Creation of Wealth

[Danoff]

**This may end up in the opinions forum, but I wanted it to start here**

So one of the things about economics that I had a hard time understanding was how wealth can be created from nothing. Most people think that the American economic system has something like a fixed amount of money – one big pie that we’re all trying to get pieces of. If that were true then when some bigshot CEO gets a big piece of the pie, you’d feel like he took some of what your share should be.

But I’ve know that wasn’t true for a long time. I knew that wealth can be and is created in America from nothing. That the size of the pie isn’t fixed, and that when some bigshot CEO gets a big piece of the pie – he almost certainly didn’t get it from me, he made it.

My question has always been “how”. How is wealth created from nothing? Where does the money come from? If someone comes along and makes wealth, they’re getting paid from other people, so their money comes directly from other people – sounds like it’s one pie to me…

I figured it out.

Imagine a village that had a fixed amount of printed money. The population is increasing in this village because more people are born than die. As more people exist, they create more businesses and offer more services. So now instead of one guy selling pumpkins there are two, and where there used to be nobody selling pickles, there is one. But if the amount of printed money stays the same while these new services show up – then there is more competition for the same money. In short, the same amount of money buys more services.

Know what that’s called? Deflation.

I means that the value of your money is going up as time goes by. Deflation is bad – very bad. It strangles economies because it encourages everyone to sit on their money. Don’t invest it, don’t risk it to create more services, definitely don’t borrow money – just sit on it. Take it out of the economy and put it under your mattress and you’ll have increased your wealth. That kind of behavior will kill an economy.

How do we prevent deflation in our village?

Print more money to attempt to keep the value of the printed money constant over time. As new services show up and the value of the money goes up, we have to print more money to compensate and drive the value back to what it was before. The result is that when joe shmoe goes out and starts his pumpkin selling business, he eventually forces new money to be printed to compensate for the new services – he created wealth!

Another way to look at it is that the new services that cause deflation are creating wealth because everyone gains wealth when the value of their money goes up – but that’s a tougher thing to see because we don’t experience deflation. What really happens is that new money is printed.

Cool huh! So next time you see someone drive by in a Mercedes think about how they created that wealth all on their own – and stop thinking they owe you any of it.

 

[Famine]

Cool huh! So next time you see someone drive by in a Mercedes think about how they created that wealth all on their own – and stop thinking they owe you any of it.

Especially since they'll be giving some of that wealth to a garage to fix it every time it goes wrong And it's a Mercedes, so it'll happen a lot...

 

[keram]

It doesn't matter how much money there is in a country is still worth the same in comparison to the rest of the world. That country has to trade to gain more 'real' money. The only way of creating an income is to produce a real product and sell that to another country and you country has their money.

 

[Danoff]

It doesn't matter how much money there is in a country is still worth the same in comparison to the rest of the world. That country has to trade to gain more 'real' money. The only way of creating an income is to produce a real product and sell that to another country and you country has their money.

Wow! That's totally wrong! Almost nothing you said was correct.

What's so special about countries? That the economy is different? The same phenomenon exists for cities and states. The value of a country's currency or products can go up or down with respect to other currencies regardless of whether or not any currency or products are traded.

What makes the income "real" when it comes from other countries? What is fundamentally different about it - that it's tied to another economy? Why does that matter?

 

[PS]

I think he means profit. When you're getting money from other countries, it didn't cost the printing press or the government anything to get it.

[edit]

Aside from whatever surplus of stuff they sold off.

 

[skip0110]

I always think of danoff's point whenever I hear an argument that the US should provide support to 3rd world contries because somehow we "stole" their wealth.

That we provide aid is soley our goodwill, noone deserves America's wealth more than we do.

 

[Danoff]

I think he means profit. When you're getting money from other countries, it didn't cost the printing press or the government anything to get it.

Well it doesn't cost much to print money. Especially if you print big bills. : )

Who's profit does he mean? The government's? There isn't really a such thing as government profit. Our government doesn't really sell goods to other countries, companies within our government sell goods. Those companies can profit from foreign money, or they can profit from local money - it's all the same to them. Trade with other countries can strengthen or weaken the value of your currency, but I see no reason why a country must trade with others before they have "real" income. A country can be completely economically isolated and still be extrodinarily wealthy - they just have to have a substantial population and lots of natural resources.

