Two Non Sequiturs

Gene Callahan in this post quotes Physics Nobel prize winner Chen Ning Yang:

“after all, what could be more mysterious, or could be more awe– inspiring, than to find that the structure of the physical world is intimately tied to the deep mathematical concepts, concepts which were developed out of considerations rooted only in logic and the beauty of form?”
Robin J. Wilson and Jeremy Gray (eds.), Mathematical Conversations: Selections from The Mathematical Intelligencer, p. 72.

The first non sequitur is the idea, derived from the success of mathematics in science, that the “physical world is intimately tied to the deep mathematical concepts.” Why not the other way around? That some deep mathematical concepts are tied to reality? And that this is an empirical and contingent fact?

After all, a considerable amount of pure mathematics has no application to the real universe, nor provides any description or model of any process or phenomenon in the real universe.

The empirical discovery that the some subset of theories in pure mathematics does describe or model reality – when these models are transformed into applied mathematics – does not vindicate apriorist Rationalism. It vindicates empiricism. You cannot use armchair deduction to know with certainty that non-Euclidean geometry is the right description of the geometry of the universe. It is empiricism that has allowed us to establish this fact.

Perhaps he was only being tongue-in-cheek, but the second non sequitur is Gene Callahan’s conclusion from this quotation that modern physics is “idealist.” How does that follow? On the contrary, the assumption of an external world of matter and energy is a fundamental postulate of modern science. Our medical science in its treatment of human behavioural disorders and mental health relies on empirical evidence that the human mind is causally dependent on the healthy functioning of the brain, and so on.

Lee’s Post Keynesian Price Theory: Chapter by Chapter Summaries

My chapter by chapter summaries of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) can be found in these posts:

(1) “Lee’s Post Keynesian Price Theory: Chapter 1,” July 6, 2013.

(2) “Lee’s Post Keynesian Price Theory: Chapter 2,” August 15, 2013.

(3) “Lee’s Post Keynesian Price Theory: Chapter 3,” August 16, 2013.

(4) “Lee’s Post Keynesian Price Theory: Chapter 4,” August 17, 2013.

(5) “Lee’s Post Keynesian Price Theory: Chapter 5,” August 19, 2013.

(6) “Lee’s Post Keynesian Price Theory: Chapter 6,” October 6, 2013.

(7) “Lee’s Post Keynesian Price Theory: Chapters 7, 8 and 9,” October 24, 2013.

(8) “Lee’s Post Keynesian Price Theory: Chapter 10,” October 25, 2013.

(9) “Lee’s Post Keynesian Price Theory: Chapter 11,” October 26, 2013.

(10) “Lee’s Post Keynesian Price Theory: Chapter 12,” October 27, 2013.

Lee’s Post Keynesian Price Theory: Chapter 12

Chapter 12 of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) is the final chapter and conclusion of Lee’s book.

A capitalist economy has a productive structure of input and output. In any given capitalist economy, 24% to 50% of output is itself used as input intermediate goods (Lee 1998: 220). This circular production model includes all primary sector, industrial, wholesale, and retail markets. Administered prices can occur in any one of these types of markets.

The calculation of costs of production for a product depends on the accounting procedure used and with the degree of mark-up will determine the administered price (Lee 1998: 228).

Administered prices are neither market-clearing nor profit-maximising prices in the neoclassical sense (Lee 1998: 228).

Above all, economic coordination in modern capitalist economies is not a straightforward function of the price system, in view of the prevalence of administered pricing (Lee 1998: 230) – a fundamental conclusion which cannot be emphasised enough.

The profit mark-up is mostly determined by custom, convention, reasonableness, fairness and short and long-term competitive pressures (Lee 1998: 226).

Finally, the administrative procedure of setting prices by means of a profit mark-up undermines the Marxist, classical and Sraffian view that there exists a tendency towards a uniform rate of profit throughout a competitive capitalist economy (Lee 1998: 226, n. 17).

BIBLIOGRAPHY
Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.

Lee’s Post Keynesian Price Theory: Chapter 11

Chapter 11 of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) begins Lee’s summing up and overview of the doctrine of administered prices in Post Keynesian economics. Lee draws on over 100 empirical studies to draw together the elements of this theory (Lee 1998: 201).

First, a misunderstanding should be dispelled. Post Keynesian price theory does not deny the existence of flexprice markets (Lee 1998: 203, n. 7). In any given capitalist economy, commodity markets (defined as those for goods and services) and asset markets are divided into (1) flexprice and (2) fixprice markets. Administered prices constitute the major form of the latter.

