Chapter V: Equilibrium, or The Tao of Economics
Open any standard economics textbook, and before you have gotten too far into it, you will see a chart that looks like this:
The vertical axis represents price for any commodity and the horizontal axis indicates quantity of that commodity. Within the chart there are two lines that cross, “S” for supply and “D” for demand. The supply curve indicates the amount of any commodity that producers are willing to supply at a given price, while the demand curve indicates the amount of that commodity that consumers are willing to buy at a given price. The point where the two lines cross, labeled “E” is called the equilibrium point, while “Q1” and “$1” represent the quantity and price at the equilibrium point. The chart is based on an intuitively obvious idea, namely that buyers want to spend as little as they can and suppliers want to get as much as they are able. Hence, the lower the price of something, the more consumers are willing to buy of that product, while the higher the price, the more suppliers are willing to produce. The equilibrium point represents the balance between supply and demand, the point where buyers are willing to buy the exact amount that producers are willing to supply at that price.
This deceptively simple chart is an extremely powerful tool, and economists put it through all sorts of permutations to arrive at all sorts of conclusions. None of that need concern us here; at this point we are mainly interested in understanding the idea of equilibrium, and how societies get to that point. . It is no exaggeration to say that the entire structure of modern, neoclassical economics is built on this chart. Therefore, some comments on the chart are in order. The first thing that we must note is that this is an idealized representation; it represents equilibrium in a static moment, but an actual economy is dynamic; prices change from day to day and even from hour to hour. Because it is an idealized portrait, it shows equilibrium as a precise and knowable point that is actually reached. In a real economy and for any real product, the equilibrium point is rarely known with any precision, but forms an attractor point around which prices and quantities fluctuate. And it should be noted that while we call them “supply” and “demand” curves, they are really both demand curves, since the supply curve represents the producers’ demand for the commodity known as “money.” This would be self-evident in a barter economy. If someone were trading shoes for fish, we would place fish on one axis (it doesn’t matter which one) and shoes on the other, and both parties would be simultaneously “demanders” and “suppliers.” It is only in a money economy, where goods and services are measured in terms of one special commodity that we can strictly separate “suppliers” from “demanders.” It is important to remember this, because in a money economy, most people become demanders only after first being suppliers, usually by supplying to the market the commodity known as labor.
The Demand Curve
Demand is affected by the consumer’s income level, his needs, tastes, and preferences, the prices of other goods, and his expectations of any changes in price levels. If a consumer’s income increases, some portion of the increase will contribute to an overall increase in demand. So, for example, an increase in the minimum wage might raise overall demand and affect the equilibrium point. What the equilibrium point really measures in not overall demand, but effective demand, by which we mean both the desire for the product and the ability to pay for it. Note that in a market system, the equilibrium point will always be less than total demand, usually substantially less. Hence, certain common goods, such as police or schools or roads are not normally provided as market goods (or some would receive none of them) but as socialized goods.
Needs, tastes, and preferences are often regarded as “individual choices”; however the truth is much more complex. While these always appear as personal actions, they are actually socially influenced. In fact, a lot of what we are has little to do with “individual choice.” For example, most readers of these words speak English not as an individual choice, but as a social gift; we were given the English language long before we realized that we might have some choice in the matter. Our preferences are heavily influenced by such things as fashion, advertising, work-place dress codes, and social conventions. Even those who wish to escape the conventional most often do so by substituting other conventions. For example, a teen-ager objecting to conventional styles may adopt “goth” styles, a social “sub-group.” Examples of a “pure” individual choice are hard to come by. Economists tend to model demand as the aggregate of purely individual choices, but this may not be the best model of what humans actually do.
Prices of other goods affect demand because we must make choices; to purchase a quantity of commodity A precludes us from using the same money to purchase B. Further, many products have substitutes. For example, if the price of beef increases relative to the price of pork, many people will substitute pork for beef in their diets. Hence a producer competes not only against others producing the same product, but against those producing products that can be substituted for his.
