[p.46]
Chapter 5
EXPECTATION AS DETERMINING OUTPUT AND EMPLOYMENT
I
All production is for the purpose of ultimately satisfying a
consumer. Time usually elapses, however¾and
sometimes much time¾between the
incurring of costs by the producer (with the consumer in view)
and the purchase of the output by the ultimate consumer.
Meanwhile the entrepreneur (including both the producer and the
investor in this description) has to form the best
expectations [1] he can as to what the consumers will be prepared to pay when he
is ready to supply them (directly or indirectly) after the elapse
of what may be a lengthy period; and he has no choice but to be
guided by these expectations, if he is to produce at all by
processes which occupy time.
These expectations, upon which business decisions depend, fall
into two groups, certain individuals or firms being specialised
in the business of framing the first type of expectation and
others in the business of framing the second. The first type is
concerned with the price which a manufacturer can expect to get
for his "finished" output at the time when he commits himself to
starting the process which will produce it; output being "finished" (from the point of view of the manufacturer) when it
is ready to be used or to be sold to a second party. The [p.47] second type is concerned with what the entrepreneur can hope
to earn in the shape of future returns if he purchases (or,
perhaps, manufactures) "finished" output as an addition to his
capital equipment. We may call the former short-term
expectation and the latter long-term expectation.
Thus the behaviour of each individual firm in deciding its
daily [1] output will be determined by its short-term expectations¾expectations as to the cost of output on
various possible scales and expectations as to the sale-proceeds
of this output; though, in the case of additions to capital
equipment and even of sales to distributors, these short-term
expectations will largely depend on the long-term (or
medium-term) expectations of other parties. It is upon these
various expectations that the amount of employment which the
firms offer will depend. The actually realised results of
the production and sale of output will only be relevant to
employment in so far as they cause a modification of subsequent
expectations. Nor, on the other hand, are the original
expectations relevant, which led the firm to acquire the capital
equipment and the stock of intermediate products and
half-finished materials with which it finds itself at the time
when it has to decide the next day's output. Thus, on each and
every occasion of such a decision, the decision will be made,
with reference indeed to this equipment and stock, but in the
light of the current expectations of prospective costs and
sale-proceeds.
Now, in general, a change in expectations (whether
short-term or long-term) will only produce its full effect on
employment over a considerable period. The change in employment
due to a change in expectations will not be the same on the
second day after the change as on the first, or the same on the [p.48] third day as on the second, and so on, even though there be no
further change in expectations. In the case of short-term
expectations this is because changes in expectation are not, as a
rule, sufficiently violent or rapid, when they are for the worse,
to cause the abandonment of work on all the productive processes
which, in the light of the revised expectation, it was a mistake
to have begun; whilst, when they are for the better, some time
for preparation must needs elapse before employment can reach the
level at which it would have stood if the state of expectation
had been revised sooner. In the case of long-term expectations,
equipment which will not be replaced will continue to give
employment until it is worn out; whilst when the change in
long-term expectations is for the better, employment may be at a
higher level at first, than it will be after there has been time
to adjust the equipment to the new situation.
If we suppose a state of expectation to continue for a
sufficient length of time for the effect on employment to have
worked itself out so completely that there is, broadly speaking,
no piece of employment going on which would not have taken place
if the new state of expectation had always existed, the steady
level of employment thus attained may be called the long-period
employment[1] corresponding to that state of expectation. It follows that,
although expectation may change so frequently that the actual
level of employment has never had time to reach the long-period
employment corresponding to the existing state of expectation,
nevertheless every state of expectation has its definite
corresponding level of long-period employment.
