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A Basic Principle About Capital

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Imagine a farm in an impoverished country, a farm where the workers are using hoes to do their work in the fields. The farm produces 1000 bushels of wheat a year, which is sold for $10,000. The farmer’s income statement reads as follows:

Revenues $10,000

Less expenses:

    Crop supplies $2,000

    Overhead        $1,000

    Worker Wages $5,000

Profit: $2,000

Year after year, the farm produces $1,000 bushels. The workers ask for raises but the farmer responds: “Sorry, I just cannot afford it. Until I can increase revenues, I just can’t give anyone a raise.”

Meanwhile, the workers save a bit of money each year and put it in the local bank. The farmer too saves some of his profits and puts his savings in the bank. The farmers and workers in the surrounding area do the same.

One day the farmer walks into the bank and asks for a loan of $5,000 to buy a new tractor. The banker says, “We just happen to have the $5,000 to lend you because everyone has been depositing his savings with us. Here is your loan.”

The farmer buys the tractor and returns home with it. The workers set aside their hoes and start using the tractor. The farm now produces 10,000 bushels of wheat, which is sold for $100,000.

The workers now ask for a raise. Do they need to depend on the benevolence of their employer? No because the neighboring farms are doing the same thing and experiencing the same bounty. There are also new stores opening up to cater to people who have more money at their disposal. Operating our of self-interest, all those farms and businesses compete for workers, which drives the wage rate up.

None of this would be possible without capital, which comes into existence through savings. It is savings and capital that are key to rising wage rates and higher standards of living.

This post was written by:

Jacob G. Hornberger is founder and president of The Future of Freedom Foundation. He was born and raised in Laredo, Texas, and received his B.A. in economics from Virginia Military Institute and his law degree from the University of Texas. He was a trial attorney for twelve years in Texas. He also was an adjunct professor at the University of Dallas, where he taught law and economics. In 1987, Mr. Hornberger left the practice of law to become director of programs at the Foundation for Economic Education. He has advanced freedom and free markets on talk-radio stations all across the country as well as on Fox News’ Neil Cavuto and Greta van Susteren shows and he appeared as a regular commentator on Judge Andrew Napolitano’s show Freedom Watch. View these interviews at LewRockwell.com and from Full Context. Send him email.