Another thing we may note about demand is its elasticity. Elasticity measures how much a change in price is required to change the volume purchased. Some products are highly elastic; a small change in price will lead to large increases or decreases in what is purchased. Other products are inelastic; it takes a large change in price to change buying behavior. For example, most of us must use a certain amount of gasoline to get to work, and have difficulty finding an alternate means of transportation. Therefore, we are likely to pay whatever the market demands for gas, making gas an inelastic commodity.
The idea that as a commodity's price falls people will tend to purchase more of that commodity is called The Law of Demand. However, it is not really a law in the way that gravity is a law, always and everywhere operative. Rather, it is a tendency, and as such there are many exceptions. Some products actually depend on the price being unreasonably high. A Ford will get you where you are going as well as will a Jaguar, but a Jaguar will display your wealth along the way. If the price of Jaguars were lowered to that of Fords, it is likely they would, after a time, sell less of them, not more. A more common example is athletic shoes. A $130 pair of Nike’s may or may not be any better than the $30 no-name pair that comes out of the same shoe factory in Vietnam. But by placing the “swoosh” on the shoe, the seller can get a large premium, a premium which contributes to the product’s image and exclusivity. Again if he lowered the price to $30, there would be nothing to distinguish it, and sales might actually fall. Nevertheless, and even with all these caveats, the law of demand is still a useful concept, even if it isn’t really a law.
Taking all these things together, we note that the deceptively simple supply curve encodes a tremendous amount of information. Any change in the factors making up the supply curve can have large consequences on the shape of the curve and hence on the equilibrium point. Moreover, this encoded information is largely social. Our actions are influenced by others and, in turn, influence others. For example, when we choose to buy a giant Hummer, we increase the demand for gasoline, and thus affect the price that everyone else pays for it, even those who have no interest in monster-sized cars.
The Supply Curve
As complex as the demand curve is, the supply curve presents even more challenges. In the standard, neoclassical theory of economics, it is relatively straightforward: firms supply product to the market until marginal revenue equals marginal costs; this is called marginal cost pricing. “Marginal” here means the cost or revenue for the last unit produced. Marginal revenue is simply the price of the product. Marginal cost, however, is highly complex. In general, we know that with a given amount of equipment and labor, we can produce one more unit of a product for a low additional cost, up to a point. Beyond that point, costs per unit will actually start to rise. It will cost more to make the last unit than the product actually sells for; hence there is no reason to produce past this point. Firms will produce product up to the point that marginal costs equal marginal revenues. Under conditions of perfect competition, this will provide the greatest possible amount of goods to the market at the lowest practical price. Society will benefit, and the firm will make a reasonable, but not outrageous, profit.
The theory is sound; however, actual practice diverges from this theory more often than not. In the first place, knowing the “marginal revenue” means knowing what the demand curve will be, and this is generally just a guess, for all the reasons we have already mentioned. But it is the marginal cost that is most problematic. When an economist thinks of costs, he thinks of all the resources that were consumed in making the product. The businessman, however, only thinks of the costs he actually has to pay. Other costs may be externalized, that is, placed upon third parties who are not necessarily purchasers of the product. For example, the owners may get the government to build them roads, finance their facilities, pay part of their work force (with food stamps or housing vouchers, for example), give them tax rebates, etc. The most obvious example of an externalized cost is pollution. A manufacturing process may dump highly toxic chemicals into the air, the land, or the water, causing health problems for everybody else. This is a real cost, but one that does not show up in the business owner's calculations. But even considering just internal costs, these turn out to be complex and difficult to measure, and few companies actually undertake such an analysis. Rather, they depend on strategies other than marginal cost pricing.
If a company has a patent on a product for which there are no substitutes, it may engage in monopoly pricing. This is especially the case in the drug industry, where patent protection allows the drug companies to charge $10’s or $100’s of dollars for a pill that may cost pennies to manufacture, even considering research costs. If there are a few companies in the same business, they may engage in a similar practice, oligopoly pricing. They may use package pricing, relying on the reputation or packaging of the product to obtain a higher price, as in the
Having drawn all of these caveats around the supply and demand curves, have we not then shown that the “Magic Chart” is not really valid? Well, perhaps, but I don’t think so. All we have shown is that the standard tools of neoclassical analysis may not be the best way to understand equilibrium. The theoretical model may be insufficiently “scientific,” that is, not really well-related to the way things really work. The truth is that all successful economies reach equilibrium, more or less. But the problem (and the analytical challenge) comes in the fact that they reach it through both economic and non-economic means. It is the means by which equilibrium is reached that must be correctly analyzed.