 

[PS]

Well, it's costs more than a nickel to make a nickel, and much more than a penny to make a penny.

Well, if a higher power in the government owns one of those money producing companies, then I guess the government can make money?

 

[MrktMkr1986]

creation of wealth = proper allocation of resources

...in my opinion...

That's it? No arguments?

 

[///M-Spec]

Wealth is the result of human endevor to turn something useless into something useful. Of course, not all humans agree on what is useful and what is not, but let's assume for the sake of discussion there are things in this world universally accepted as useful... water, food, shelter, medicine, etc.

When wealth is traded intelligently, it becomes multiplied with each iteration of the exchange. True wealth is when humans can reap maximum reward for minimal effort. This is why you are sitting in front of a computer reading about some esoteric topic rather than knee deep in a rice paddy or sitting in a bush waiting for something furry to scamper by.

Let's take danoff's village example. Say it's the neolithic era and the village's 100 men and women can just survive by working from sunrise to sunset.

It may not be very much but this work creates wealth. They create wealth by hunting, gathering, planting or making simple goods and shelter. However, they consume the same amount just to survive.

Say one villager gets the idea to tie a sharp stone to a stick. This lets him hunt game that is larger than what he can catch with his bare hands. This creates wealth too. It creates for him an opportunity to hunt less for the same reward or hunt the same amount for greater rewards.

So soon, all the men are walking around with sharp stones on the end of sticks. This means they quickly have suplus animal skins. This is, of course, wealth.

Maybe one astute fellow decides to take his extra skins, walk to an adjacent village and trade them. --after all, now that he doesn't need to hunt all day, he can take the time.

Maybe he returns from his trip with this amazing white, flakey thing they have whereby if you put them on your animal meat, it will preserve them for much longer than if they just sat in the ground wrapped in fur. Soon, the village is trading extra skins and meat for salt and they have for the first time ever, a store or extra food in case hard times came upon them. Hey, that's wealth.

It was created by the people in village who used their brains in order to turn useless things (rocks. sticks. salt.), into something more useful. Walking long distances is not very useful, so someone invented animal domestication and wagonry. Sitting by the river waiting for fish to swim by so you can poke them with your stick is not especially useful, so someone invented the net, the line and boats.

Of course, maybe one day some fellow figures it'd be easier to take all village's men and their stoney pointed spears, poke some holes in the men from the nearby village and take their wealth. This of course doesn't create wealth, but merely transfers it. In fact, with all the men in the neighboring village dead, the net wealth of the area would decrease. Of course... the per capita wealth of the area would temporarily increase as macabre as that sounds.

Fast forward thousands of years and despite humanity's penchant for creating things of dubious value, all wealth is the still the result of human endevor.

creation of wealth = proper allocation of resources

...in my opinion...

That's it? No arguments?

My only argument is the word "proper" is widely disagreeable. What's proper for me may not be proper for you, and vice-versa. Multiply this quandry 5.7 billion ways and you have a recipe for disaster.


M

 

[Danoff]

///M,

While your post attacks the issue of the creation of wealth at a much more fundamental level, I think it coincides with what I wrote originally pretty well. Wealth is created from nothing when new useful goods and services are created.

I think not long ago I could have followed what you wrote perfectly and still been clueless about how that played out today. It wasn't until I realized how the money supply was affected by the introduction of new goods and services that I realized how the pie grows for us today in America.

By the way, what do you and MrktMkr think about this notion that the true wealth of nations is only measured in trade with others?

That's it? No arguments?

I doubt we'll be arguing much when it comes to economics.

creation of wealth = proper allocation of resources

+ creativity

 

[MrktMkr1986]

My only argument is the word "proper" is widely disagreeable. What's proper for me may not be proper for you, and vice-versa. Multiply this quandry 5.7 billion ways and you have a recipe for disaster.


M

I see your point.

I will, however, say this. Everyone has resources. How you use them is what invariably determines wealth.

This assumes that one works in a market economy (in the broadest meaning of the term).

 

[MrktMkr1986]

///M,

While your post attacks the issue of the creation of wealth at a much more fundamental level, I think it coincides with what I wrote originally pretty well. Wealth is created from nothing when new useful goods and services are created.

