Where to start? Here, there, or how to get from here to there?
The natural place to start is of course here, because we can observe it. Unfortunately, merely observing is not understanding. Someone once said that, “All science would be superfluous if the outward appearance and the essence of things directly coincided”.
So to understand we need to analyse, which means breaking reality into smaller, more intelligible bits, and then combining those bits back together. We hope to split and combine in the right sort of way so that we recreate our observations (or something close). Only then might we feel justified in claiming some understanding.
But this process is far from easy, especially as economic systems are very complex, and consist of lots of different kinds of things (people, material stuff, markets, institutions, property laws, contracts, money etc.) interacting in lots of different ways.
So we will need to be patient. We need to break down and simplify, before we can build up and start talking about the phenomena we really care about.
The first bit of economic reality we’ll examine is the production of commodities.
Most commodities are made by people combining their skills and expertise to transform material inputs into material outputs. For example, to produce 1 acre of corn typically requires at least some of the following: fertile land, seed corn, fertiliser, lime, herbicides, fuel, tractors, insurance and hired labour. All these inputs combines in definite proportions.
The precise proportions may change over space and time, for a variety of reasons. But at any given time and place we find a specific technology of corn production.
The number of inputs used-up to produce any commodity is typically very large (even Figure 1 is an immense simplification). But without loss of generality let’s simplify and, for the moment, say that producing 1 unit of corn requires some corn (in the form of seed), some iron (which represents hard tools) and labour.
Let’s also say that to produce 1 unit of iron requires 0.1 iron and 0.2 hours of labour.
We can also use the language of inputs and outputs to describe how labour is “produced”. Workers consume a collection of goods and services called the real wage, which normally includes such things as food, clothing, housing and so forth. This consumption “produces”, or rather reproduces, their living being and their ability to supply labour services to the economy. To keep things really simple, we’ll assume that the workers only consume corn (in the form of bread).
We can combine the corn, iron and worker technologies to form a single composite technology:
This composite technology, although simple, captures an essential feature of real economies: commodities are produced using other commodities. Making things involves a circular flow of materials, where those materials get repeatedly transformed and reproduced. (Many materials, sadly, do not get reproduced, but are simply extracted without replacement or maintenance, such as natural resources).
In theory, we can observe the composite technology that includes all the goods and services produced by a real national economy. We’d need to measure what goes in and what goes out of all the “factory gates” over a period of time, say a month or a year. That’s a tall order. Nonetheless, economists compile such data, although they aggregate firms into distinct industrial sectors. For example, you can download the input-output table for the USA economy from 1997-2014 from the US Bureau of Labor Statistics.
We’ve defined a technology, which describes how things can be made from specific proportions of inputs. But so far this is a mere static specification. In a subsequent post, we’ll look at the next chunk of economic reality, which is how a production process dynamically transforms inputs into outputs according to a technology.