Economic Equilibrium
When people come together in families or firms to produce things, they add wealth to the economy; in fact, this is the only economic way to add wealth.[1] If they get an equitable share of the output, or the wealth they create, there will be enough purchasing power in the economy to buy all the things they produce. This is the much-maligned “Say’s Law of markets,” which states that “supply creates its own demand.” When there is an excess of goods supplied to the economy, we have a recession, or worse. Say’s Law is much criticized because if you examine it closely, it says that recessions are impossible; there will always be enough purchasing power to clear the markets. Clearly, we purchase things in terms of other things. If, for example, you are a fisherman and you want some shoes, you catch some fish and trade them with the cobbler (in a barter economy). The total number of things created equals the total number of things that can be used for purchasing the other things. The two quantities are in fact the same quantity, so that there can never be a shortage of purchasing power in the economy. Granted, there may be a temporary disequilibrium in any particular market. The fisherman may catch more fish than people really want to eat; the cobbler may make too few shoes. But such a situation will normally not persist. A fisherman who cannot sell all of his fish will cut back on the time spent fishing and devote himself to other things. Perhaps leisure, or perhaps he will take up cobbling, thereby adding to the supply of shoes. But in any case, a recession in these circumstances cannot be of long duration or great importance. And yet, recessions do happen, quite obviously. Long ones. Deep ones. Serious ones. So what is wrong with Say’s “Law”?
To understand the problem, we have to look at the sources of demand in a money economy. And these sources are two: wages, and interest or profit.[2] Wages are, of course, the rewards of labor, and profit the reward of capital. In another sense, however, these are the same rewards since capital is merely “stored-up” labor, or things produced in one period to be used to continue production in the next period. For example, if a farmer wishes to have a crop next year, he must save some seed-corn from this year’s crop. Now, the corn he consumes and the corn he saves are the same corn from the same crop. But by saving some corn for seed, it becomes “capital.” Hence, the return on this capital is really a return on his prior-period labor, just as his wages are a return to current-period labor. Clearly the returns to capital and labor, interest and wages, spring from the same source (labor). Capital, then, ought to have roughly the same rewards as labor, plus some premium for saving. Or, to put it in “eco-speak,” the returns to capital and labor should be “normalized” to each other. This normalization of incomes from capital and labor is the condition of equity in an economy. That is, the same kind and quality of labor, whether in its original or “stored-up” form of capital, should produce roughly the same return.
Interest (or profit) and labor constitute the economic sources of demand, and if they are normalized to each other, economic recessions are unlikely.[3] There will be enough purchasing power distributed equitably to clear the markets. In capitalist economies, the vast majority of men are not capitalists; that is, they do not have sufficient capital to make their own livings, either alone or in cooperation with their neighbors, but must work for wages in order to live. And since the vast majority of men and women work for wages, then the vast majority of goods will have to be distributed through wages. In conditions of equity, this will not be a problem; so long as there is equity, there is likely to be equilibrium, and periods of disequilibrium are likely to be brief. But it may happen, and quite often does, that interest and wages are not normalized to each other. In almost all cases (although there are exceptions), this means that capital gets an inordinate share of the rewards of production. This, in turn, means that the vast majority of men and women will not have sufficient purchasing power to clear the markets, and the result will be a disequilibrium condition, that is, a recession. When this happens, governments and societies often look to non-economic ways of restoring equilibrium.
Non-Economic Equilibrium
The major non-economic means of restoring equilibrium are charity, welfare and government spending, and consumer credit (usury). Each of these methods transfers purchasing power from one group, which presumably has an excess, to another which has a deficit. The first method, charity, will always be necessary to some degree. This is because even in the most equitable and well-run economies, there will always be people who are incapable of making a decent living, perhaps because of mental impairment, moral deficiency, or physical handicap. One hopes that there is enough generosity and benevolence in society to voluntarily cover the needs of these people. However, when low wages become widespread, and when self-interest becomes the dominant motivation in society, it is likely that charity will be insufficient, and other means must be used.