Flexprice markets are prevalent in primary commodities and asset markets, while newly produced goods and services tend to be fixprices. A “flexprice” market – as the name suggests – indicates that prices are generally flexible and are determined by the dynamics of supply and demand, either in (1) competitive auction-like markets or (2) markets where a buyer and seller haggle and negotiate an individual price for an individual exchange (as in the oriental bazaar). Of course, destructive price wars can also lead to flexible prices that deviate from costs of production (Lee 1998: 203, n. 7), but it is notable how frequently businesses shun such price wars.

Administered prices generally seem to represent the majority of prices in most advanced market economies. Empirical studies conducted since the publication of Lee’s book confirm this.

For example, in the Eurozone, the percentage of administered prices in a given nation ranges from about 50% to 65%. The average for the Eurozone as a whole is 54% (Fabiani et al. 2006: 18, Table 4). Once other fixprices caused by government regulation are added to this, the percentage for fixprices generally appears to rise to about 60% to 70% of prices – which is the overwhelming majority (I conservatively assume about 10% of the third category of prices called “other” in Fabiani et al. [2006: 18, Table 4] represent prices fixed by government regulation, but the Eurozone average is actually 18%, so that 68% to 83% might actually be a more realistic estimate).

Enterprises that adopt administered prices employ a cost accounting system that calculates direct factor input costs (the direct costs) plus overhead costs (Lee 1998: 201–202).

The cost of a product is then calculated at standard, estimated or budgeted output or capacity utilisation (Lee 1998: 202–203). The mark-up is then added to the cost to create a price.

Lee distinguishes three types of administered prices which differ owing to the type of cost accounting systems that underlie the calculation of average costs:

(1) standard mark-up pricing;

(2) normal cost pricing, and

(3) target rate of return pricing. (Lee 1998: 204–205).

However, all involve a mark-up for profit over average costs, and types (2) and (3) are the most prevalent (Lee 1998: 206).

Administered pricing is not restricted to monopolies, oligopolies, or cartels: it also occurs in competitive markets. But even here businesses tend to establish a similar administered price, and shun price wars, as Lee points out:

“Consequently, co-ordination is required among the enterprises if destructive price competition is to be avoided and an acceptable, single market price established. Business enterprises have therefore utilized a range of private market institutions, such as cartels and price leadership arrangements, buttressed by an array of ancillary conventions, traditions, and restrictive trade agreements to establish an orderly market with a single market price. When the private market institutions have failed to control price competition, enterprises have turned to quasi-government or purely government organizations, legal decrees, and laws in order to establish an orderly market with a single market price.” (Lee 1998: 207).

Within private administered price markets with competition, often the most powerful business acts as a “price leader” by setting a price that competitors follow: when average costs differ, other businesses adjust their profit mark-up to set roughly the same price (Lee 1998: 207–208).

When governments offer goods and services for sale, they too often adopt the very same administered price procedures to set the price of their products (Lee 1998: 207). In this respect, there is nothing “unnatural” about such government price “fixing”: governments simply follow the same practice as the private sector.

For the private sector, administered pricing provides security and stability of profits, to allow businesses to survive over time and grow (Lee 1998: 208–209).

A consequence of administered pricing is that many such prices generally remain stable and fixed from periods varying from three months to a year (Lee 1998: 209). Administered prices consequently do not normally change when demand changes, which violates a fundamental tenet of neoclassical price theory. Moreover, administered prices are not market clearing prices and are not even intended to be.

A fixed and predictable price allows businesses to build “goodwill” relationships with their customers, a practice which is very important to businesses (Lee 1998: 212).

Most astonishing of all is that empirical studies show that many products do not have well behaved demand curves:

“Where reported … business enterprises stated that variations in their prices within practical limits, given the prices of their competitors, produced virtually no change in their sales, and that variations in the market price, especially downward, produced little if any changes in market sales in the short term. Moreover, when the price change is significant enough to result in a non-insignificant change in sales, the impact on profits has been sufficiently negative to persuade enterprises not to try the experiment again.” (Lee 1998: 207).

The significance of this is that, if many administered price businesses tried to clear their product markets by price reductions (as one fundamental step in a convergence to a general equilibrium), then it would simply not work or would result in massive losses and most likely mass bankruptcy of many businesses.

