10. Flows of goods, productivity and prices

1. The flow of the real economy
2. Full employment
3. References

10.1 The flows of the real economy

The final purpose of the private sector is to supply the society and its inhabitants with goods and services. This chapter describes the real economy, how the labor force takes part in the production of goods and services. The domestic production together with the imports of goods and services make up the supply of commodities for the society. The usage is divided between consumption, exports and investments in fixed capital or stocks. The connection to the monetary economy will also be described below.

The production of the public sector is not considered now because the public production consists (in Sweden) mainly of goods and services that has other purposes than the private production.

Let us first take a look at the flow of commodities:

Figure 10.1:1. Flows of goods and services. Notations are the same as for Model D1.

A balance of supply and expenditure can be set up for volume flows of goods and services as well as for payments that measures the flows in terms of money.

Table 10.1:1 Balance between supply and usage of goods and services, measured as volume flows.

The supply side consists of the domestic production in the private sector and imports.

The expenditure side consists of private consumption, public purchases, investments, exports and change in stocks.

Because the goods and services are very different, a common measure for the volume flows has to be found. A homogenous group of goods e.g. cars can be measured as units/year or tons/year. This measure is not suitable for services. Let us choose man-years/year as a common unit of measurement, with a work day of 8 hours/day, during a certain base year using the technology of that year. We can call it produced man-years/year or product man-years/year (pmy/year). The unit implies that the utility of the commodities can be represented by the labor done using standard production methods. The consumption of fixed capital is not included in the value of the commodities. The consumption of fixed capital will instead be deducted from the investments when calculating the amount of real capital (buildings, machinery etc.).

If less labor is needed for the production of a certain kind of commodity by the use of a different technology, then the value of the commodity will not be less. The ratio between the volume of the products, measured as product man-years, and the actual amount of labor done, measured as worked man-years (wmy) is the productivity factor (pmy/wmy) or simply the productivity. When the productivity increases by e.g. 10 percent, then the productivity factor is 1.1 and 10 percent more goods can be produced by the same number of employees or alternatively 9 percent less personnel is need for the same production.

Let us now consider the production process. A number of workers go to their jobs and stay a certain number of hours each day. The work done/year depends upon the number of employees at work X(24) and the daily working hours. The production volume/year X(25) is determined by the productivity factor pf and the work done per year (worked man-years/year). The total earnings/year is determined by the earnings per man-year ( with 8 hours/day) pw and the amount of work done.

Table 10.1:2. Labor and production.

The flows are shown on the left side of the figure below:

Figure 10.1:2. Relations between production volume, labor and payment flows.

The solid arrows of figure 10.1:2 above show the flows of labor and commodities (the real economy). Small circles are starting and end points for the flows (source and sinks). The capacitor symbols (=) are locations where flows accumulate. Dashed arrows indicate connections, with the corresponding price factors, to the monetary economy. Imports and exports also connect to their payment flows but that is not shown here. See table 10.1:4.

The total flow of labor etc. is shown in the figure below. It is the same figure as figure 7.1:2 but with a new numbering of the flows. The new numbering belong to Model D1 that will be described in chapter 12.

Figure 10.1:3. Flows of employees etc. , Notations as for Model D1.

In order to study different income distributions, three categories of employees have A, B and C have been introduced. Each category is assumed to have its own yearly income, daily working hours, productivity factor and make up a certain share of all employees. This gives the following weighted sums:

Table 10.1:3 Definitions of average income level pw and average productivity factor pf.

Using the same notation for volume flows (pmy/year) as in figure 10.1:1 and for payment flows (CU/year) as for Model D1 (figure 12.1:1) gives the following equations :
Note: CU = Currency Units, a factor 1/1000 is used in the equations of the Excel calculus in order to convert from million CU to billion CU.

Table 10.1:4 Payment flows that correspond to volume flows of labor, goods and services.

