Wednesday, May 22, 2013

Kirzner on Hayek on Prices

Kirzner (1985) is a discussion of Kirzner’s interpretation of the role of prices in market economies, but heavily based on Hayek’s work.

In the first section, I sketch Kirzner’s argument. In the second I provide a critique.

I. Kirzner on Hayek on Prices
Hayek’s view of the role of prices as communicating economic knowledge is well known.

In a market for any particular commodity, an equilibrium market price equates demand with supply and ensures that there is no excess demand or excess supply (Kirzner 1985: 197). Equilibrium market prices communicate the necessary information to buyers and sellers to achieve economic coordination (Kirzner 1985: 198). In this economic sense, an equilibrium (or market clearing) price is the “right” price. In a general equilibrium, there is perfect communication signalling and economic coordination.

But prices in the real world are virtually always disequilibrium prices, and the general system can never be in a general equilibrium state. Kirzner – like Hayek – conceives the price system as providing a mechanism to progressively improve information and coordination in relation to the past. Disequilibrium prices may communicate incorrect information and result in waste, but their movement towards equilibrium values permits a “discovery” process by market participants to generate greater economic coordination (Kirzner 1985: 205).

That is, in an uncoordinated or relatively uncoordinated economy, a flexible price system in which market buyers and sellers move prices in trades towards their market-clearing values will
“generate systemic changes in market decisions about price offers and bids, in a way that, by responding to the regrettable results of initially uncoordinated sets of decisions, tends to replace them by less uncoordinated sets” (Kirzner 1985: 198).
Thus even when prices are in disequilibrium they will achieve this higher degree of coordination as long as in exchanges they are flexible and moved towards their equilibrium (or market clearing) value.

For example, excess supply in a particular market indicates that prices are too high, so that sellers will eventually move their price downwards (Kirzner 1985: 199).

Disequilibrium prices in the sense of prices not at costs of production also provide profit and loss (Kirzner 1985: 205), and higher profits signal that entrepreneurs should move into these markets, while losses signal that they should move out into other lines of production.

Kirzner contends that Hayek sometimes failed to communicate properly this point about the coordinating role of flexible disequilibrium prices in his earlier work (Kirzner 1985: 203), but that it is brought out most clearly in Hayek’s papers “Competition as a Discovery Procedure” (Hayek 1978) and “The Meaning of Competition” (Hayek 1948).

II. Critique
But what are the problems with this Austrian model of economic coordination? Kirzner complains that “governmentally imposed obstacles to price flexibility” thwart the process of economic coordination (Kirzner 1985: 203).

But with widespread fixprice markets where administered prices dominate, the private sector itself already overwhelmingly shuns the flexible price system required in the ideal and almost utopian vision of Austrian economics. Disequilibrium prices are deliberately created and maintained by fixprice enterprises in a vast swathe of the economy, simply because they prefer it that way. Such businesses are not generally in the habit of using flexible prices as their normal method of clearing supply, or equating demand with supply. In other words, the whole Austrian view that flexible movement of prices towards market-clearing levels provides continuing, coordinating adjustment of supply and demand and permits a “discovery” process for capitalists is simply wrong in the fixprice markets. And these fixprice markets dominate advanced capitalist economies.

Even the existence of “clearance” and “liquidation” sales do not change this fact, for clearance sales are very much the exception, not the rule. In the retail trade, for example, what are called “clearance sales” are often a matter of some discounts, but with deceptive psychological tricks with advertising. Very often producers with excess supply will merely add this to inventory.

Supply is mostly equated with demand by direct output and employment changes, and changes in the quantity of stock. This is how a real economy generally achieves economy coordination. Prices are relatively inflexible, and so much so that fixprice firms only rarely change their prices, perhaps on average once a year (Melmiès 2010: 450), and even then the price adjustments are mostly caused by changes in the costs of factor inputs and wages.

Another consequence of these fixprice markets is that profits too tend to be relatively stable. A business wants its profit markup to be relatively stable (at least in terms of avoiding large falls in it), and so there is some degree of stability of profits that results from price administration (Gu and Lee 2012: 461). Stable profits in turn allow stable margins for internal financing of investment (Melmiès 2012).

Stable fixprices mean a rise in money supply or credit does not necessarily or even generally cause the price “distortions” imagined in Austrian theory, for fixprices are generally inflexible with respect to demand changes (though matters are different in flexprice markets).

There is no doubt that profit and loss has a major role to play in market economies in driving investment, but the particular importance given to profit and loss signals in the Austrian view of flexible prices is exaggerated, for fixprice firms generally shun the losses that they would suffer by sharply reducing the prices of their goods below costs of production to clear their product markets (Gu and Lee 2012: 461).