When administered prices are changed, the change tends to be driven by (1) labour and materials costs or (2) changes in the profit mark-up (Lee 1998: 213).


BIBLIOGRAPHY
Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.

Lee’s Post Keynesian Price Theory: Chapter 10

Chapter 10 of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) looks at the Josef Steindl and the later development of his “stagnation thesis.” Again, this chapter is only of marginal interest for me, given that I prefer to concentrate on the central idea of administered prices.

I merely provide a brief sketch below.

Steindl used the theory of mark-up pricing in his “stagnation thesis”: the idea that over time oligopolies and large corporations would tend to dominate advanced capitalist economies, and that, because their profit margins would exceed new investment, over time the aggregate level of economic activity would tend to be dampened (Lee 1998: 192).

This thesis was taken up by certain Marxists such as Paul Baran and Paul Sweezy (Lee 1998: 193–194). Their book Monopoly Capital (1966) developed the “stagnation thesis” and argued that the tendency to stagnation was checked by (1) business advertising and sales promotions to create new demand for products and (2) government expenditure (Lee 1998: 196). Whatever the merits of this thesis, it did at least understand that many markets are dominated by firms that actively set prices to stabilise profits.

Another novel and interesting elaboration of the theory by Harry Magdoff and Sweezy himself was the idea that the financial sector provides another important element of the process: consumer credit from financial institutions promotes more demand but corporate spending on financial assets tends to reduce real capital investment and re-enforce the stagnation tendencies.


BIBLIOGRAPHY
Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.

Lee’s Post Keynesian Price Theory: Chapters 7, 8 and 9

Chapters 7, 8 and 9 of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) deal with the work of Michał Kalecki (1899–1970). Unfortunately, these chapters are more useful for the history of Kalecki’s work and his influence on some Post Keynesians, rather than administered prices per se. I provide only a brief summary of interesting points below.

Kalecki’s initial work focussed on the price rigidity, monopoly and oligopolistic tendencies in market economies, and was imbued with explicit marginalist ideas (Lee 1998: 147–149).

But Kalecki’s early work, as it had emerged by the 1940s, was subsequently developed in two ways:

(1) from 1952 to the 1980s, by Sraffa, Geoffrey Harcourt, Peter Riach, Joan Robinson, Kaldor, Athanasios Asimakopulos, Adrian Wood, Aldred Eichner, and Kalecki himself, and

(2) from 1945 to the early 1980s by Josef Steindl, Sylos-Labibi, Paul Baran, Paul Sweezy, Harry Braverman, and David Levine in the “stagnation thesis” (Lee 1998: 152).

During WWII, Kalecki worked at Oxford with Steindl, Fritz Burchardt and G. D. N. Worswick, and came to develop his theories (Lee 1998: 153).

Burchardt and Worswick soon became interested in markup pricing, and by 1944 Kalecki himself seems to have been aware of the idea (Lee 1998: 154, n. 2). Strangely, however, Kalecki, in a revised version of his economic ideas, in the Theory of Economic Dynamics (1954) did not explicitly adopt markup, cost-based pricing, and it was not until the 1960s that he adopted it in his analysis (Lee 1998: 167).

All in all, Kalecki’s early work contained a number of marginalist elements, though arguably he abandoned marginalism by 1954 (Lee 1998: 172–173), and a non-marginalist interpretation of Kalecki’s work inspired Post Keynesians to develop some of his theories on monopoly power, administered prices and the causes of the profit markup.


BIBLIOGRAPHY

Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.

Kalecki, Michał. 1954. Theory of Economic Dynamics: An Essay on Cyclical and Long-Run Changes in Capitalist Economy. Allen and Unwin, London.

Administered Pricing in the United Kingdom

There are two recent surveys of price setting and price rigidity in the UK: Greenslade and Parker (2012) and Hall, Walsh, and Yates (2000).

Greenslade and Parker (2012) report the following:

“The latest UK survey asked firms how prices were determined. Firms were asked: How are UK prices for your main product or activity primarily determined? The explanation that received the highest proportion of ‘important’ and ‘very important’ responses was that prices were primarily determined by the competitors’ price (68% of firms). The importance of the mark-up over costs form of pricing was seen clearly as well, with variable mark-ups (58%) and constant mark-ups (44%) being the next most accepted explanations. Only 27% of firms accepted the explanation that their prices were primarily determined by customers.” (Greenslade and Parker 2012: F9–F10).

