Tag Archives: time preference

Eduard Braun on Opportunity Cost

From Finance Behind the Veil of Money, page 32:

The opportunity-cost concept does not allow for the inclusion of time. Opportunity costs, in other words, are not a matter of action but of choice. James Buchanan is not the only one who stresses the close relationship between choice and opportunity cost. G. F. Thirlby, who published a lot on the cost problem, also writes: “By deciding to take the preferred course, he [any person] incurs the cost—he displaces the alternative opportunity.” According to this opinion, costs appear at the point of time when the decision is made and then lose all of their “significance . . . because the decision displaces the alternative course of action.” However, it seems to be problematical to link cost to choice. Decisions are not bound up with costs. To illustrate this hazardous statement, let’s have a look at an example.

Let us suppose friends X and Y are on a trip in the mountains. X has two apples in his bag. Y loves apples, but has forgotten to pack one. During the first break, X permits Y to take one of the apples. Well, one could say this is a great deal for Y! However, things look differently if one takes into account opportunity cost. As soon as Y takes one of the two apples, he abstains from taking the other one. If we assume, for simplicity, that the two apples are alike, then the disadvantage in this decision is just as great as the advantage. According to opportunity-cost theory, Y is not better off at all although he has received an apple for free. His preference for one of them cost him the other one.

It is interesting to see that the story would run totally differently if X had not offered that Y take one of the apples, but if X had given one to Y. In this case, Y does not have any opportunity costs. Those only appear when he has to choose like he had to in the first example. From this point of view, as George Reisman also notes, the possibility of choosing between several alternatives—a possibility that one would think to be beneficial from the point of view of the person choosing—appears to be something bad, even destructive. The best that could happen to anyone would be to have no freedom of choice. No opportunity cost means—from the point of view of most economists—no cost at all.

My response to this is that if X says Y can have one apple, the other apple is not the opportunity cost. The forgone alternative is not having an apple. This solution is the same as Rothbard’s solution to the Buridan’s Ass problem–the ass does not just face the choice between two equal bales of hay, but the choice to eat or not to eat.* Therefore indifference is never, ever a problem in economics, because there is always a third “option” of not having the satisfaction at all.

Just because X was not specific about which apple was the gift doesn’t mean that the choice is between one apple or the other. It means that the choice is between taking an apple or not taking one, just like the donkey facing the choice between eating from one of the bales of hay and going hungry.

This may actually help explain time preference (which is what Braun was on his way to redefining). If action is undertaken to remove some “uneasiness” (Mises, Human Action), then there is an universal reason for preferring the satisfaction of an end sooner rather than later: the longer it takes to have the satisfaction, the more time is spent feeling the “uneasiness”. Indeed, with each passing moment in which the choice in question is not made, the actor incurs the opportunity cost of not having the end satisfied.


*Rothbard on Buridan’s Ass:

Buridan postulated a perfectly rational ass who found himself equidistant between two equally attractive bundles of hay. Indifferent between the two choices and therefore unable to choose, the perfectly rational ass could choose neither and thereby starved to death. What this example overlooked is that there is a third choice, which presumably the ass liked the least: starving to death. So that it was therefore “perfectly rational” not to starve to death but rather to choose one of the two bundles even at random (and then to proceed to the second bundle).

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Production and Interest

Our present stock of means can only be used in two mutually exclusive ways: consumption or saving. For means that expire, the decision of how and when to employ them is simplified. If they are not consumed or used for production now, then they are lost forever. However, for durable means, we have the choice of employing them presently or employing them at a later time. The timing of the employing of means is further complicated because they can be employed for consumption or production. Because of time preference, the present valuations of both consumption and production carry a premium over their future counterparts. Present consumption is, ceteris paribus, valued more highly than future consumption because we exist in the present. The same can be said for production, but an important qualification must be made: the present value of any line of production has only derivative value. It derives its value from the consumable output of the line of production, which must be discounted because production takes time. It is because of this discount that interest emerges in markets for factors of production.

Interest is more plainly seen in the market for present money in terms of future money (credit market). Because of varying degrees of time preference, present money may be allocated to those with a higher willingness to pay in terms of future money. The relative spread between the future payment for a present loan is the interest rate in such a transaction. Because of competition for these loans, the market will tend toward a market-clearing interest rate.