That is one factor of production -- entreprenuership.

By the way, what do you and MrktMkr think about this notion that the true wealth of nations is only measured in trade with others?

I believe that that is one factor. I still maintain that the main factor is the allocation of resources.

I doubt we'll be arguing much when it comes to economics.

Why? There are many theories that can be discussed depending on a particular point of view.

+ creativity

Creativity usually coincides with entreprenuership -- one factor of production. Therefore, creativity (in a sense) can be considered a resource -- which in turn must be allocated in order to produce new goods/services (and the cycle continues).

 

[Danoff]

That is one factor of production -- entreprenuership.

I wasn't just talking about entreprenuership. I was talking about any increase in goods and services.

Creativity usually coincides with entreprenuership -- one factor of production. Therefore, creativity (in a sense) can be considered a resource -- which in turn must be allocated in order to produce new goods/services (and the cycle continues).

I thought you might say that.

 

[Mike Rotch]

Imagine a village that had a fixed amount of printed money. The population is increasing in this village because more people are born than die. As more people exist, they create more businesses and offer more services. So now instead of one guy selling pumpkins there are two, and where there used to be nobody selling pickles, there is one. But if the amount of printed money stays the same while these new services show up – then there is more competition for the same money. In short, the same amount of money buys more services.

Know what that’s called? Deflation.

I dont know if I agree with this paragraph danoff. If the same amount of money is chasing more goods, the value of your money may go up as in you have less of a scarce commodity, but your purchasing power does down as you effectively have less money to buy more goods. Wealth may appear created as some people have more of it then others and arent scared to put it to us in the form of austentatious assets.

As Gertrude Stein said, "Money stays the same - its the pockets that change".

 

[MrktMkr1986]

I dont know if I agree with this paragraph danoff. If the same amount of money is chasing more goods, the value of your money may go up as in you have less of a scarce commodity, but your purchasing power does down as you effectively have less money to buy more goods. Wealth may appear created as some people have more of it then others and arent scared to put it to us in the form of austentatious assets.

As Gertrude Stein said, "Money stays the same - its the pockets that change".

That is correct. Money/wealth is not "created" in that sense. It is simply transferred.

 

[///M-Spec]

I dont know if I agree with this paragraph danoff. If the same amount of money is chasing more goods, the value of your money may go up as in you have less of a scarce commodity, but your purchasing power does down as you effectively have less money to buy more goods. Wealth may appear created as some people have more of it then others and arent scared to put it to us in the form of austentatious assets.

As Gertrude Stein said, "Money stays the same - its the pockets that change".

I don't think that would happen, Mike. The PRICE of goods would come down due to competition with the other goods. The value of fixed currency cannot drop at the same time that it's ability to purchase goods increases. That's a contradiction.


M

 

[Danoff]

As Gertrude Stein said, "Money stays the same - its the pockets that change".

...which is incorrect from the viewpoint of growing economies. That's exactly the kind of statement I'm fighting.

If the same amount of money is chasing more goods, the value of your money may go up as in you have less of a scarce commodity, but your purchasing power goes down as you effectively have less money to buy more goods.

Not quite.

Your purchasing power does not go down – your purchasing power goes up.

Think of it this way. The collective currency in the village is 100 dollars. That money is just exchanging hands around and around. The people in the village buy the following on a given year.

10 pumpkins (5 dollars each)
20 apples (2.5 dollars each)

As new goods are introduced the supply increases, as does competition. The result is a drop in price which spurs and increase in demand.

20 pumpkins (2.5 dollars each)
40 apples (1.25 dollars each)

… and the village gets a little fatter. I don’t know why they need so many pumpkins, I guess Halloween comes every month…

So the same amount of money now buys more goods. That’s deflation, the purchasing power of the same amount of money increased. Granted things are significantly more complex than this in the real world - but the same trend holds true. As new goods and services are introduced, if the amount of currency to buy those goods stays the same, the purchasing power of the currency goes up.

 

[Mike Rotch]

///M and danoff, I think we aer looking at the same coin, except from two different sides. I agree with your apples and pumpkins example. Prices will drop where new vendors start duplicating existing business. Excess supply dictates lower prices.