The second non-economic means is welfare and government spending in general. By these means, the government seeks to re-establish equilibrium conditions either by supplementing the income of some portion of the population, or simply by increasing its spending to create more jobs and thus add more purchasing power to the economy. This strategy is at the heart of Keynesian economics. The “market” economy is allowed to continue to produce inequitable (and therefore disequilibrium) conditions, but the government will tax and redistribute the excess incomes in an amount sufficient to restore equilibrium. For a while, this method worked fairly well. However, it created some problems. In the first place, it created entitlements. Unlike charity, which depends on the benevolence of the donors and may evoke gratitude on the part of the recipients, welfare depends on the police powers of government and is more likely to evoke resentment on the part of both the recipients and the “donors.” Further, these re-distributions require increasingly intrusive bureaucracies to collect and disburse the funds. The recipients, no less than the donors, find that every aspect of their life is subject to government review and control, and this is never a comfortable feeling for either.
Despite the fact that Keynesian transfers now consume a huge portion of the federal and state budgets, these transfers have been, for some years now, insufficient to balance supply and demand, and for some time now the economy has depended chiefly on the third method, usury or consumer credit. Here we must distinguish between lending for investment and usury. Investment means giving money to firms and entrepreneurs in order to expand production and increase the wealth of society. In this case, interest is merely the investor’s participation in the profits; it is the “wage” of the capital supplied, and the one who supplies it is entitled in justice to that wage. Usury, on the other hand, is lending money at interest to increase consumption. Nothing is added to the wealth of society, however much may be added to the wealth of the lender. Since nothing is produced, there is no valid claim to profit; interest payments in this case merely constitute a transfer of wealth from the borrower to the lender, but no net increase in the social stock of wealth. In fact, wealth is actually “used up” in this process without making a contribution to production, hence the name “usury.”
This is the plastic economy, an economy based on credit cards. And to the extent than an economy depends on consumer credit, it is, quite literally, a house of cards, and will be as unstable as those structures usually are. In fact, usury is the most destructive way of increasing demand. Usury actually delays the problem, postpones the crisis to a future period. This is because a borrowed dollar used to increase demand today must be paid back tomorrow and hence decrease demand in a future period by that same dollar—plus interest. This requires more borrowing, which of course only makes the problem worse. Eventually, the system falls of its own weight, as credit is extended to an increasingly weakened consumer, and a credit crisis results.
Non-economic equilibrium provides us with a measure of just how well an economy is doing in economic terms. If the economy has a high dependence on non-economic means, we may assume that there are serious problems in the economy itself. This is an important point. Those who wish to scale back the extent of government involvement in the economy must first analyze the failures in the economy that make heavy government involvement necessary. Those who would effect a cure, must first analyze the cause. And the cause is always and everywhere the same: a lack of justice.
[1] There are non-economic ways to add wealth to a nation, such as plundering other countries.
[2] There is actually a third source of income, economic rent, or an amount paid beyond what it takes to keep an asset in productive use. Economic rent introduces some serious complications, and will be dealt with in a later chapter.
[3] However, there may be “non-economic” or “exogenous” causes for a particular recession, such as flood, famine, or plague.
9 comments:
John, I have to admit I had some problems with this chapter. First, I'd always read that there were three, not just two, factors of production, land being the missing element in your account. Granted, you could combine land and capital into one, calling it, say, property income, as opposed to labo(u)r income. You could do that, but as far as I could tell, you personally did not, and hence my problem in this matter.
As to economic or quasi-rent, that seems to me to be not so much a third (or fourth) way of garnering income as an unjust enhancement of any of the other three factors. And in the case of profit, it largely balances out in well-diversified portfolios anyway. Not entirely tho, I'll admit.
I'm not certain either why charitable, governmental, and credit expenditures are classified as "non-economic". They're non-productive in the strictest sense, certainly, but involving money as they do, why aren't they economic in at least a limited sense?
