Expectation Determines Output and Employment Icon

January 26, 2020

The goal of aLL production is to satisfy a consumer. Time elapses after the producer incurs costs and before the ultimate consumer purchases the output.

Meanwhile, the entrepreneur (including both the producer and the investor) has to form the best expectations[1] as to what the consumers will pay when he is ready to supply them after the long time from investment to production.

Business decisions depend on these expectations as:

  1. Short term expectation= For example, the decision on what price a manufacturer can expect for his “finished” output when he first starts to make it.
  1. Long term expectation= The decision on what the entrepreneur can hope to earn as future returns if he purchases (or, perhaps, manufactures) “finished” output as an addition to his capital equipment.

Thus the firm decides its daily[2] output from short-term expectations composed of:

  • expectations of the cost of output
  • expectations of the revenue of this output

In the case of additions to capital equipment and even of sales to distributors, these short-term expectations will largely depend on the long-term (or medium-term) expectations of other parties.

The amount of employment offered by firms depend on these various expectations. The actual production and sale of output will only be relevant to employment in as they change the subsequent expectations.

The original expectations are also irrelevant, which led the firm to acquire the capital equipment and the stock of intermediate products and half-finished materials with which it finds itself at the time when it has to decide the next day’s output.

Thus, on each and every occasion of such a decision, the decision will be made, with reference indeed to this equipment and stock, but in the light of the current expectations of prospective costs and sale-proceeds.

A change in expectations (whether short-term or long-term) will only produce its full effect on employment over a considerable period.

The change in employment due to a change in expectations will not be the same on the second day as the first, nor the same on the third day as on the second, and so on, even though there be no further change in expectations.

In short-term expectations, this is because negative changes in expectation are not, as a rule, sufficiently violent or rapid as to cause the abandonment of work.

  • Positive changes to expectation are likewise are not so rapid as to increase employment so quickly.

In long-term expectations, equipment will continue to give employment until it is worn out.

  • Positive changes to long-term expectations may cause employment to more rise initially than later when the equipment has been adjusted to the new situation.

If expectation continues for a sufficient length of time for the effect on employment to have worked itself out so completely that there is, broadly speaking, no piece of employment going on which would not have taken place if the new state of expectation had always existed, the steady level of employment thus attained may be called the long-period employment[3] corresponding to that state of expectation.

Expectation may change so frequently that the actual level of employment has never had time to reach the long-period employment corresponding to the existing state of expectation.

Nevertheless every state of expectation has its definite corresponding level of long-period employment. Let us consider, first of all, the process of transition to a long-period position due to a change in expectation, which is not confused or interrupted by any further change in expectation. We will first suppose that the change is of such a character that the new long-period employment will be greater than the old.

Now, as a rule, it will only be the rate of input which will be much affected at the beginning, that is to say, the volume of work on the earlier stages of new processes of production, whilst the output of consumption-goods and the amount of employment on the later stages of processes which were started before the change will remain much the same as before. In so far as there were stocks of partly finished goods, this conclusion may be modified; though it is likely to remain true that the initial increase in employment will be modest. As, however, the days pass by, employment will gradually increase.

Moreover, it is easy to conceive of conditions which will cause it to increase at some stage to a higher level than the new long-period employment. For the process of building up capital to satisfy the new state of expectation may lead to more employment and also to more current consumption than will occur when the long-period position has been reached. Thus the change in expectation may lead to a gradual crescendo in the level of employment, rising to a peak and then declining to the new long-period level.

The same thing may occur even if the new long-period level is the same as the old, if the change represents a change in the direction of consumption which renders certain existing processes and their equipment obsolete. Or again, if the new long-period employment is less than the old, the level of employment during the transition may fall for a time below what the new long-period level is going to be.

Thus a mere change in expectation is capable of producing an oscillation of the same kind of shape as a cyclical movement, in the course of working itself out. It was movements of this kind which I discussed in my Treatise on Money in connection with the building up or the depletion of stocks of working and liquid capital consequent on change. An uninterrupted process of transition, such as the above, to a new long-period position can be complicated in detail.

But the actual course of events is more complicated still. For the state of expectation is liable to constant change, a new expectation being superimposed long before the previous change has fully worked itself out; so that the economic machine is occupied at any given time with a number of overlapping activities, the existence of which is due to various past states of expectation.

The level of employment at any time depends on past and present expectation.

The past expectations, yet to be realized, are embodied in the today’s capital equipment which forms the basis for the entrepreneur’s decisions for today.

Thus, today’s employment is governed by today’s expectations taking into account today’s capital equipment. Express reference to current long-term expectations can seldom be avoided.

But it will often be safe to omit express reference to short-term expectation, in view of the fact that in practice the process of revision of short-term expectation is a gradual and continuous one, carried on largely in the light of realised results; so that expected and realised results run into and overlap one another in their influence.

Although output and employment are determined by the producer’s short-term expectations and not by past results, the most recent results usually play a predominant part in determining what these expectations are.

It would be too complicated to work out the expectations de novo whenever a productive process was being started.

It would be a waste of time since a large part of the circumstances usually continue substantially unchanged from one day to the next. Accordingly it is sensible for producers to base their expectations on the assumption that the most recently realised results will continue, except in so far as there are definite reasons for expecting a change.

Thus in practice, there is a large overlap between:

  • the effects on employment of the realised sale-proceeds of recent output and
  • the effects of the sale-proceeds expected from current input

Producers’ forecasts are more often gradually modified in the light of results than in anticipation of prospective changes.[4]

Nevertheless, we must not forget that, in the case of durable goods, the producer’s short-term expectations are based on the current long-term expectations of the investor. It is of the nature of long-term expectations that they cannot be checked at short intervals in the light of realized results.

Moreover, as we shall see in Chapter 12, where we shall consider long-term expectations in more detail, they are liable to sudden revision.

Thus the factor of current long-term expectations cannot be even approximately eliminated or replaced by realised results.

Author’s Footnotes

  1. It is not necessary that the level of long-period employment should be constant, i.e. long-period conditions are not necessarily static. For example, a steady increase in wealth or population may constitute a part of the unchanging expectation. The only condition is that the existing expectations should have been foreseen sufficiently far ahead.

  2. This emphasis on the expectation entertained when the decision to produce is taken, meets, I think, Mr. Hawtrey’s point that input and accumulation of stocks before prices have fallen or disappointment in respect of output is reflected in a realised loss relatively to expectation. For the accumulation of unsold stocks (or decline of forward orders) is precisely the kind of event which is most likely to cause input to differ from what mere statistics of the sale-proceeds of previous output would indicate if they were to be projected without criticism into the next period.


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