Investment vs. Consumption 1 The difference between investment and consumption.
Investment vs. Consumption 1
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- I've been wanting to make a video on a couple of terms
- that people have really thrown around for a while now.
- And I think it really hits the core of some of the issues
- we're dealing with now with the credit debacle but it's
- kind of at a deeper level.
- So the things I want to go over are the ideas of savings,
- consumption, and investment.
- And you hear these a lot.
- Everyone obviously says, I've invested in the stock market
- or I've invested in a house and I really want to give you
- a framework for how I think about these ideas.
- And frankly, I haven't seen them depicted this way in any
- economics book, although they've kind of touched on
- this, but I think this is really how you should think
- about these things.
- So if you save money, and I think we all know what that
- means, that's money that you didn't spend, there's a couple
- of things that you can do with it.
- You can either consume your money or you
- could invest your money.
- So, let's just think about a bunch of different situations
- and think about whether those things are consumption or
- So let's say, I have $100,000 that I'm dealing with.
- So let's say, I take that $100,000
- and I build a factory.
- And I think that that factory is going to be able to
- produce-- I'll make up some product-- it'll be able to
- produce cars more efficiently and cheaper than any other car
- factory out there.
- Well, I think we'd all agree that this is an investment.
- And why is it an investment?
- Because I'm taking this $100,000 and I'm putting it to
- some use that is creating, hopefully, more value than my
- original $100,000.
- In fact, I'm expecting some type of a return on this
- And I've made a bunch of videos on what a return on
- investment is, and you can usually quantify it.
- If I take a $100,000 and I build this factory and this
- factory spits out $50,000 a year, it's probably creating
- at least $50,000 a year value, assuming that nothing corrupt
- is happening in our system.
- In fact, it's normally creating more than $50,000 a
- year of value.
- It may be creating a $100,000 a year of value and $50,000 of
- that may be going to the person who's doing the
- production and then the other half of the value is actually
- going to the consumer of whatever
- this factory is making.
- And you have to think about it, because if all of the
- value went to the person who produced the factory then
- there's not a huge incentive for someone to use his
- products anymore.
- But anyway, that's not the topic of discussion.
- We're just trying to get at a mental framework on what
- consumption is versus investment.
- So I think we all agree that if I were to build a factory
- that this is-- let's say I'll do everything in green as
- So building a factory is an investment.
- Now let's say that I'm homeless
- and I have this $100,000.
- And because I'm homeless, I don't have a place to go and
- eat dinner and rest and relax.
- Because I don't have that, I can't get a job and I can't
- become a productive member of society.
- So maybe, I'm going to use this $100,000 to buy a simple
- house that meets all of my needs.
- Let's say build a simple house, and I'll do that in a
- neutral color.
- This is my other use of this $100,000, instead of building
- a factory, I'm going to build a simple house.
- And this house, it provides shelter for me and my family,
- it allows us that security that now my kids can go to
- school and they can themselves become
- more productive citizens.
- I now have an address.
- I have a place to take a shower, that allows me to go
- get a job and I can now create value for society as a whole,
- instead of being on the corner and begging
- for money from people.
- I would argue that this is also an investment.
- Why is it?
- Because I'm taking this $100,000, that maybe I had or
- someone gave to me, and it's generating a return.
- And what is that return?
- Well, with a factory, it's maybe a
- little easier to quantify.
- But at minimum, it's this work that I'm able to do because I
- now have a house.
- Because I have the security, I have the address.
- I have the shelter.
- I'm able to relax.
- It's that security and it's also the return that probably
- my kids are going to be able to now contribute to society.
- Maybe if they grew up homeless, they would have
- never been able to contribute.
- And now that they have a roof over their head, and are able
- to go to school, et cetera, they are going to be able to
- give some economic value back to society.
- It's hard to value, maybe I didn't have any job before and
- now I have a job and I can contribute
- $30,000 a year to society.
- Maybe I'm working at someone's factory.
- Maybe I'm providing some other-- maybe
- I'm a farmer now.