Therefore, all entrepreneurs may compare an expected return on their investment in production with the expected return from lending to a borrower at the market interest rate. The tendency will be for these rates of return to equalize because a higher rate of return in, say, production will discourage lending (and so decrease the supply of loanable funds) and encourage spending on factors of production (and so bid up their prices). A decrease in the supply of loanable funds will allow the remaining suppliers to bid up the interest rate, and an increase in the price of factors of production means the costs of production are increased relative to the expected return and so the rate of return on production is diminished. The opposite scenario (interest rate is higher than rate of return in producing goods) results in the opposite tendencies and so the two rates of return will tend to equalize.

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Jeffrey Herbener’s PTPT book introduction

Professor Herbener’s introduction to The Pure Time-Preference Theory of Interest is excellent. Not only does it have very quotable passages (see below), but it details the fundamental differences between Böhm-Bawerk’s theory of interest and that of Frank Fetter, siding with the latter. Herbener argues that Fetter’s conception of time preference and interest is in the vein of Mengerian economics, and that Böhm-Bawerk’s is a departure from Menger. He also points to the influence of John Rae on Böhm-Bawerk in understanding time preference as an agio on present goods over future goods, instead of present satisfactions over future satisfactions. I think this distinction is important for responding to contemporary criticisms of PTPT.

I felt vindicated when I read Herbener’s take on Mises crediting Böhm-Bawerk as the foremost among time-preference theorists:

As the excerpt from Human Action, included in this volume, shows Ludwig von Mises accepted Fetter’s PTPT of interest, although he failed to give Fetter proper credit in developing the theory. In Mises’s view, “economics owes the time-preference theory to William Stanley Jevons and its elaboration, most of all, to Eugen von Böhm-Bawerk.” Fetter’s contribution was in helping to perfect the theory. “It was on the foundation laid by him [i.e., Böhm-Bawerk],” Mises wrote, “that later economists—foremost among them Knut Wicksell, Frank Albert Fetter and Irving Fisher—were successful in perfecting the time preference theory.”

…because I had the same thoughts when I recently read the same passages in Human Action. This shouldn’t discredit Böhm-Bawerk’s other notable contributions, just the popular view that he was a great progenitor or expounder of PTPT as laid out by Mises or Rothbard.

Fetter’s “Interest Theories, Old and New” is in his Capital, Interest, and Rent compilation edited by Murray Rothbard and in Herbener’s book, The Pure Time-Preference Theory of Interest. Fetter shares Herbener’s opinion of Böhm-Bawerk and Fisher: “From the moment Fisher begins his first approximation he takes his standpoint in the money market and supposes an existing rate of interest to which rates of time-preference of individuals are later brought into conformity. His treatment throughout is of the actuarial, mathematical type, concerned with the explaining and equalizing of incomes which are assumed to be present.” Fisher’s (early) work on interest was circular in this regard, as was Böhm-Bawerk’s, but for different reasons.


I mentioned at the beginning that there are some very quotable passages in Herbener’s introduction. Here is one example (brace yourself for a long quote–I promise it’s worth it):

The thrust of Menger’s approach, in contrast, is to discover the causal laws of human action and integrate them into a single coherent system, a body of true propositions that explain the underlying, universal causes of all human action as well as those for each relevant sub-category of human action, consuming, producing, buying, selling, and so on. The wellspring of all economic theory is the reality of the human condition. As a finite being, man makes a distinction between ends and means. He cannot attain his ends by an act of will alone, but must apply means to attain his ends. Man lives in an orderly, but finite world. Using means produces only limited effects in attaining ends. Endowed with reason, man is able to perceive the causal connection between the use of means and the attainment of ends. Any action toward the attainment of an end requires surrendering the attainment of another end with the same means. And any action using a set of means requires foregoing using another set of means to attain the same end. Action, therefore, requires choice. As a purposeful being, man selects what he perceives to be higher-valued ends to pursue and what he perceives to be lower-valued sets of means to employ. Choice, therefore, requires a judgment of the mind. Since attaining the end is the purpose of an action, the value a person attaches to the attainment of the end is primary. A person attaches only derivative value to the means used in action since they are merely aids to the attainment of the end. Means have no value independent of the value a person attaches to the end they help attain. The human mind imputes value to the means according to the aid they render in attaining a valuable end. The technical properties of each of the means that combine to attain an end can be valued differently by different persons or by the same person at different times and, therefore, have no causal impact on choice and action independent of the judgment of the mind.