At first sight, this seems strange, but on closer investigation, it must be the case that the category of price setting based on “competitors’ price” (68% of firms) actually involves a considerable number of administered prices, since the profit markup in many administered price markets is determined by the most powerful and productive firms: hence firms would report that their administered price is based on that of their most important competitors.

This is surely the case because cost plus variable or constant mark-up pricing was also reported by a very large percentage of firms as their pricing strategy (58% and 44% respectively).

Also of interest is that Hall et al. (2000: 436–437) found that constant marginal costs (as reported by 53.8% of firms surveyed) and cost-based pricing (47.1%) were the two major reasons reported by firms for why they do not change prices.

Furthermore, if there is a boom in demand which cannot be met from stocks or inventories, most UK firms simply increase overtime of workers (as reported by 62% of firms), hire more workers (12%), or increase capacity (8%), rather than increase the price of their product (12%) (Hall et al. 2000: 442).

Hall et al. (2000: 443) discovered that the New Keynesian idea of menu costs as a fundamental explanation for price stickiness is unsupported by empirical evidence (and was given as a reason by only 7% of firms’ surveyed). That is confirmed by Greenslade and Parker 2012: F12).

Another very interesting empirical question not (as far as I can see) addressed in these surveys is this: what percentage of the labour force is employed in the administered price industries and businesses?

I would suspect it is quite high, simply because most flexprice markets like primary commodities, mining and agriculture* employ a small percentage of the labour force in virtually every industrialised nation. In the UK, for example, agriculture employs just 1.4% of the labour force, while most people work in services (80.4%) and then industry (18.2%) (as estimated in 2006). According to data from the Eurozone, about 50% of service industry prices are straightforwardly administered prices (Fabiani et al. 2006: 18, Table 4) and a higher percentage of goods prices: it follows, then, that much employment is located in administered price sectors.

The higher the percentage of people employed in the administered price sector is, the more it is the case that the level of employment and unemployment in a modern market economy is a function of the demand for labour from administered price businesses – a fundamental sector where aggregate demand drives employment and output, exactly as Keynesian theory tells us.


Note
* Of course I do not deny that many agricultural prices are set by commodity stabilisation programs and government interventions.

BIBLIOGRAPHY
Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Greenslade, Jennifer V. and Miles Parker. 2012. “New Insights into Price-Setting Behaviour in the UK: Introduction and Survey Results,” Economic Journal 122.558: F1–F15.

Hall, S., Walsh, M. and A. Yates. 2000. “Are UK Companies’
Prices Sticky?,” Oxford Economic Papers 52.3: 425–446.

King’s Nicholas Kaldor: Chapters 1–3

I currently reading John King’s book Nicholas Kaldor (Basingstoke and New York, 2009), and note below some interesting points about Kaldor’s early life and career from Chapters 1 to 3.

Nicholas (Miklos) Kaldor (1908–1986) had been born in Budapest on 12 May, 1908. His father was a lawyer, and he attended the Model Gymnasium in Budapest until he enrolled in economics at the Humboldt University in Berlin in 1925 (King 2009: 4). Kaldor left for England in 1927 and began study at the London School of Economics (LSE).

He was first taught by the American Marshallian Allyn A. Young, and then Lionel Robbins (King 2009: 5).

One of Allyn A. Young’s major achievements in economics was original work on increasing returns to scale, an issue which would concern Kaldor throughout his career (King 2009: 5).

After Young’s death, Kaldor was influenced by Lionel Robbins who was more in the tradition of Walrasian and Austrian economics, than Marshallian theory.

When Hayek arrived at the LSE in 1931, Kaldor fell briefly under his spell, but abandoned this flirtation with Austrian economics by the mid-1930s (King 2009: 17).

In 1935–1936, Kaldor held a Rockefeller Scholarship and travelled widely in the United States.

Already in 1937, Kaldor was criticising Austrian capital theory (King 2009: 18–19), and another of his early articles was on welfare economics, ordinal utility and the compensation principle (King 2009: 23– 27).

King judges Kaldor’s “Speculation and Economic Stability” (Kaldor 1939a) to be one of the most important of his early articles (King 2009: 27–28). The paper analyses the nature of speculation, expectations and the effect of speculation on economic activity.

During WWII, the LSE was relocated to Cambridge, and there Kaldor had a productive friendship with Piero Sraffa, Joan Robinson and Keynes (King 2009: 36).

In “Principles of Emergency Finance” (Kaldor 1939b), Kaldor anticipated Keynes’s arguments in How to Pay for the War.