However, not all businesses will be duplicates. As the village grows, additional differentiated businesses will open. however, with a set amount of currency in the village, villager 1 will be able to afford fewer of many products. All of a sudden now, there is an apple, orange, turnip, avocado, banana, carrot and bottled water store (!). He has the same amount of money, but can only afford two or three of those items. Hence his purchasing power (not measured in terms of inflation) has decreased.

 

[MrktMkr1986]

If that happens, they should then invest their money in order to hedge inflation.

 

[Minnesota01R6]

I was always under the impression that wealth was made by combining labor with a vessel to contain that labor (creation), or through finding something of value. Here are a few examples:

chop down a tree and cut it into fire wood. It is now worth more than it was because your labor has been combined into it.

plant seeds, tend the field, and harvest your crop. You now have more wealth because you combined your labor with the land.

go to the stream to get some water, find a gold nugget.

John Locke, Carl Marx, and Labor theory come to mind, but I don't have time to look them up in order to refresh my memory. I do know that in my property class, there were only 5 ways to acquire property - both real property (real estate) or chattel (movable property). The 5 ways are: Find, creation, gift, conveyance, and adverse possession. The only 2 on the list that don't involve getting the property from someone else are find and creation.

 

[Danoff]

however, with a set amount of currency in the village, villager 1 will be able to afford fewer of many products. All of a sudden now, there is an apple, orange, turnip, avocado, banana, carrot and bottled water store (!). He has the same amount of money, but can only afford two or three of those items. Hence his purchasing power (not measured in terms of inflation) has decreased.

...and all of those new people are competing for the same currency, so prices have to drop for all of those things. Now whereas the villager could only afford an apple before, he can afford an apple an orange and a turnip - and his purchasing power went up. Prices HAVE to go down, if they stayed the same, almost all of those new businesses would go under.

Don't worry about how much money each villager has, or how many new products they can afford. Just think about how prices will go down and the currency amount stays the same, so deflation occurs - which can be viewed as a creation of wealth by itself, but is best countered with additional currency which is where we get to see all the new wealth in physical form.

 

[///M-Spec]

However, not all businesses will be duplicates. As the village grows, additional differentiated businesses will open. however, with a set amount of currency in the village, villager 1 will be able to afford fewer of many products. All of a sudden now, there is an apple, orange, turnip, avocado, banana, carrot and bottled water store (!). He has the same amount of money, but can only afford two or three of those items. Hence his purchasing power (not measured in terms of inflation) has decreased.

I follow you here, Mike. But just because there is more diversity in the market doesn't mean the villager has to consume them. He only NEEDS a certain amount of food for him and his family. Since his needs (demand) stay the same but he has more choices in what to buy (supply) the average price has to come down.

In other words, if an apple, banana, orange merchant are all trying to sell their wares to the same guy who only wants to eat ONE peice of fruit, then they pretty much have to lower their prices in order to make sure theirs is the only peice of fruit their customer buys.

Similarly, if car manufactuers introduce more car models, you're not going to suddenly buy more cars than you need.


M

 

[MrktMkr1986]

I was always under the impression that wealth was made by combining labor with a vessel to contain that labor (creation), or through finding something of value. Here are a few examples:

chop down a tree and cut it into fire wood. It is now worth more than it was because your labor has been combined into it.

plant seeds, tend the field, and harvest your crop. You now have more wealth because you combined your labor with the land.

go to the stream to get some water, find a gold nugget.

John Locke, Carl Marx, and Labor theory come to mind, but I don't have time to look them up in order to refresh my memory. I do know that in my property class, there were only 5 ways to acquire property - both real property (real estate) or chattel (movable property). The 5 ways are: Find, creation, gift, conveyance, and adverse possession. The only 2 on the list that don't involve getting the property from someone else are find and creation.

Labor is one resource/factor of production. There's also land, capital, and entrepreneurship. All of these are used to create wealth.

Labor = salary/wages etc.
Land = rent
Capital = interest/dividends <<< my favorite!
Entrepreneurship = profit/royalties etc.

Everyone has at least one of these resources. So you use one to create more wealth, and then allocate those resources into other factors of production, and so on. How you allocate these resources is what determines your wealth.