As a temporal being, man distinguishes between sooner and later. He can, therefore, judge the value of attaining an end sooner differently than attaining it later. Just as the principle of preference is implied by man’s finitude, time preference is implied by his temporality. [*] Temporal beings prefer the satisfaction of an end sooner to the same satisfaction later. Man places a premium on present satisfaction over future satisfaction. Since time preference refers only to the difference in value of the satisfaction of an end sooner instead of the same satisfaction later, the discount a person places on the future will be uniform across all actions with the same intertemporal structure. Moreover, the discount applies to all actions regardless of when a person chooses to undertake any one of them. In choosing to take an action later, a person is demonstrating that the value of the action in the future exceeds its value in the present, even when the discount of the future is applied. His temporal choice, then, conforms to the general principle of action, that he chooses a more-highly valued alternative and foregoes a less-highly valued one. He economizes his actions across all aspects of action subject to choice: ends, means, place, and time.

In short, the human mind integrates all the factors affecting human action into a systematic whole, reconciling the objective, technical features of the world, including time, through judgments of value in a way that renders the highest satisfaction of ends.

The market economy performs this integration for society. Prices are determined by the underlying preferences of buyers and sellers. Objective factors have no independent effect on prices, but influence prices only through preferences. Prices of consumer goods are directly determined by the preferences consumers have for them as expressed in their demands for the goods. Prices of producer goods used to produce each consumer good are indirectly determined by consumer preferences as they generate revenue for entrepreneurs to justify the demand entrepreneurs express for them. Entrepreneurs pay each factor of production the monetary value of its contribution to production. If the factor payment is made sooner than the revenue is received from the sale of the output produced, then the payment is discounted because of time preference. This discount of future money relative to present money is interest and determines the pure, or time preference, rate of interest. Because all exchange of present money for future money of the same time structure involves time preference, the pure rate of interest is uniform across all such intertemporal exchange. It follows that all present goods that generate future money will have their prices determined by discounting the future money by the rate of interest to obtain the equivalent amount of present money. This process of capitalization results in a uniform rate of interest as the difference between the present money spent to acquire factors of production and the future money obtained from selling the output produced. Prices, so determined, are the basis for economic calculation which permits entrepreneurs to appraise the lines of production and investment that people find most valuable.

*My only critical comment about this passage is that Herbener sort jumps from just one premise in the logic of time preference (we exist in time) to the conclusion of time preference (we prefer sooner to later) without giving the other premises or careful reasoning. Herbener does a cannonball into the deep end of the pool instead of carefully wading in. I try to connect the dots here.

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Böhm-Bawerk’s Labor Theory of Capital?

In Capital, Interest, and Rent, Fetter criticizes Böhm-Bawerk’s attempt to construct a coherent, non-circular theory of interest. There are three issues involved here–three (and a half) questions both authors are trying to answer:

  1. What is capital? (1a) What is it’s value?
  2. What is the relationship between capital and the roundaboutness of production?
  3. Where does interest come from?

Fetter quotes Böhm-Bawerk as answering the “What is capital?” question with “Previous labor is a rough but essentially true definition.” Böhm-Bawerk clarifies in a footnote: “It is more exact to say, stored-up, previously applied productive force, which can be not only labor, but also valuable natural forces or uses of land.” Fetter claims that this is a “value concept of capital” and therefore “comes near to the discredited labor value theory.” I think we can give Böhm-Bawerk the benefit of the doubt and assume that he didn’t mean the value of capital is solely based on the number of labor hours involved in producing capital, but was just trying to measure the average length of production. Fetter thinks Böhm-Bawerk is answering question #1, when he is probably on his way to answering #2. It’s worth mentioning that in the ERE, there is no difference between the value of capital and the value of the labor that goes toward its production, except for interest because of time preference, which gives us the answer to #3.

