Developing a Model

In the five steps of developing this system model we have demonstrated four principles of the economic systems:

1. Production always precedes consumption
2. Production rates influence consumption rates
3. Consumption rates less than production rates result in accumulated savings
4. Savings have a positive, reinforcing, influence on the production rate

These four systemic principles represent four fundamental principles found in economic systems of any size: e.g. an individual, an organization, a community, or a nation.

Caution: These models use a unit of measure—i.e. Economic Unit—that represents a higher level of abstraction. As a result, some precision gets lost. The viewer should see this model is a representation of economic principles and theories, and not a representation of a real economic system.

The Simple Economy

Production Before Consumption: Stocks and Flows

The first and most fundamental principle that we demonstrate from these models consists of the stock and flow relationship between production, consumption and savings in all economic systems. The flow of economic goods proceeds from production to consumption (higher production leads to higher long-term consumption.) The flows of production always precede the flows of consumption. Stocks of Savings always result when the rates of consumption fall below the rates of production.

These relationships exist in economies of all scales—from the individual hunter gatherer to complex market societies like the United States. The hunter gatherer must pick the berry (i.e. produce) before he can eat it (i.e. consume). The mine operator must dig for ore before lower order producers make the metal products consumers use.

This relationship provides a foundation for understanding the processes of an economic system. It also helps to refute the idea that increased consumption can "stimulate" an economy.

Production Rate Influences Consumption Rate

As alluded to above, because production must precede consumption, the rate of production will influence the rate of consumption.

Consumption and Savings

At any rate of production, the level of Savings will increase as a result of lower fractional consumption rates (or consumption rates that amount to less than 100% of the production rate.) In simple terms this means that in order to save an economic system must limit its rate of consumption. Only individuals can determine their appropriate rate of consumption.

Savings and Production

A positive feedback exists from the level of Savings to the rate of production. Any increase in the level of Savings will tend to increase the rate of production. Of course, the fractional rate of that improvement will vary based on the type and level of the Savings and the preference of the individual actor. The principal, however, applies to all levels of the economy.

In the simplest economy, the gatherer can increase his production because of the additional time he can devote to production as a result of prior Savings. In a more advanced economy, a cobbler, for example, can acquire additional tools or hire an assistant by trading the shoes that he has saved.

Because higher production supports higher consumption and savings positively influences production, paradoxically lower rates of consumption in the short-term ultimately lead to higher rates of both production and consumption in the long-term.

In summary, saving—or consumption denied—leads to a higher standard of living.

Economic Intervention

As we have seen in The Simple Economy, increased consumption, even though it may make us feel good and buy our votes in the short-run, eventually becomes a drag on the economy.

Intervention and Consumption

Since limiting consumption ultimately leads to increases in longer-term production and consumption, any activity or intervention that increases the rate of consumption will ultimately lead to a decline in production and consumption. The activities of government tend to stimulate current consumption; therefore, government intervention becomes a long-term problem for a productive economy.

Attempting to "stimulate" the economy by increasing consumption contradicts sound logic and operates contrary to sound economic principles and theories. The two models in the Economic Intervention section do not prove that economic stimulation does not work, but they do demonstrate the effects of increased consumption based on sound economic reasoning.

Monetary Stimulation

Some people might ask, "What about Monetary Stimulation?" How does that government intervention in the monetary system influence production, consumption, and savings?

Using money as a measure of macro-economic activity represents an error in applying levels of abstraction. I have presented these models as a higher level of abstraction of economic activity, not as an aggregate of economic activity at a lower level (e.g. the model does not add pigs + Chevys + iPad + etc.) (For clarification of this point refer to Transition to a Generalized Model: Step 2.)

Although you can aggregate the dollars (a unit of money) spent in individual exchanges, that does not depict the dynamics of the economy. I address the affects of monetary intervention in the Pricing Model. (Will describe the relationship between this model of economic activity and the pricing model in later presentations.)

Conclusions

Taken together these models develop the relationship between production, consumption, and savings over a long period of time. In general, they demonstrate that short-term changes in consumption in one direction lead to long-term changes in consumption in the opposite direction.

The Keynesian "savings dilemma" does not exist. A choice does, however, exist between having a little more now and having a lot more in the long-run or having a lot more now and having a lot less in the long-run.

You decide.