Let us consider, first of all, the process of transition [p.49] to a long-period position due to a change in expectation,
which is not confused or interrupted by any further change in
expectation. We will first suppose that the change is of such a
character that the new long-period employment will be greater
than the old. Now, as a rule, it will only be the rate of input
which will be much affected at the beginning, that is to say, the
volume of work on the earlier stages of new processes of
production, whilst the output of consumption-goods and the amount
of employment on the later stages of processes which were started
before the change will remain much the same as before. In so far
as there were stocks of partly finished goods, this conclusion
may be modified; though it is likely to remain true that the
initial increase in employment will be modest. As, however, the
days pass by, employment will gradually increase. Moreover, it is
easy to conceive of conditions which will cause it to increase at
some stage to a higher level than the new long-period
employment. For the process of building up capital to satisfy the
new state of expectation may lead to more employment and also to
more current consumption than will occur when the long-period
position has been reached. Thus the change in expectation may
lead to a gradual crescendo in the level of employment, rising to
a peak and then declining to the new long-period level. The same
thing may occur even if the new long-period level is the same
as the old, if the change represents a change in the direction of
consumption which renders certain existing processes and their
equipment obsolete. Or again, if the new long-period employment
is less than the old, the level of employment during the
transition may fall for a time below what the new
long-period level is going to be. Thus a mere change in
expectation is capable of producing an oscillation of the same
kind of shape as a cyclical movement, in the course of working
itself out. It was movements of this kind which I discussed in my
Treatise on Money in connection [p.50] with the building up or the depletion of stocks of working and
liquid capital consequent on change.
An uninterrupted process of transition, such as the above, to
a new long-period position can be complicated in detail. But the
actual course of events is more complicated still. For the state
of expectation is liable to constant change, a new expectation
being superimposed long before the previous change has fully
worked itself out; so that the economic machine is occupied at
any given time with a number of overlapping activities, the
existence of which is due to various past states of expectation.
II
This leads us to the relevance of this discussion for our
present purpose. It is evident from the above that the level of
employment at any time depends, in a sense, not merely on the
existing state of expectation but on the states of expectation
which have existed over a certain past period. Nevertheless past
expectations, which have not yet worked themselves out, are
embodied in the to-day's capital equipment with reference to
which the entrepreneur has to make to-day's decisions, and only
influence his decisions in so far as they are so embodied. It
follows, therefore, that, in spite of the above, to-day's
employment can be correctly described as being governed by
to-day's expectations taken in conjunction with to-day's capital
equipment.
Express reference to current long-term expectations can seldom
be avoided. But it will often be safe to omit express reference
to short-term expectation, in view of the fact that in
practice the process of revision of short-term expectation is a
gradual and continuous one, carried on largely in the light of
realised results; so that expected and realised results run into
and overlap one another in their influence. For, although output
and employment are determined by [p.51] the producer's short-term expectations and not by past
results, the most recent results usually play a predominant part
in determining what these expectations are. It would be too
complicated to work out the expectations de novo whenever
a productive process was being started; and it would, moreover,
be a waste of time since a large part of the circumstances
usually continue substantially unchanged from one day to the
next. Accordingly it is sensible for producers to base their
expectations on the assumption that the most recently realised
results will continue, except in so far as there are definite
reasons for expecting a change. Thus in practice there is a large
overlap between the effects on employment of the realised
sale-proceeds of recent output and those of the sale-proceeds
expected from current input; and producers' forecasts are more
often gradually modified in the light of results than in
anticipation of prospective changes. [1]
Nevertheless, we must not forget that, in the case of durable
goods, the producer's short-term expectations are based on the
current long-term expectations of the investor; and it is of the
nature of long-term expectations that they cannot be checked at
short intervals in the light of realised results. Moreover, as we
shall see in Chapter 12, where we shall consider long-term
expectations in more detail, they are liable to sudden revision.
Thus the factor of current long-term expectations cannot be even
approximately eliminated or replaced by realised results.
Footnotes: [p.46] 1 - For
the method of arriving at an equivalent of these expressions in terms of
sale-proceeds see footnote (3) to p.24 above. [back to text]
[p.47] 1 - Daily here stands
for the shortest interval after which the firm is free to revise its decision as
to how much employment to offer. It is, so to speak, the minimum effective
unit of economic time. [back to text]
[p.48] 1 - It is not necessary that
the level of long-period employment should be constant, i.e.
long-period conditions are not necessarily static. For example, a steady
increase in wealth or population may constitute a part of the unchanging
expectation. The only condition is that the existing expectation should
have been foreseen sufficiently far ahead. [back to text]
[p.51] 1 - This emphasis on the
expectation entertained when the decision to produce is taken, meets, I think,
Mr. Hawtrey's point that input and
employment are influenced by the accumulation of stocks before prices
have fallen or disappointment in respect of output is reflected in a realised
loss relatively to expectation. For the accumulation of unsold stocks (or
decline of forward orders) is precisely the kind of event that is most likely to
cause input to differ from what the mere statistics of the sale-proceeds of
previous output would indicate if they were to be projected without criticism
into the next period. [back to text]
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