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Artificial Demand

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Lathanar

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Ok, so what if the jet manufacturer itself started handing out installment programs to let those not normally able to afford it do so? What do you call that? That is my question, I have always called this artificial demand.

An installment plan can be seen as a form of savings.

Let's say you want a PC, but don't have the $1,200 it costs. One thing you can do is save some money until you acumulate enough. Of course, there are no guarantees you'll save the needed money. You may loose your job, you may need money to handle some emergency, you might be robbed, etc. But you can quantify the likelyhood of such risks, and know you will be able to afford the PC in, say, 12 months.

Suppose a store offers you the same PC at a higher price, let's say $1,300, but payable in 12 monthly installments. You pay more, but you get the computer now, not a year from now. The seller doesn't get paid full price immediately, but he starts getting money from you at once; and at the end of the year, he winds up collecting more money from you than he would ahve otherwise. Also, he may just have taken a customer from the competition.

Of course, the seller is taking a risk, too. But he has remedies available if you slip on your payments, including repossesing the PC. Nor is your risk eliminated.

Now, let's say, as I recall you asked earlier, that the whole economy tanks badly and you can't possibly pay him a dime.

This happened in 1995 in Mexico. Following a devaluation of the peso, interest rates shot up sky high. A mortgage taken out at around 12% was now 80-90+% Credit cards with a 25% rate now dmanded rates above 100% And if you fell behind on payments, the bank would charge you interest on the interest you'd failed to pay.

The end result was, a lot of people, a large majority of those with credit devts to banks, defaulted on their loans and mortgages. The banks wound up with a lot of unpaid, and in many cases unpayable, loans. Many banks went under (in fact, today no Mexican bank extant in 1995 is still owned by the same people it was then). The government bailed out the banks, and stepped in to meddle some more. There were new rules set up for how banks would collect interest, at what rates, etc etc. It also raised the national sales tax from 10% to 15% (naturally. we can't expect the government to do without, can we?). It raised other taxes, too, and it imposed sales taxes on interest payments (hw would that help to pay interest at already astronomical rates?). It secured loan gurantees from the US, with oil wells as collateral, and assorted emergency aid contributions, too.

It can be argued that without government intervention things would have been much worse. Savings, for example, did not evaporate in the debacle. It may even be true. but let's not overlook the government's responsibility for the crisis in the first place. Had the government not handled monetary policy, it would not ahve been able to cook the books to make things seem better than they were. Had the government not had so much power over the economy, then political tribulations would not have had as much impact on the economy.

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I've only seen the term 'artificial demand' used in the context of particular goods - for example an artificial demand created for <consumable_good_X> via a massive advertising campaign, or an artificial demand for military goods due to government spending, and so on. An 'artififcial demand' for everything doesnt really make sense so again if that's what Keynes said then it also sounds silly.

I do not think that increased sales through more advertising would or should be called artificial demand as I've mostly seen it done. Those people have the capital available to purchase those goods. Even government spending wouldn't be in my eyes as long as they aren't deficit spending. It's when people are given a way to spend way outside their means that I see it, trading on promises instead of goods.

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Let's say I save some money and it ends up being loaned to a guy called Jack who buys a Corvette from it.
  • Does this increase Jack's demand for Corvettes? Sure it does. If I hadn't loaned the money, Jack would not be able to buy the Corvette.
  • Does this increase the total demand for Corvettes? That depends on what I would have done with the money if I hadn't loaned it.
    • If I would have spent it on a Corvette myself, then my demand for Corvettes has decreased due to the loan, which cancels out the increase in Jack's demand for Corvettes--so the total demand for Corvettes is unchanged.
    • If I would not have spent it on a Corvette myself, then the total demand for Corvettes has increased.

Ok, now in a situation like this, say you lent Jack a lump sum to buy his car, or a bank did. Jack loses his job and can no longer make payments to you or the bank. That does not change the fact that the car was bougth and paid for from GM.

Now say GM has an installment plan, and Jack gets a car on that without borrowing money from anyone. If he loses his job and has to return the car, what does that do to the demand for Corvettes? While he was able to afford payments, demand for Vette's had increased, but when he could no longer afford it, the car was no longer purchased (in my eyes), it went back into the manufacturer's inventory thus lowering demand. So if I am right in this, did GM create demand that would not have otherwise existed?