Fetter summarizes his objections to Böhm-Bawerk’s argument that an increase of capital in production is the same as an increase in the production period via the labor hours involved in the production of the former:

If we put together these objections to the argument, we have it in this form: if it were true in any case, it would be true (1) only when the diminishing returns of natural agents did not offset it; (2) when the change in the amount of capital is not merely the expression of a change in the rate of interest; (3) when the increase does not represent accumulated interest or monopoly gains embodied in capital; and (4) when the increase is not the capitalization of the uses of natural agents. There is involved in Böhm-Bawerk’s argument, therefore, the fallacy of an unsound premise. If all capital does not consist of, or owe its value to, previous labor, a false conclusion is drawn when the length of the production period is assumed to be fixed by the relation between the stock of capital, counted as previous labor, and the annual amount of labor.

Again, it seems Böhm-Bawerk is trying to answer a different question than Fetter thinks he is answering. Böhm-Bawerk is trying to conceive of a real, tangible, and physical concept (the length of production) while Fetter is focused on the intangible, subjective nature of value and capital accounting.

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Hülsmann and Braun on time preference

I couldn’t get through the first bits of Eduard Braun’s Finance Behind the Veil of Money without first re-reading Mises’ chapter in Human Action, “Action in the Passing of Time”, and Prof. Hülsmann’s 2002 QJAE article, “A Theory of Interest”. Braun refers to both liberally in his reformulation of interest theory. Time preference, à la Mises, is cast aside as the source of value spreads over time and new explanations are offered.

Hülsmann tries to pinpoint the value spread as existing between means and ends. The thinking goes like this: means are employed to satisfy ends. Means are always employed prior to the satisfaction and are “given up” in exchange for the end. Therefore, means are valued less than the ends they attain. I will only give up present means for a future satisfaction if I value the means less than the ends.

The problem with this is that means aren’t directly valued on their own. They receive only derivative value based on the ends they can achieve for the actor. Means are never placed in a preference ranking except as a convenient way to describe the end they satisfy. When “$100 in the present” occupies a place in my preference ranking, it actually stands for “the ends I would/could satisfy with $100 in my pocket right now”. So Hülsmann’s language,

Originary interest is the fundamental spread between the value of an end and the value of the means that serve to attain this end.

is confusing and nonsensical. One cannot separate the value of an end and the value of the corresponding means. It’s more than an equality between the two (which Hülsmann criticizes along familiar lines as the criticisms against the concept of indifference), it’s that they are the same thing. The value of any means is the value of the end it can satisfy–in a literal, substantial sort of way, not a mathematical, quantitative sort of way.

Braun strikes Hülsmann with the flat of the blade, saying that the value spread comes from the categories of cost and revenue, not means and ends, and then goes on to his own reformulation of the fundamentals of action in time. The differences may just be semantics, but that remains to be seen. My current research interest is in the subsistence fund/wages fund theories (featured in Braun’s book), and Hülsmann’s and Braun’s departure from Misesian/Rothbardian time preference theory of interest may just be tangential rabbit-chasing, but maybe it deserves more dedicated and serious inquiry.

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Time and Action

Humans act in every conscious, perceptible moment. As we proceed through time, always forward, we are constantly selecting and employing means at our disposal toward the satisfaction of some end. This means that every action is costly: the means we used for our satisfaction could have been used in a different way to satisfy a different end, or we could have used a different set of means entirely to satisfy some different end. The next highest ranked alternative is the opportunity cost of any action. Because action always takes place in the present, but is forward-looking, and because we cannot revisit or retry an action in the past, there is a time cost for every action as well. Given a set of means suitable for want-satisfaction, we can mentally distribute, allocate, or plan the use of those means for a certain time or in a certain order based on our current expectations of future valuations/preference rankings. This type of action may be called a temporal allocation of means.

In production or lending or borrowing, however, we do not simply temporally allocate a given set of means toward want-satisfaction at various times, we substitute, or trade, a satisfaction of one time for a satisfaction of a different time. I may give up a present satisfaction so that I may have a future satisfaction, or I may forego a future satisfaction by presently employing some means to satisfy an end. This type of action may be called an intertemporal exchange of satisfactions. All present consumption reveals a systematic preference for present consumption over future consumption because all present consumption has the opportunity cost of delaying or postponing the consumption of the same means for later. An intertemporal exchange of present satisfaction for a future satisfaction can only happen if the future satisfaction is (presently considered) more highly ranked than the present one foregone. As such, all future satisfactions carry a present discount in relation to present satisfactions. This feature of human action is called time preference.

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