As noted above, fixprices are generally not adjusted in response to changes in demand, and instead output or inventory will be adjusted. Therefore when demand has changed in response to changes in credit, it does not follow that, say, consumer prices will rise and then the profits in those consumer industries as well, which will (according to Austrian theory) drive overinvestment in these lines of production. Instead, direct output and employment changes are more likely. Profits will increase but not because prices have increased: it is because extra demand has led to extra sales with increased production. When demand falls, changes in inventory and production will follow.

Another assumption underlying the Austrian vision of economics is the belief in a strong tendency for profits to be equalized across the economy. But that idea is unconvincing. It assumes an unrealistic degree of competition across markets, whereas in the real world very different degrees of competition between industries, market power, barriers to new entry, patents, labour issues and other factors will thwart the process.


Links
Jonathan Finegold Catalán, “Conceptualizing Price Distortions,” Economic Thought, 21 May, 2013.

BIBLIOGRAPHY
Gu, G. C. and F. S. Lee. 2012. “Prices and Pricing,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 456–463.

Hayek, F. A. von. 1948. “The Meaning of Competition,” in F. A. von Hayek, Individualism and Economic Order. University of Chicago Press, Chicago. 92–106.

Hayek, F. A. von. 1978. “Competition as a Discovery Procedure,” in New Studies in Philosophy, Politics, Economics, and the History of Ideas. University of Chicago Press, Chicago.

Kirzner, Israel M. 1985. “Prices, the Communication of Knowledge, and the Discovery Process,” in Kurt R. Leube and Albert H. Zlabinger (eds.), The Political Economy of Freedom: Essays in Honor of F.A. Hayek. Philosophia Verlag, Munich. 193–206.

Melmiès, J. 2012. “Price Rigidity,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 452–456.

16 comments:

  1. Hayek's notion of markets hearkens back to the bazaar, with all actors haggling until an agreeable price is determined. This, of course, almost never happens. Nearly every price I pay is fixed; I can either pay it or not, but no amount of wheedling is going to alter that particular "signalling".

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  2. A common theme of many of your recent posts has been that the existence of 'cost+markup' pricing somehow undermines Austrian pricing theory.

    As had been pointed out by Catalan here:

    http://www.economicthought.net/blog/?p=1322

    Such pricing models are very much a part of Austrian theory.

    Böhm-Bawerk in "The Positive Theory of Capital" developed this theory decades before any Post-Keynsian did , and built it on firm analytical principals, not (as appears to be the case with Post-Keynsans) mainly on the basis of empirical observation.

    While I agree that this aspect of Austrian pricing theory is often not put in the foreground there is no doubt it is there.

    So: I think it would be very useful if you would read "The Positive Theory of Capital" (if you have not already done so) before writing any more posts where you use "cost+markup" as a silver-bullet to slay Austrianism.

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    1. "Such pricing models are very much a part of Austrian theory."

      No, they are not. Modern Austrian theory virtually ignores it. Lachmann briefly spoke of it, and there is some brief comments in Reisman.

      And just because Böhm-Bawerk and Wieser spoke of cost of production pricing many years ago (over a century ago in the former case), it does not follow that 20th century Austrians bothered to follow them, study the issue and think through the implications for their economic theory.

      Where is the serious discussion administered pricing in Mises, Hayek, or Rothbard? Care to cite me any passages?

      There aren't any I know of. And administered pricing simply throws a spanner in the works of Misesian and Hayekian price theory and economic coordination theory.

      The Hayekian idea of "prices communicating crucial knowledge" mostly falls apart.

      That is no way around it.

      "Böhm-Bawerk in "The Positive Theory of Capital" developed this theory decades before any Post-Keynsian did , and built it on firm analytical principals, not (as appears to be the case with Post-Keynsans) mainly on the basis of empirical observation."

      He said something about it, but not much. And analysis of real world economies is based on empirical observation
      of reality, not arm chair apriorist method.

      " I think it would be very useful if you would read "The Positive Theory of Capital" "

      I've already read the relevant part. And what Wieser said about it. I find them both highly inadequate.

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    2. On cost+markup: Both Mises and Hayek follow Bohm-Bawerk in showing that in equilibrium prices would be cost adjusted by the rate-of-interest. Of course for Austrians "cost" is a subjective concept that can be explained by marginalist theory while for Post-Keynsians "cost" is never really explained.

      On Administered Pricing: The reason Hayek and Mises don't talk about this is because it is not a useful concept.

      Sometimes changes in market conditions will result in changed quantities but not price (for example if the relative demand for shoes over sandals increases then the result may be reallocation of labor from the production of shoes to sandals with little or no change in relative prices).

