarily subtracts from someone else’s ability to consume the service it is considered rival. This produces four types of services. The ideal private services are those that are both excludable and rival, and private markets generally are inadequate to provide for public services, since their benefits or their costs will unavoidably spill over into the common spaces. For this reason the conventional wisdom is that these services are more appropriately managed by governments. Commons and clubs can be managed either by the state or a private firm or a hybrid solution.
Forms of capital
There are different forms of capital and different policies could favor the development of one form of capital over another. Five types of capital are presented here - physical capital (plant, equipment), natural capital (ecological), intellectual property, human capital (skills, experience) and entrepreneurial capital. The traditional, familiar meaning of capital is closely related to the physical form of capital and can be either movable such as equipment - fleet vehicles, shop floor machines or can be fixed capital such as towers and real estate buildings. Intellectual property (IP) is the instructional know-how of how to operate a firm and can take the form as software code, patents, trade secrets, or can be open source freely available to the public. Some forms of IP such as process workflows are an emergent result of an inseparable combination of human capital and other forms of capital in the firm that is not easily transferred to another firm. Human capital here is the general term for labor that is capable of being employed by the firm. Entrepreneurs are defined here as a specific form of human capital that is involved in the creation of new firms or modify the functions of existing firms to resolve problems of supply and demand in the market.
Productivity, wages, hours
Poverty is defined as zero surplus income, where the nominal wage is at or below the living wage. Changes in real wage track changes in surplus income since an increase in the living wage is inflation and decreases real wages at constant nominal wages and visa versa. So the opportunity for poverty reduction on average is dependent on surplus income and real wages above a certain threshold. The real wage can be increased either by productivity improvement or by public investments to reduce costs (true costs, not subsidies) in essential goods and services and hence a reduction in the living wage. This second approach can be considered another form of productivity improvement at a system level rather than firm level.
The conditions for sustaining a continuous source of savings available for investment is the constant or rising labor productivity and household non-essential consumption less than the surplus income. This savings is the source of investment available for the maintenance and replenishment of capital to sustain and improve productivity and to redress imbalances. Policy makers monitor aggregate measures of economic activity to gauge the health of the operation of this system. One of the most prominent measure of the health of economic activity is Gross Domestic Product (GDP).
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