- Whatever, I'm providing some source of value.
- And maybe my kids-- if they never got an education, they
- would have maybe added $10,000 of value per year to people
- and now they can add $20,000 of value.
- So that difference would also be some of the return on this
- So I also consider this to be an investment.
- Now, my question to you is, let's say that I already had a
- house-- so this is an investment.
- Let's say I already had a house and my family is happy
- and we have everything we need.
- We have food on the table and my kids go to school and I'm
- able to get a job and all of that exists.
- But let's say, I still have a $100,000 and I use that
- $100,000-- I'll do it in yellow-- to put in some
- granite counter tops.
- I have some money left over, let's say, I'm going to add a
- bathroom to my house and I will put the latest hardwood
- floors, so that my family will be impressed.
- You can imagine.
- And maybe I add 2,000 square feet.
- You normally can't get all that for a $100,000 but I
- think you'll bear with me.
- So I'm essentially doing some major home improvements.
- So my question to you is-- is this an investment or is this
- Now, in our everyday world, with most people we deal with,
- they will call this investment in my house.
- And why are they saying that?
- Because they say, by spending a $100,000 in the house in
- this way, that maybe-- if you watch the Home and Garden
- channel, they're doing this all the time-- that if you
- pour this a $100,000 into your house, that maybe the value of
- your house is going to increase by $150,000.
- Or someone else, all of a sudden, is going to perceive
- the value of your house as being $150,000.
- They'll say, well, you got a $50,000 return on investment.
- I'd argue that that is not investment.
- That it's speculation.
- You are, essentially, piling money into this stuff-- and
- I'll do this in red, consumption is red.
- What's happening here truly economically?
- When you add granite, or you add an extra bathroom or
- hardwood floors or this extra 2,000 square feet, is it
- making anyone who's living in that house more productive?
- Is it making you harder working; is it making you more
- likely to invent the cure for cancer, or more likely to
- invent a way of getting cheap energy, or
- produce more widgets?
- No, it's just, if anything, providing more things for you
- to have to take care of, that you're not going to be able to
- focus as much on your work.
- Or more energy is going to have to be extended to
- maintain this type of place, to heat and cool a 2,000
- square foot house.
- So if anything, by actually pouring the $100,000 here,
- you're actually creating something that is going to
- suck more out of society.
- In fact, in no way is this going to contribute to the
- collective wealth of society.
- The last two examples I gave contribute to the collective
- wealth society, some of which you share, and that is your
- return on the investment.
- But as a whole, this is an investment into society.
- And it's going to make the pie bigger.
- This right here, does not make the pie bigger.
- It might make you a little bit happier, make your ego feel a
- little bit better, let your pride grow, and your self
- righteousness grow, and show other people that you've
- arrived, but it's not going to increase
- the wealth of society.
- And when you say that you've invested, you are really just
- saying I've speculated.
- What you're saying is-- by paying this $100,000, you're
- going to find, essentially, a greater fool out there.
- They could have done the same thing, they could have bought
- your house, spent $100,000 and done this, if this is what
- would have made them happy.
- But what you're saying is, essentially, that you're going
- to find somebody out there who's willing to pay $150,000
- extra for something that should
- have only cost $100,000.
- And in fact, if anything, if you use this at all, the value
- of this is going to go down.
- So you're just somehow assuming that the granite
- counter tops that you choose are going to be the taste that
- someone else would like or that the hardwood floors are
- going to be the taste someone else would like.
- I would actually argue that when you customize your house
- in this way, you are creating $100,000 of consumption to
- your taste.
- And I'd be surprised if someone else, truly, is
- willing to pay more than $100,000 unless they're being,
- in some way, irrational or they can finance this because
- it's part of the mortgage.
- Anyway, this is, I think, just the big picture: investment
- adds value to society.
- A simple house adds value to society.
- Consumption is something where people might call it an
- investment because it's kind of speculation.
- One might find some other guy willing to emotionally pay
- more for something.
- But it's money that's burned; it's not creating more value
- for society.
- I continue this in the next video.
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