For lecture videos, readings, and other class materials, you can sign up for this independent study course at academy.mises.org

1. Production & the
Market Process
Robert P. Murphy
Mises Academy
July 27, 2011
Lecture 2: 1st
Half of Chapter 6 of
Man, Economy, and State

2. 1st
Half of
Chapter 6 of MES
I. Assumptions
II. Stationary Economy
II. Interest Theory in the
Austrian Tradition
A. Bohm-Bawerk
B. Fetter
C. Mises

3. I. Assumptions
Chapter 6 deals with the “pure” rate of interest
(due to time preference). Later chapters will
handle the components of the market rate of
return due to a purchasing-power-premium
and risk.
However, we relax some of the unrealistic
assumptions from Chapter 5. We allow for
factors to be used in various goods (i.e. less
specific), and we have capitalists paying factor
owners after each each stage (i.e. not joint
ownership).

4. II. Stationary Economy

5. A. Facts About Economy of Fig. 41
Interest rate observable from price spreads;
about 5.2% (with rounding) at each stage.
Sum of capitalist and factor owners’ income
equals total consumer spending.
Total gross investment = 318 oz.
(95+76+57…)
Gross investment x interest rate = total
income of capitalists (with rounding)
Net investment = 0 oz.

6. B. Capital Goods in the ERE
Capital goods earn no “independent” income
in ERE; only land and labor do.
Income accruing to capitalists is due purely to
the time element; they advance present goods
to workers in exchange for future goods.

7. III. Interest Theory in Austrian
Tradition

8. A. Eugen von Bohm-Bawerk
Interest problem: Why is it that capitalists earn
an income, without seeming to contribute
anything productive (like labor or natural
resources)?

9. 1. Naïve Productivity Theory
Bohm-Bawerk said the answer not that “capital
goods are productive.”
Yes, we can produce more with capital goods
than without them. But that explains why
businessowners pay prices for capital goods.
It doesn’t explain why investors pay lower prices
for capital goods than they will eventually yield
them (when the higher output is sold).

10. 1. Naïve Productivity Theory (cont’d)
$100,000
$110,000

11. 2. Bohm-Bawerk’s Agio
Theory
Present goods are preferred to a like kind and
quantity of future goods.
Now, one of the reasons Bohm-Bawerk thought
present goods subjectively preferred to future
goods, was the higher (technical) productivity
of “roundabout processes.”

12. B. Frank Fetter
Thought Bohm-Bawerk had ironically slipped
back into the same error he had exploded.
Fetter argued that interest had nothing to do
with productivity of capital at all; it was due
entirely to subjective time preference.

13. C. Ludwig von Mises
Agreed with Fetter, but thought time
preference was a necessary implication of
action. (Fetter had just thought it was an
empirical fact about human valuation.)