Wealth, Cost and Price

This is required reading for the 2nd online session of Jan 22nd.

In the following, we continue to add to our vocabulary. In the ultimate analysis, it’s all about learning the meaning of words, and then using words to reason about the world. 

First wealth. Then the transformation of natural stuff into wealth by using energy and technology. Then cost and price of stuff. 

In the end, we will note that the cost (and therefore the price) of everything is decreasing all the time. The question we have is this:

What is the one exception to this decreasing cost trend?

Wealth

Wealth is a broad category of material objects. We will use the word to denote all things that people find useful and/or value. Note that people are intimately identified with wealth in the sense that only people — not non-human animals — create wealth and are the evaluating entities.

Where does wealth come from? Wealth does not exist in nature. Only naturally occurring stuff exists on earth. For example, iron ore has existed for billions of years but it was not wealth. For all practical purposes, the amount of stuff that exists on earth has not changed. What has happened is that some of the natural stuff has been transformed into wealth. That process of transformation is not automatic.

Plants and trees grow from seeds by their very nature. Animal species evolved naturally over millions of years. Those processes are natural in the sense that no human agency was involved.

But iron ore does not naturally get transformed into iron and steel. That requires human action or human agency. All wealth, in this sense, is artificial and arises from human action.

Transformation

Humans transform naturally occurring stuff into useful things. Flint occurs naturally. The wiki notes that it is “a sedimentary cryptocrystalline form of the mineral quartz, … Flint was widely used historically to make stone tools and start fires.”

Flint is just stuff with useful properties. “Flint breaks and chips into sharp-edged pieces, making it useful for knife blades and other cutting tools.” People discovered how to fashion tools out of flint. That knowledge of how to shape flint into tools is what we call technology.

Technology

The mantra we keep repeating is that technology is knowledge of how to transform materials. Another word for that is called a recipe.

Knowledge is necessary for creating wealth useful objects out of stuff. Over thousands of years, humans have discovered various recipes for getting things done. At some point they discovered how to start and maintain a fire. Fire — a source of heat — could then be used to transform stuff into more useful stuff, for instance in cooking food.

Energy

Only humans have the technology for using heat to transform things. Heat is a form of energy, and energy is a key ingredient in the creation of wealth.

The history of human progress and human civilizational advancement is the history of human ability to harness ever more powerful sources of energy.

First the only source of energy was just human muscles; then domesticated animal muscles augmented it; add to that energy from wind, water, wood and coal; then oil from whales, etc.; then petroleum; then nuclear fission; and in the (near) future we will have fusion energy.

Energy has become cheaper over time as humans have discovered more powerful sources of energy. The cost of anything at all is the amount of energy required to produce it.

Food

Energy is the critical factor in the cost of production. Consider the fact that the cost of food has steadily decreased over time. That’s because the cost of energy has decreased over time.

The example of US agriculture is instructive. US agriculture is enormously productive. The labor productivity is so high that only around 1 percent of the US labor force is sufficient to produce so much food that it exports quite a bit of it. 

In 2018, the US was a net exporter of food. Exports were $140 billion and imports were $129 billion. [Source: US Dept of Agriculture.]

What accounts for the high productivity of US agriculture? The intensive use of energy: huge machines that plant and harvest crops use energy; and fertilizers, which ultimately is derived from fuel.

Because of that, food is so cheap in the US that the average person has to perhaps work for less than a day to afford the food needed for a month.

Note that in poor countries relative to rich countries, food costs more in terms of the amount of work required to pay for food. That comparison is across countries. But for a particular country across time, the generalization is that food continues to become cheaper. 

So 100 years, Americans had to work on average around five days to earn enough to afford food.

Everything Gets Cheaper

Food is cheaper now than ever before because energy is cheaper now than ever before. Not just food but everything is getting cheaper because energy is getting cheaper.

More energy and more efficient use of energy is the reason that things are cheaper than before.

Time Price of Things

One useful measure of the cost of something to a particular person is the time one has to devote to earn enough to afford that something. That’s the time cost — a more reasonable measure of cost than just the price-list number.

But wait a minute, you might say. Don’t prices keep increasing? Yes, prices do change, and not necessarily downward.

We have to pay attention to real prices and not nominal prices. What matters is relative prices. 

If you have to work only one day to afford something which used to cost you two days of work previously, we say that the real price is half of what it used to be. It really does not matter that the list price increased. 

We also have to pay attention to relative prices. You could buy 1 MB of computer storage for $1 million in 1955, and you could buy 1,000 acres of farmland in Iowa for that amount. Now you can buy 1 MB of computer storage of about $0.0000001 and you would pay $10 million for 1,000 acres of Iowa farmland. The price of farmland relative to price of computer storage has increased by a factor of 10**16 — a 1000 trillion times.

Of course, this is an extreme example but you get the idea. 

Exercise

Practically everything has decreased in real price because of the fall in the cost of energy. The one exception? That is the question we need to think about. 

Author: Atanu Dey

Economist.

4 thoughts on “Wealth, Cost and Price”

    1. I think you are right. Borrowing the cake example from the reading, It’s a fixed size cake (for now). There might be a fluctuation and decrease in the land’s real price if humans can find a habitable place outside the planet earth or colonize Mars, as Elon Musk thinks. 🙂
      I think it’s also important to point out that humans don’t live for eternity, and the birth and death cycles play a significant role. I would like to know what others think about this.

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