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The marginal propensity to spend is always one, or very close to it. The marginal propensity to consume may be less than one, which means that you save some of your earnings, but most of what you save will end up being invested--in other words, spent on capital goods.

As I wrote on another thread, a penny saved is simply a penny spent by somebody else. The only way to make a penny and not have it spent is to keep it in a yieldless form (gold, coins, or bills), which you wouldn't want to do beyond your current payment needs. A bank account is safer, more convenient, and yields interest too. And the cash you keep for your current payment needs is cash you are going to spend.

Loaning the dollar IS saving it.

I'm totally with you on this now, sorry for the mistake on my part.

Let's put it this way: They can err on the particular mix of products they create. Say, they could make a million apples, a hundred cars, and zero spaceships, when in fact they would be better off making a hundred thosand apples, a thousand cars, and four spaceships. But it can't be that they make too many apples AND cars AND spaceships AND anti-cancer drugs AND hurricane prevention technologies AND crime investigation innovations AND everything you can concieve of. There can be no general overproduction ; as long as there is life, there will always be "problems," which are in fact opportunities for improvement. The challenge is not that we may run out of problems, but whether we are able to create the values that will solve them.

Here you seem to be talking to Keynes instead of Lathnar, who has said that he has no knowledge of Keynes work and that any duplication in terminology was coincidince. Although, I also have a question about this part, if you removed R&D/products that do not yet exist from the equation would it be possible for every company to produce to much of every product? I would guess that such a situation would be extremely unlikely at the very least do to the sheer unlikelyhood of everyone producing too much of every product at the same time, and the fact that staying in business while producing to much of all of your products would be difficult short-term and impossible long-term.

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I totally agree with what you're saying. What I want to know however, is what is it called when you keep producing pencils even though there is no market for it. Could that not be called excessive output or overproduction?

We could settle on "overproduction of pencils." B) I have no problem with the word as long as you refer to a specific kind of product. My objection is to the notion of general overproduction, and to it being used to explain the Great Depression.

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Now say GM has an installment plan, and Jack gets a car on that without borrowing money from anyone. If he loses his job and has to return the car, what does that do to the demand for Corvettes? While he was able to afford payments, demand for Vette's had increased, but when he could no longer afford it, the car was no longer purchased (in my eyes), it went back into the manufacturer's inventory thus lowering demand. So if I am right in this, did GM create demand that would not have otherwise existed?

Yes, the instalment plan did create demand for Corvettes that would not have otherwise existed. Now, as always, we have to ask ourselves what the alternative would have been. If GM had not offered the instalment plan, they would have manufactured fewer Corvettes (since they knew the demand for them was lower), so they would have spent less cash on the raw materials and labor needed for them. This cash would then have been available for other kinds of spending.

Let's say the Corvette costs $50,000, of which $20,000 go into raw materials and labor (i.e. the variable costs). So without Jack buying one on instalment for $50,000, there would have been $20,000 spent on other things--which means the instalment plan added $30,000 to aggregate demand!

How did it accomplish this? By better utilizing the capacity of GM's plant. The managers who came up with the idea of the instalment plan created $30,000 worth of wealth (which is what they get paid for!). So we have an act of wealth creation--that is, production--that has increased aggregate demand. As I said, production is the only thing that can increase aggregate demand. And again, because it is the result of production, the demand is true and real and justified.

Now what if Jack ends up losing his job and fails to get another job, and therefore can't pay the instalments? Then you have to ask why he lost his job and couldn't get another job. Did he become an alcoholic, for example? Then it was his excessive drinking that destroyed the wealth previously created. He wouldn't have lost his job if he hadn't hit the bottle so hard. We have an act of wealth creation (through better capacity utilization) canceled out by a subsequent act of wealth destruction (through excessive drinking), rather than a case of artificial demand and excessive production.

1929 and the ensuing years witnessed an enormous wealth destruction caused by a surge in statism. Laws like the infamous Smoot-Hawley Tariff destroyed business opportunities that had previously existed, and that's why millions of people lost their jobs. They wouldn't have lost their jobs if the government hadn't forbidden so many people to produce. The prosperity of the 20s was true and real and justified, and could have been sustained. Again, we have wealth creation followed by wealth destruction.