      Sometimes changes in market conditions will result in changed prices as well as quantities (for example an increase in demand for diamond rings will likely lead to an increase in price and quantity).

      Austrian pricing theory can explain both scenarios within a unified theory. Administered pricing theory can not (beyond saying that the theory doesn't apply in the second case, which is kind of lame).




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    3. "Both Mises and Hayek follow Bohm-Bawerk in showing that in equilibrium prices would be cost adjusted by the rate-of-interest. "

      I have no idea what you're talking about. In Mises's ERE or "final state of rest" there would be no profits, and prices would be at the cost of production.

      "Of course for Austrians "cost" is a subjective concept that can be explained by marginalist theory while for Post-Keynsians "cost" is never really explained. "

      Never explained? If you mean Post Keynesianism rejects the idea that people only buy things that they demand or derive utility from, you are mistaken.

      Yes, without demand, things are not produced. That truth does not take you very far in any analysis of how prices are set in real world economies.

      "On Administered Pricing: The reason Hayek and Mises don't talk about this is because it is not a useful concept."

      This is a bizarre non sequitur.

      You are implying that administered pricing either (1) does not exist or is (2) an incoherent concept. Both ideas are nonsense.

      And then you go right on to admit that it does exist ("Sometimes changes in market conditions will result in changed quantities but not price ..").

      Lastly, Post Keynesian price theory does not deny the reality of flexprice markets or some hybrid prices (both possibly flexible or alternately inflexibly), or the complexity of the real world.

      You appear to erroneously think Post Keynesian see ALL prices as administered prices. That is totally untrue.

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  3. 'I have no idea what you're talking about. In Mises's ERE or "final state of rest" there would be no profits, and prices would be at the cost of production.'

    Prices would be at the cost of production plus a mark-up for rate of interest, which is what I said. If you disagree - then I suggest you read these writers more carefully.

    'This is a bizarre non sequitur. You are implying that administered pricing either (1) does not exist or is (2) an incoherent concept. Both ideas are nonsense.

    And then you go right on to admit that it does exist ("Sometimes changes in market conditions will result in changed quantities but not price ..").'

    To clarify: I'm saying its incoherent. If "Sometimes changes in market conditions will result in changed quantities but not price .." is what Post-Keynesians mean by administered-pricing then the theory is not explaining anything that can't better be explained by Austrian theory. The incoherence of the theory is shown in statements like "Post Keynesian price theory does not deny the reality of flexprice markets or some hybrid prices (both possibly flexible or alternately inflexibly), or the complexity of the real world". Austrian theory can explain markets that appear "fixprice" to post-Keynsians as well as ones that appear "flexprice" within a single unified theory. No need to divide the world into markets of different types, following different sets of rules.

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    1. Nobody outside the tiny circle of think tank internet schoolars in Austrianism,cares much about what sort of ideas a Bohm Bawek or Mises,had to say about price formation,they where very diffuse.The school has not developed in an positive way since Carl Menger died,and no Austrian have yet solved Bohm-Bawerks still unfinished Capital Theory.Austrian economics is an example of Negative Heuristic,it have been more
      unreal and unimportant over time ,it has not developed.

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  4. a revevant recent post by Steve Keen:

    http://www.businessspectator.com.au/article/2013/5/20/economy/seductive-super-models-supply-and-demand

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    1. Very nice link, y.

      Thanks.

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    2. Highlights:

      "Over 150 empirical studies since the early 1930s have found that at least 90 per cent of firms don’t face rising costs as output rises – and in fact for the majority of firms, unit costs fall as production increases.

      The most recent person to rediscover this particular wheel was none other than Alan Blinder, a one-time vice chairman of the Federal Reserve. He undertook a huge survey of American business to find out why prices might be ‘sticky’, which is an essential part of the “New Keynesian” explanation for unemployment. As part of that he instructed his PhD student interviewers to find out what costs were like for the average American business – and he fully expected to confirm the standard “upward sloping” supply curve.

      In fact, his empirical research contradicted it. Much to his amazement, he found that almost 90 per cent of his sample reported that their unit costs either remained constant or fell as output rose."


      Kaldor made a similar point about increasing returns to scale being the fundamental trait in many industries.

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  5. I'm not sure that I agree with the way you present the discovery process. In Hayek (and Kirzner) this is seen as an injection of disequilibrium into the marketplace. It is not that entrepreneurs respond to some "signal" passively. Rather they actively intervene to create disequilibria which other, slower entrepreneurs have to "follow".

    Elsewhere I pointed out the mythic status of this belief. In all religious systems there must be a hero myth to justify the system (Joseph Campbell called it the "monomyth"). So, for Christianity its Christ, for Buddhism its Buddha, for Austrian economics its the entrepreneur who "upsets the balance" and "brings the new into existence" (just as Christ brings the Holy Spirit).

