Nature provides limited resources, and there is a finite supply of labor, which comes at the cost of leisure time. To fulfill our wants, the only solution is to increase the number of capital goods employed.
In a primitive scenario where the actor lacks any capital goods, their time will be spent either on leisure or on acquiring consumer goods directly. This limits the actor to satisfying only those wants which do not require production, and as a result, only a small quantity of consumer goods can be obtained.
In order to increase productivity, an actor must use their labor in combination with available natural resources to create capital goods of lower order. This always comes at the expense of satisfying their immediate wants for consumer goods, since the time spent creating a producer good cannot be used for leisure or acquiring direct consumer goods.
By utilizing deeper production stages, it is possible to either increase the quantity of the same good or to create entirely new goods that were not previously attainable without the necessary producer goods.
The individual will only work on increasing their capital stock if the estimated sacrifice of leisure forgone and direct consumption in the present is lower than the potential benefit of having more consumer goods available and higher satisfaction of wants per unit of time in the future. The extent to which present sacrifice outweighs future return is the individual's time preference.
The point at which the actor will stop acquiring direct consumer goods in favor of laboring on indirect producer goods depends on the individual's subjective value scale. If the actor urgently wants the producer good, he will have a higher rate of restriction of direct satisfaction. In other words, the greater the subjective value the individual places on the producer good, the more willing he will be to sacrifice direct satisfaction in the present for the potential benefit of more consumer goods available and a higher satisfaction of wants in the future. This decision is influenced by the individual's time preference, which represents the extent to which present sacrifice outweighs future return.
Since the completion of a producer good increases the individual's productivity, they can then choose to either have more leisure time or accumulate more consumer goods. Therefore, in order to maximize overall satisfaction, it might be more favorable to prioritize the accumulation of producer goods over immediate consumption of consumer goods.
The time required for production not only includes the direct labor time that an individual spends to create the producer's good, but it also includes the waiting time starting from the first action of production until the ultimate consumer good is completed. By increasing the quantity of capital goods, the waiting time until the consumption goods can be obtained is decreased, which can lead to a faster satisfaction of wants.
Capital accumulation inherently relies on savings, which means that not all desires can be immediately satisfied, even if the necessary consumer goods are available. Without a saved stock of consumer goods, the actor cannot devote his time to deepening the production stages. Instead, he must invest some of his saved capital to sustain himself during the production process, and he can only do this if he previously refrained from consuming these goods.
Most capital goods are perishable, which means that they get used up and transformed during the process of production. Some goods might be transformed completely by only one use in the production stage, for example, the flour required to bake bread, while other capital goods can be used in numerous production stages before they perish, for example, the oven that bakes the bread. For those long-lived producer goods, the depreciation rate is the inverse of the total expected lifetime.
In order to maintain his capital stock and sustain his standard of living, the actor must allocate a portion of his savings to repair or replace any perishable capital goods that break during the production process. The need for this constant investment in upkeep emphasizes the importance of savings and capital accumulation in achieving long-term economic growth and increasing overall satisfaction. Without sufficient savings, the actor would be unable to replace or repair broken capital goods, which would inevitably lead to a decline in productivity and a reduction in his standard of living.
Individuals have three options when it comes to capital goods: increasing the capital structure, maintaining the capital, or consuming the capital. The decision on which option to choose depends on the individual's disutility of waiting, which in turn is influenced by their time preference, as well as their desire for higher productivity and a greater amount of consumer goods.
In order to satisfy his most urgent wants first, other things being equal, the actor will build those consumer goods that have the shortest production stage. Thus, any additional saved capital will be invested in marginally deeper production stages. As a result, in a wealthy economy with a lot of capital, the production stages may become so deep that the higher-order capital goods are far removed from the ultimate consumer goods.
Capital goods are stored up land, labor and time.
The rate of time preference reflects an individual's preference for present goods compared to future goods, and the discount rate is the rate at which future goods are discounted to reflect this preference. Individuals will invest in production stages of goods that have a higher expected return than the value of present goods forgone, taking into account the discount rate. The higher the discount rate, the less attractive future goods become relative to present goods.
The individual has numerous potential investment opportunities at any time, and the value of these opportunities is discounted by his time preference. He will invest his capital first into those production stages with the highest present value, then into the second highest valued, and so on. However, with each investment, his stock of available present goods decreases, which increases the marginal value of future consumer goods. The investment stops when the disutility of the present consumer goods is greater than the discounted present value of the future product.
The individual continually assesses the uncertain future and evaluates the likelihood of various potential scenarios. Based on his assessment, he acts toward the future scenario that he perceives as having the highest value. However, if the resulting scenario is worse than he expected, then his predictions have failed. He may have been mistaken in his understanding of how his actions would play out or made an error in implementing his strategy.
As the quality of producer goods deteriorates with time and use, the cost of replacing or repairing them can become prohibitively high. At some point, it may make economic sense to abandon a capital good. This means giving up all the possible uses of the good in production and consumption, resulting in a decrease in the quantity, quality, and number of ends that can be satisfied. However, if the ongoing cost of maintaining the capital good is only marginally less than its potential benefit, abandoning it can lead to an increase in total capital and is not wasteful.
The choice of which land to use in production depends on the actor's evaluation of their prospect of satisfying his ends. For example, a land with fertile soil and existing fruit trees is more satisfactory for someone who wants to have more fruits compared to barren rock land. Capital is deployed to develop land areas with a positive marginal return, while submarginal land remains undeveloped. However, land in its original state is not directly suitable for production and requires labor to shape and refine it into a state where it is more useful for satisfaction. By improving the land, it turns into a saved capital good and a prerequisite for production.
[[Time]] [[Time Preference]] [[Means]] [[Production goods]] [[Consumption goods]] [[Labor and leisure]] [[Choice]] [[Scarcity]] [[Entrepreneurial profit]] [[Law of marginal utility]] [[Subjective preference scale]]