Consumer Credit and the PPF
I keep hearing and reading that far too many Americans are in serious debt. Consumer credit is easy get and difficult to get rid of. Because of the high interest rates and monthly payments, people cannot build savings and have to use more credit when anything out of the ordinary happens. Though we may be tempted to say it serves them right for not living in their means, the consequences are more dire.
In the field of Economics there is a concept called the Production Possibilities Frontier (PPF). This concept basically compares two forms of production in a given time frame where technology remains fixed. For example, assume that your company can produce DVD players or coffee makers (your two divisions) and you want to know what is the most productive you can be by shifting resources from one division to the other. Sure, some resources can be shifted and others can?t; that just leads to a higher cost of conversion for each additional shift. By looking at a mathematically computed ratio, the PPF, you can find the most productive balance.
One of the regular comparisons used to teach the PPF is the production of consumer goods to capital goods. Consumer goods are those things that one buys and uses up. Examples of consumer goods include necessities such as food, medicine, and shoes. Other examples are more in the luxury category. These include large screen televisions, fancy watches, golf clubs, and two hundred dollar sneakers. Most consumer goods lose value the moment you purchase them.
Capital goods are things that one uses to be more productive. If you buy a tool of your trade, that is a capital good because you use it to get more stuff. This also includes machinery, research, and hiring employees to make your products. Though capital goods can lose value once purchased, they tend to not lose value as quickly as consumer goods. The cost of capital goods is usually recuperated in the production of more stuff.
When shown on the PPF, there has to be a balance between capital and consumer goods. In Iowa we often have to balance between building housing for people to live and keeping that land for farm production to grow food. Not everything can be switched, though. Obviously we want to produce enough food, clothing, and shelter for everyone. The question is, do we need to produce enough High Definition Televisions for everyone?
There is another important point about this particular PPF. Remember that I said the PPF only describes specific time period. If you produce enough capital goods during that time, the frontier is expanded in the next time period. That?s right; an increase in capital production lets you be more productive next time around. Of course, the opposite is true as well. If you do not produce enough capital goods, your PPF shrinks in the next time segment and you will produce less overall.
How does all this connect to the high rate of consumer debt? That?s simple. When an entrepreneur goes into debt, it is to buy things that he or she hopes will give a good return on investment. There is a plan to use the purchased item to produce more resources such that the debt, including interest, is still lower than the amount brought in by the purchase of the resource.
Consumer debt is based on the purchase of consumer items. When you buy a seventy-two inch television, you are not planning on getting more than the cost, plus interest, back from the use of the thing. The money you spent is gone. Since the money probably came from selling your labor, that labor is gone and there will be no increase from its loss.
That?s a real shame when it is just one person. Now think of how many people in this country have debt based on unnecessary consumer expenditures. That is a huge amount of lost resources. Sure, most weren?t going to buy machinery to start building widgets, but education is a capital expenditure too. Instead of increasing their or their families? abilities to produce more, they?ve decided that sitting on the couch for extended amounts of time is better.
Don?t get me wrong, there is a definite need for leisure activities; it?s an important part of staying sane. However, most people don?t even think about their various choices and how they can better them selves. It doesn?t hurt to stick with the nineteen inch T.V. for a couple more years while the money builds. At least save up to pay cash so the interest isn?t lost.
With more and more people going into consumer debt and fewer investing in capital production, I can only assume that our national PPF will be smaller in the coming times. The rich (who know these things) will get richer and the poor (who do not know) will get poorer and neither side will understand fully why.