10.2 Full employment

Now we are ready to make some conclusions about the circumstances prevailing at full employment. It is more difficult to tell how to get there because the state of the economy is the result of many individual decisions. One decision that may seem to go in the right direction but can have undesired side effects or be counteracted by other decisions (e.g. taxation may be neutralized by a diminishing base for the taxation or by tax planning that was not foreseen at the first decision). Anyhow, it is easier to reach the goal of full employment if it is known which state to aim at. The following conclusions can be made by combining the reasoning from chapter 7 about the separated circular flows with the statements in this chapter.

• There shall be opportunities for all who want a job. One part of the population in the age of potential labor force may prefer to study or be at home (housewives). They are most often supported by a husband who works for the family income. Others may be pensioners with disability pension.
• If there should be a surplus of labor force when all have got a job, then the daily working hours have to be decreased. It is demoralizing not to be needed at work (have excess of spare time), if may be better to be free and make something meaningful at home (for the family and the children) or in the society (club activities, politics).
• When the needs for public and private production are satisfied, then remains the distribution of the result of the production. The public production is usually distributed according to needs (child care, health care) or obligation (primary school). The payment for these services from own money is usually very small or none. The private consumption is distributed according to income. Full employment does not presuppose any special distribution of income. Figure 9.1:1 (previous chapter) shows four separate payment flows that have significance for the income distribution: wages and salaries to employees in public sector, transfers, wages and salaries to employees in private sector and dividends (capital income). These together make up the total sources of tax revenue from the households. (Pensions are due to taxation but e.g. child allowances are not).
• The investments have no direct influence upon to income distribution. The investments uses one part of the production that otherwise would be used for immediate consumption.
• The tax rate is determined by the ratio between the amount of public wages, salaries and transfers and the total of all incomes, the sources of tax revenue.
• It is possible to increase dividends and to maintain the number of employees at the same time. If those who do not have capital incomes shall maintain their consumption, then the prices on goods and services have to be kept constant. This is possible if more is produced with the same labor force and the same income level, which means a higher productivity. This is one kind of economic growth. The total increase of the production goes to those who have capital incomes.
• The productivity will always increase in the manufacturing industry. In order to maintain the number of employees, the production has to increase simultaneously (economic growth) or the daily working hours have to decrease.
• Increased exports give an immediate increase of the private earnings, private employment or dividends. The imports will also increase in the long run, because more foreign currency will be available. The increase of imports counteract the initial increase of domestic income by directing the private expenditure towards imported goods instead of domestic production. The final benefit for the own country will be that we can buy goods that can not be produced in our country or that we for the same price can buy goods that require more working hours that it is possible to get by paying domestic wages and salaries.
• One way of increasing the employment is to pay less to each employee. This has been used in the (Swedish) public sector by different labor market policy measures. One method is to re-employ unemployed people, who were fired from the public sector, and give them wages and salaries that correspond the compensation for unemployment and somewhat more: age 55+ category special employment, quality augmenters, youth appointments and so on.

The reasoning above is of course simplified. It shows the main mechanisms of the economy. The labor force is not homogenous and all goods are not of the same kind. It is not possible to move labor between public and private occupations in a short time, because the different sectors require different skills. The distribution between the different sectors can change in the long run by changing the number of students in different educations. Salary rises can also increase the number of employees in professions that need more labor.

Although a uneven income distribution may be compatible with full employment, it can destabilize the economy. John Kenneth Galbraith tries to analyze to causes for the 1929 economic crises in his book "The Great Crash 1929" (1). He has the opinion that one of the five weak points in the economy was "The uneven distribution of income. … those five percent of all income-earners in the USA, that had the highest incomes, had one third of the total personal incomes in the country. … incomes that originated in interests, dividends and rents … This utterly uneven distribution of income required a high investment rate or a large consumption of luxury goods or both. The wealthy people can not buy a lot of bread. If they are going to used their income, they have to buy luxury goods or invest in new factories and projects. Both investments and consumption of luxury are inevitably more sensitive to business cycles and vary more than the expenditures of common income-earners for food and rent. "

The Excel calculus that describes Model D1 can be downloaded here .

Back to home page or contents. Next chapter Chap 11.

10.3 References

1. John Kenneth Galbraith: Den stora börskraschen, Ordfront 1997. Sid 180.
   (The Great Crash 1929, page 180)