Before my final point, I have a confession to make: my prejudice may not allow me to assess one of your remarks fairly. You see, it strikes me that I've read too many utopian screeds denouncing the "middle man" (read: such evil types as grocers) not to be immediately skeptical of statements saying that someone gets money without producing anything. In this case, I'm dubious about your excoriation of the lender for consumption. Yes, you can say that the wealth of the economy is not increased; but it's the same process as the lending for investment, of which you approve. And is easing the way of a consumer to buying an item really so valueless after all? Isn't that just greasing the wheels of commerce? But as to the interest rates charged and the amount of credit available, I would say, yes, both those have gone way too far.
Best,
Viking
This is quite an excellent chapter, it brought me back to my neo-classical economics classes. One thing that I thought might be nice would have been the inclusion of the supply curve as you described it with the supply, MC, MR etc shown, just as a visual aid (much like the S/D curve at the beginning). I can vaguely remember what it looks like but it is difficult to picture what you are saying without it.
As for the points I like the idea that equity=equilibrium, it is something that we are "trained" to disbelieve in economics class. Equity is some 'pink' concept dreamed up by utopian (probably Nazi for some reason) communists. I also think that it is a very obvious but overlooked point that capital=sorted up labour (hence labour is justly entitled to the 'wages' earned from it).
A curiosity point based on Viking's points: What about land? This is a factor that would surely limit the amount of 'additional' wealth could be added to the economy. Say oil, or fuel in general, if you don't have it then it may limit the amount you may produce, and hence then also consume. Or is land, as a limiting factor, already been taken into account? One merely assumes that there will be land, even if limited, to use, which labour can change into produce or capital.
Viking, The question of property, the most basic economic relationship, will be dealt with extensively in later chapters. Here, I do mention the role of rent, but only in a footnote, as the question is outside the scope of this chapter.
I do not rail against the so-called "middle-man," because there is no reason to do so. There are cases where the middle-man is just rent-seeking, but that is not true in the general case, where he forms an important part of the distribution chain and certainly works for his just reward.
The major point is that wealth without work is the greatest economic evil, not merely on moral grounds, but on grounds that the rewards they seek without work must come from someone who does work. If you get wealth without a contribution, then someone else must make a contribution without getting any wealth.
Finally, the actual process of making an investment loan and a consumption loan are entirely different. An economy that depends on credit to support consumption must sooner or later fall of its own weight, and right now that looks to be sooner rather than later.
William. I had considered putting in an MC/MR chart,and may do so in the final edition, but I want to keep the text as non-technical as possible. The editorial issue here is whether or not people grasp the idea of a marginal cost, the cost to produce the last unit. If it turns out to be confusing to most people, I will add a chart, but I would like to do without it.
I want to keep it to the one chart for another reason. In a preview of coming attractions, I will draw the same chart for three special "commodities," (land, labor, and credit) that do not and cannot follow the chart, as they do in neoclassical economics. They have no "equilibrating" or market-clearing price. The whole of neoclassical economics stands or falls on "commodifying" land, labor, and money. But it cannot be done and never happens in practice. Keeping it to one basic diagram concentrates the question
Greetings all,
John, I may be quite irritating to you and sounding like the proverbial broken record, of which we have few these days, and I'm truly sorry for that if so. But I still don't see where you addressed most of my points. You didn't remark on my query as to why charity and welfare state expenditures weren't economic, nor on my statement that quasi-rent was not a separate category of income. As to land, my objection was not that you didn't concentrate on it, but rather that you didn't mention it at all in conjunction with garnering income. Btw, in tandem with labor and capital, it can generate revenue other than by rent. Indeed, its economic value is ubiquitous, and so your suggestion that capital is essentially stored-up labor (I believe Marx called them "fluid" and "crystallized" labor) may need some additional qualification.
Apologies for apparently seeming to accuse you of condemning middle men, but that's not quite what I meant, and you indeed did not say that. Rather, my point was that you seemed a bit harsh in your critique of consumer credit lenders, which reminded me of these other authors' views of the middle man. That's all. I am self-admittedly puzzled by your description of business and consumer credit as "entirely different". That might be the case if all the consumer credit were in credit cards, but I doubt that very much is. The majority of consumer lending would have to be loans for buying residences, would be my guess. After that, probably loans for autos and trucks would be next. Credit cards might consume more than loans for home improvements and repairs, but that would still make them a likely distant third. And these three besides the cards seem to have very similar application-and-decision processes to those of business loans. In both kinds of case, the financial institution makes its best effort to determinine if the lendee is a good credit risk, that is,if she, he, or they is/are likely to pay back the loan.