    I think this is important to understand because it goes right to the heart of the irrationalism at the heart of libertarian ideology. This is a system that requires a huge amount of emotional investment from its believers, who are generally weak-minded and desperately require authority and emotional reassurance. The hero myth of the entrepreneur is central to the psychological reinforcement they receive. If He were passive he would no longer constitute for the libertarian an ego-ideal [https://en.wikipedia.org/wiki/Ego_ideal] and the system would cease to have such profound psychological effects.

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    1. Rather they actively intervene to create disequilibria which other, slower entrepreneurs have to "follow".

      Wrong, markets are always in disequilibrium; entrepreneurs exploit such conditions via intertemporal arbitrage.

      The hero myth of the entrepreneur is central to the psychological reinforcement they receive.

      So Henry Ford, Sam Walton, Fred Smith, Akio Morita, Jeff Bezos, Brin and Page, Peter Thiel, Steve Jobs--and countless others who no one has ever heard of--have contributed nothing to human welfare through their entrepreneurship?

      One might think that it wasn't libertarian hero worship that made these people rich and famous--it was the millions and billions who used their innovations that did. But that's just right-wing mythology, of course, as any sensible person knows.

      And if you must know--yes, you're right, the success of these entrepreneurs does give my weak mind immense emotional reassurance. Wait, wut? #phildontknowwtfhestalkingabout

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    2. I think you will find that the heroic entrepreneur is Schumpeter's baby.

      It is Schumpeter who's equilibrium required disruption. In equilibrium people just get on with the same old stuff over & over, so why do we need competition?

      Mises & Hayek & Kirzner replied that the Market was a process & equilibrium an imaginary tool, so the need to break out of equilibrium was a pseudo problem.

      Schumpeter who explicitly took the side of the neoclassical socialists in the 1930's calculation debate, did not have this option open to him. So his entrepreneur became the force of 'creative destruction', pushing progress against the grain of the ordinary people who would be happy just to stagnate in equilibrium otherwise.

      On the other hand for Mises & Kirzner (or at least Mises as interpreted by Kirzner based on Human Action)entrepreneurship is a type of action that EVERYONE engages in all the time. Now while this may be criticised for watering down the concept, it is hardly a "heroic" conception.

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    3. Excellent,spot on! : " I pointed out the mythic status of this belief. In all religious systems there must be a hero myth to justify the system (Joseph Campbell called it the "monomyth"). So, for Christianity its Christ, for Buddhism its Buddha, for Austrian economics its the entrepreneur who "upsets the balance" and "brings the new into existence" (just as Christ brings the Holy Spirit)."

      It reminds about what John Kenneth Galbraith said in an interview on the question ,"Are there any analogies with the present period and the period of the Great Crash that you described in your book?":
      J.K Galbraith:
      "One s now, as in the late '20s, the impression (and this is a very subtle but a very important point) that somehow or another if everything is left to the market, the laissez-faire, if the government keeps its hands off, there is a God-given tendency for things to work out. Laissez-faire, laissez-passer, this is a ruling fact and is above and beyond government, a theological commitment to doing nothing, on the assumption that the economy can not fail -- a neo-classical idea that has classical roots"
      http://globetrotter.berkeley.edu/conversations/Galbraith/galbraith6.html

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    4. Great comments on Schumpeter and Kirzner, Malthuso.

      "for Mises & Kirzner, entrepreneurship is a type of action that EVERYONE engages in all the time.

      Exactly. Workers who invest in upgrading their skills are disequilibrium-exploiting entrepreneurs, too. Example: people who attend the "programmer bootcamps" that have sprouted up in the US. http://devbootcamp.com/faq/

      Bootcamp attendees correctly perceive that the IT industry is crying out for more web and app developers. The above-average salaries given to newly minted programmers are the prices that signal this information. As the market for programmers becomes saturated, wages will decline towards the average level.

      During this process, more people get programming jobs, IT companies satisfy their growing labor requirements, and consumers get better and cheaper applications. Experienced programmers will face some decrease in their expected future earnings, but since they aren't competing for entry-level jobs, this effect is muted. Even future unemployed workers benefit from this process since declining wages will indicate that they'd be better off investing in skills for some other industry.

      Just about everyone wins. No elitism here--and no trace of Luke Skywalker, either.

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  6. In saying something about the prices of a firm's output you are probably also saying something about their costs too. If their produced inputs (at least) are subject to administered prices then the marginal costs of additional of additional production are relatively small compared to their fixed costs and quite large economies of scale apply.

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