The Production, Property and
Power Model
A Visual Model of the Semi-Free-Market Economy
Gordon C. Boronow, FSA, Ph.D.
Associate Professor of Economics
Nyack College
Managing Director, Pol-Econcepts
gordon.boronow@nyack.edu
The Venerable Circular Flow Diagram
Source: Internet Image
Shortcomings of the Circular Flow Diagram
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Ignores Government Role in the Economy
Cannot Explain Capital Accumulation
Stagnant/Equilibrium
Present Oriented
Consumption-only Model
A More Complete Teaching Model
• Retain as much simplicity as possible
• Include the essential decision makers
• Bring out the human behavior aspect of
economics
• Bring out the future orientation of the
economy
• Reveal the tension and balance in all
aspects of the economy
Presenting:
Production,
Property,
And Power
A Model of a semi-free
market economy
The Economic Decision Makers
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Who are they?
What factors into their decisions?
What tensions are balanced?
What motivates them?
Production, Property, and Power
Household Decision Maker
Concepts:
Enjoyment of Consumption
Security in Property (Savings)
Forward-looking
Cares about Future Households
Balances need for income and security
against enjoyment of leisure and
consumption now and in the future
Motivated by Desire for a Good Life and Avoidance of
Insecurity
Production, Property, and Power
Entrepreneur
Concepts:
Innovation, improvements, and growth
Risk-taking, success and failure
Forward-looking
Essential uncertainty of the future
Creative destruction
Balances the cost of money and effort
against the likelihood of sufficient future
profits to make the venture worthwhile
Motivated by Opportunity for Future Profits
Production, Property, and Power
The Financial Intermediary
Concepts:
The Bank Aggregates Savings
The Banker Allocates Capital
(Performs Due Diligence)
“Animal Spirits”
Balances the cost of funds
against the potential for a
profitable loan transaction
Motivated to Earn Profits for the Bank
Production, Property, and Power
Politicians (Government)
Concepts:
Authorized to provide security and control risk
through legislation and regulation
Enforced with police power
Constrained by behavioral effects on tax revenues
(Laffer curve)
Short-sighted (next election)
“Public Servants” (with Self Interests)
Balances the urge to control against the
discontent and tax avoidance of taxpayers
Motivated by an Urge to Control and to Use Power to “do
good” (i.e., to implement their “Vision”)
The Production Cycle
• Households:
– Own the resources of the economy (land, labor,
capital, ability)
– Receive income (wages, rents, interest, profits and
welfare) which they save or spend on consumption
– Allocate time to work or leisure
• Firms:
– Produce consumer goods and/or capital goods
– Maximize profits by adjusting prices and quantities of
production
Property Loop: The Head of Household
• Chooses how much to spend or save
• Savings are converted to property which stores
purchasing power for a future household
• More property increases the feeling of security
for the future
• The opposite of saving is borrowing, which
transfers purchasing power from the future
• Debt reduces net holdings of property, and
increases feelings of insecurity
Property Loop: The Entrepreneur
• The Entrepreneur envisions a new idea for a
product, a process or a new market
• The idea requires resources that the
entrepreneur must acquire from retained
earnings or from financial markets (e.g. bank)
• The resources are used to purchase capital
goods in the production cycle
• Factor income from the production of capital
goods flows back to the households
Combined Property Cycle
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Savings Leave the Production Cycle
Investments Enter the Production Cycle
There is a Gap in the Property Cycle!
“Mind the Gap”
A Financial Intermediary:
The Banker
• Allocates savings to the most profitable (to
the bank) projects of the entrepreneurs
• Performs “Due Diligence” (a process of
risk analysis on each project to protect the
bank-and by extension the household-from
too much risk)
• Affected by “animal spirits”
The Power Loop
• Government power is necessary to protect
life and property in the economy
• Politicians are the embodiment of
government
• They tax the economy (households, since
any tax ultimately affects some household)
• They spend the tax, which returns it to the
production and property cycles
The Power Loop: Budget Deficits
• Politicians routinely spend more than they
collect in taxes
• They borrow current resources:
– Funded by household savings (assuming no
money or credit creation by government is
going on)
– Reduces resources available to entrepreneurs
• Transfers purchasing power from future
government to the present government
Forces in the Economy
Market, Psychological and Political Motives
• Forces exert Pressure in the Economy
• Without Pressure, there is Slack in the
Economy
• Under Market, Psychological and Political
Forces, Slack Gives Way to Pressure,
which Tends to Balance
• That Unstable Stability is “Equilibrium”
Equilibrium: Negatively Defined
• Firms are unable to further increase profits
• Households are unwilling to work longer hours at
the going wages
• Households are unwilling to spend or save more
at current prices and interest rates
• Entrepreneurs do not want to make investments
at the current cost of capital
• Government is unwilling to increase taxes
• Government is unwilling to increase debt
Equilibrium: Positively Defined
• Firms have maximized profits
• Households have maximized the pleasure
of consumption and enjoyment of security
• Entrepreneurs can finance all the projects
they want to implement at the current cost
of capital
• Government Controllers have provided the
maximum degree of security possible
given the resources at their disposal
The Production, Property and Power Model
A Visual Model of the Semi-Free-Market Economy
The End.