Best,
Viking
Viking, I don't find your critiques at all irritating, and by all means keep it up. That's the point of putting all this out before publication.
As to the distinction between economic and non-economic means, it seems obvious enough to me. But even if one does not like the terminology, one must acknowledge that there is a difference in these two ways of balancing the economy: economic equilibrium arises from purely economic processes, while welfare arises from a political process. Granted that one generally gets money for charity or redistributions by participating in the economy, but this is still at one step removed, so my distinction is valid. This is, in fact, Keynes's own view: general equilibrium was a rare and special case in the economy as such, and in general the economy had to be balanced by political means, namely re-distribution.
As far as usury goes, the justification for collecting interest is that the money produces something and that the lender (investor, really) has a right to claim a share of the profits. But with consumer credit, there is no "profit" in which the lender can participate. There is an argument, and a valid one, that housing loans capitalize the rent flows of the property. The same could be said of cars and trucks. Further, if we treat "big ticket" household items like refrigerators, washers, and dryers, as the capital items of household production, then there certainly is justification for your argument. However, even as capital items, they are "over-capitalized."
Your distinction does have one important aspect. By seeing these household goods as the capital of household production, you introduce the question of "production for use," an economic item ignored by nearly all economists. Yet, this production for use, as opposed to production for exchange, is a large part of economic activity. Some put it as high as 40% of actual production. I think that number is high, especially today, when a lot of household work is "outsourced" to day-care, restaurants, prepared foods, etc. Nevertheless, the point still remains, and I intend to cover the distinction between production for use and production for exchange in a later chapter.
Hi again all,
John, thank you for that gracious statement about appreciating my and others' contributions, and sorry this is so late. Hope you won't regret the declaration afterwards.
I finally figured out why I had such trouble with your description of charity and the welfare state, along with usury or consumer credit, as non-economic: you sound like your ideological opponents, the neo-classical economists. That is, when you state, in earlier chapters, that "economics" isn't as satisfactory a term as "political economy" (with which I agree, btw), you can't then consistently oppose "politics" and "economics", as you do here. I can see the distinction, it's obvious to me as well, but the non-economic label simply doesn't work for me. You could call them non-market-based or non-praxeological, if my memory for ten-cent words suffices in the latter instance.
I see we have no disagreement important enough to debate the usury/consumer credit matter, so I won't go into that.
Now, for something completely non-diffident. I'm feeling so audacious as to offer you my re-writings of parts that bothered me. You can do with them as you wish, as long as it's nothing anatomically unpleasant to me. I meant for the best, after all, really I did.
Where you state that "we have to look at the sources of demand in a money economy", I've already recorded my dismay with your following exclusion of land. Here's what I'd say for the next few sentences after the sentence quoted above: "These sources are three in number: (1) labor; (2) capital; and (3) land. More specifically, they are wages, salaries, and commissions for the first; profits and bank interest for the second; and rent for the third. Entrepreneurial income, or that made by a proprietor or partner, may take in two or all three, but to determine what the relative shares is quite complicated. That is, a farmer may use his land's productivity, his own work, and his supply of machinery, seed, fertilizer, etc, to earn his total compensation - but as it's a total package, who is to say what percentage is for his labor, what for his buying the land, etc? Capital, incidentally, may be viewed as a combination of the other two, as it's the result of past labor working with the products of the land." Then the farmer and his seed corn.
I've already stated my opinion as to substitution of non-market or non-praxeological for non-economic. (Assuming both that I'm right about the latter's definition, and that you supply said definition prior to inflicting it upon your readership.) May I suggest, and I know this is rather long, that for the sub-title "Non-Economic Equilibrium", you use instead "Non-Market Solutions for Market Disequilibrium"? It's concededly lengthy, but it seems more accurate to me.
Finally, on the footnote concerning economic rent: "There can be an addition to the income of any of the three sources of demand: economic rent, or" (then your definition).