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We could settle on "overproduction of pencils." B) I have no problem with the word as long as you refer to a specific kind of product. My objection is to the notion of general overproduction, and to it being used to explain the Great Depression.

Ok, I attribute a lot of problems that led to the Great Depression to the overproduction of radios and cars.

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Let's say the Corvette costs $50,000, of which $20,000 go into raw materials and labor (i.e. the variable costs). So without Jack buying one on instalment for $50,000, there would have been $20,000 spent on other things--which means the instalment plan added $30,000 to aggregate demand!

How did it accomplish this? By better utilizing the capacity of GM's plant. The managers who came up with the idea of the instalment plan created $30,000 worth of wealth (which is what they get paid for!). So we have an act of wealth creation--that is, production--that has increased aggregate demand. As I said, production is the only thing that can increase aggregate demand. And again, because it is the result of production, the demand is true and real and justified.

Ok, I can see your stance now stated like that, however it still does not sit well with me. If I'm spending 20,000 dollars to make a product and selling for 50,000 but in reality only taking 1,500 with the promise that I'll get the rest, I don't see it as really selling the car. I can not get myself to the point yet where I see any wealth being created until the asking price has been met. I can't put my finger on it, but something isn't right there.

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If I'm spending 20,000 dollars to make a product and selling for 50,000 but in reality only taking 1,500 with the promise that I'll get the rest, I don't see it as really selling the car.

But accountants do, and I agree with them. Your assets grow by $30,000 the moment you sell the car:

Debit	 Credit
Inventory 20,000
Cash 1,500
Instalments Owed by Clients 48,500
Operating Profits 30,000[/code] An obligation to pay you $48,500 is an asset just like $48,500 of cash is an asset; the former may be considered riskier and is less liquid, but what matters is that [i]it's something you have.[/i] (In fact, unless it's all gold, the $48,500 in cash is [i]also[/i] an obligation to pay you $48,500; the only difference is that the debtor is a reliable and widely known bank, rather than an individual you know little about.) The instalment payments only shuffle wealth between two classes of assets:
[code]Debit Credit
Cash 1,500
Instalments Owed by Clients 1,500

You have $1,500 more in cash, but $1,500 less in "money-owed-by-Jack." Your total assets are unchanged.

I can not get myself to the point yet where I see any wealth being created until the asking price has been met.

The asking price is "$1,500 in cash now and a promise to pay $48,500 in cash according to the schedule attached." As soon as Jack hands over the $1,500 and signs the contract, the asking price has been met.

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But accountants do, and I agree with them. Your assets grow by $30,000 the moment you sell the car:

Hahaha, thanks so much, that I can sink my teeth into. I had almost even said both columns must match in my previous post. Don't you at some point though reach a spot where your handing out too much credit?

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Wouldn't this mean that you can expand demand via expanding credit?

You expand production through expanding credit and that will in turn expand demand. The important thing to note here is that this is not an artificial or fake expansion, but a perfectly well-earned one.

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Don't you at some point though reach a spot where your handing out too much credit?

Obviously, it wouldn't be prudent to extend credit to each and every person that walks into the showroom, bums and billionaires alike. You have to check their creditworthiness: that is, whether they will be able to make their payments when they become due. As long as you can be reasonably confident that Jack will be a good debtor, you have no reason to deny him credit, no matter how much credit you've extended before. On the other hand, if it looks like he's a questionable debtor, then you should reject him, even if he would be your only client buying on credit.

It's a bit like the "small government / big government" question. It's not that the government "shouldn't be too big" ; but rather, that the government should be just, and its size should be determined by whatever amount of government is needed for justice. And similarly, it's not that there shouldn't be too much credit, but rather that all credit should be sound, and the amount of credit extended should depend on how many good debtors you can find.

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I still can't shake the thought that expanding through credit is not a good thing to rely on, it keeps prices at a level they shouldn't be at, and it puts too large a point of failure. There should be some formula or what-not that takes into account a break even point that if all credit accounts defaulted and inventory was returned it would be detrimental to the inventory supply and price. I'm going to have to do some more research before I come back to this one.

[edit] Any suggestions for books on economic theory would be appreciated.

Edited by Lathanar
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You expand production through expanding credit and that will in turn expand demand. The important thing to note here is that this is not an artificial or fake expansion, but a perfectly well-earned one.

What happens if the debt can't be fully paid?

Edited by Felix
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