Best,
Viking
Oops, I was mistaken. Praxeology is the science of human action in general, not just of market transactions. I must have gotten the wrong impression by reading von Mises's "Human Action", or at least my faulty memory of same. Is there a science of the market - "agorology", say? Anyway, sorry for the bad info.
Viking
John
Despite your saying things so very well, you are here saying the wrong things as a result of misunderstanding several key points in this chapter. First, if the system is "dynamic" then (a)equilibrium is not a STATE but a constant SPEED, i.e. one which the macro "forces" of supply and demand (or micro costs and anticipated profit) are neither accelerating nor decelerating. (b) Supply and demand are not states but PROCESSES, the minimal definition of which involves a beginning, a middle and an end, and in continuous processes cyclic repetition.
Secondly, the supply and demand of current economic theory are static abstractions, leaving out people and crucial differences between types of thing by reducing everything to expected quantities. How, then, can you say "The theory is sound", when it leaves out all connection with reality? At best it can only be "self-consistent".
To understand the problem, we have to look at the sources of demand in a money economy. And these sources are two: wages, and interest or profit ...
Thirdly, while agreeing the first sentence here, the SOURCE of demand is not monetary income but a sub-process within living people. Using energy as we react to stimulae, our bodies repeatedly demand food, information and the means to reacquire them. Wages and profit are means of SUPPLY which do not themselves supply but merely inform suppliers of a conventional right to be supplied. Such means of course fail to reach everybody, though everyone's body makes demands.
Fourthly, in a monetary economic system there are not one but two circular macro economic processes: a real one and a monetary one which for purposes of convenience represents it. People demand specific resources and recycle them as waste from which resources are regenerated by Nature, including people who reproduce demanded specifics. Since not everyone has access to all natural resources, a process of distribution is required, and a monetary cycle facilitates transfer of natural resources from (a) those who have them (the function of investment, hence the human role of investor) to those who need them for the function of reproducing specifics (the role of producer); (b) from producers to those in the role of distributors (c) from distributors to people in their natural role of consumers.
Fifthly, it is a mistake to take for granted that people should acquire their livelihoods in the form of wages or profits for services already rendered. They can equally and much more aptly given (if not so much justly as respectfully and charitably) in the form of a stipend which one is subsequently required to earn. That is the way life works: our parents first invest in us, then we earn our own living, then we end up caring for/pensioning off our parents. This is what is implied if one interprets all money as debt. It also eliminates the curse of misinterpreting money as easy wealth, so that criminals and hoarders are attracted to it.
Clearly the returns to capital and labor, interest and wages, spring from the same source (labor). Capital, then, ought to have roughly the same rewards as labor, plus some premium for saving.
Sixthly, this curious conflation of "returns" and "rewards" is quite mistaken, although from an other point of view (that of diminishing returns or maximum power transfer in a flow system) highly significant. Wages come from money after the wealth corresponding to it has been created, but interest is by definition paid on debt, most of which is in a fractional reserve system money created in the first place as an empty symbol, which as yet has no real value to justify the return of interest or collateral in the form of mortgaged property. This money with imaginary value does however PHYSICALLY exist, so that its continuous creation increases the amount in circulation, decreasing its average value and inflating prices. Interest charged in the form of annual percentages can absorb most of earnings-limited repayments in the early years of long-term loans, with house mortgagees often paying in interest more than twice the market value of their house. Interest, in short, ensures there can be no equilibrium in monetary flow. It can be a legitimate way of providing incomes for post-work pensioners and workers in pre-productive occupations like science and education, but for equilibrium to be possible it should be as a percentage of earned income/repayments, not nominal capital.
Dave, I basically agree with all of your comments. Equilibrium is a process rather than a state, and it is well not to confuse the two. I need more on the distinction between the real economy and the monetary economy, and how to ensure that the later remains the servant of the former rather than (as is currently the case) the other way round. The idea of stipend is worth persuing and I am sure the Social Credit theories could be useful here, though it may not fit into this context (I'll have to think about it.) Interest can be a real return, or a mere tax, it can be a legitimate sharing of the profits or pure usury. The distinction between usury and legitimate profit-taking needs to be made clear.
Thanks for your careful reading; it is very helpful to me.
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