After the war, Kaldor resigned from the LSE and worked briefly for the United Nations in Geneva from 1947 to 1949, but returned to Cambridge in 1949 to take up a fellowship in King’s College, where he would spend most of his career (King 2009: 57).

BIBLIOGRAPHY
Kaldor, N. 1939a. “Speculation and Economic Stability,” Review of Economic Studies 7: 1–27.

Kaldor, N. 1939b. “Principles of Emergency Finance,” The Banker 51: 149–156.

King, J. E. 2009. Nicholas Kaldor. Palgrave Macmillan, Basingstoke and New York.

Administered Prices in the Eurozone: Some Empirical Data

Fabiani et al. (2006) provide empirical evidence of the extent of administered prices in Eurozone nations from a number of surveys and studies.

The data are below:

Nation | Total Percentage of Markup Prices
Belgium | 46%

Spain | 52%

Italy | 42%

Netherlands | 56%

Portugal | 65%

Euro Area | 54% (average for whole Euro Area)

(Fabiani et al. 2006: 18, Table 4).

It is very striking indeed that for the Eurozone as a whole the average is 54% – a majority of prices.

It is also very telling that the number of prices affected by government regulation or controls is far lower than the percentage of prices directly administered and made relatively inflexible by private sector businesses themselves.

This can be seen here in the category Fabiani et al. call “other” price-setting rules:

Nation | Total Percentage of “Other” Prices*
Belgium | 18%

Spain | 21%

Italy | 26%

Netherlands | 21%

Portugal | 23%

Euro Area | 18% (average for whole Euro Area)

* N.B. This category also seems to refer to other types of price setting apart from government regulation.
(Fabiani et al. 2006: 18, Table 4).

Furthermore, Fabiani et al. have a second category of prices called “competitors’ prices,” which describe prices influenced by pricing of competitors. This does refer to many types of flexprices, but may possibly conceal some administered prices too, so that the first percentages given above may be underestimates.

Unfortunately, total percentages for Germany and France are not given, but data for goods (as opposed to services) markets are:

Nation | Percentage of Markup Prices for Goods
Germany | 73%

France | 40%
(Fabiani et al. 2006: 18, Table 4).

It is striking how high the percentage of administered prices is for goods markets in Germany: it stands at 73%.

BIBLIOGRAPHY
Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Lee on Post Keynesian Price Theory in The Oxford Handbook of Post-Keynesian Economics

Frederic S. Lee has a useful and up-to-date chapter on Post Keynesian price theory in The Oxford Handbook of Post-Keynesian Economics. Volume 1: Theory and Origins (Oxford, 2013). I summarise the main points below.

The crucial conclusions from empirical investigation of real world capitalist price systems are as follows:

(1) administered prices make up somewhere between about 50–70% of prices in modern market economies (for direct evidence for these percentages in, for example, the Eurozone, see Fabiani et al. 2006: 18, Table 4).

(2) in these widespread administered, fixprice markets, prices are not primarily a mechanism for economic coordination in the neoclassical sense, but a method by which a business obtains and stabilises its income and profits, in order to support the survival of the business (Lee 2013: 467–468). Administered prices are not market clearing prices, nor are they set in order to equate marginal costs to marginal revenue. Administered prices are set before the sale or exchange takes place and sometimes even before production (Lee 2013: 470). They are not the product of competitive bidding in a Walrasian auction-like market or a haggling process familiar from bazaars (Lee 2013: 474).

Rather, intense price competition is often shunned by businesses because competition via flexible prices and price wars will drive many enterprises toward bankruptcy. Hence administered prices provide a way by which private businesses control and avoid the uncertainty attached to intense and destructive price competition (Lee 2013: 476).

(3) administered price businesses are not concerned with maximisation of profits in the neoclassical sense. Rather, they wish to create a steady flow of income and stable profit to maintain and grow their business, increase market share, engage in new investment and/or produce new products, and so pursuit of profit can be conceived of as an “intermediate objective” (Lee 2013: 468). When possible, profits are generally increased by increasing the profit markup and reducing costs, rather than adjusting prices in response to demand changes.

(4) an administered price is calculated from average total costs (ATC) at a given capacity utilisation or output plus profit markup. Average total costs (ATC) are broken down into product average direct costs (ADC) and average overhead costs (AOHC) (Lee 2013: 469). In an industry where competition exists, the outcome is normally that a “price leader” – the largest and most successful producer or producers – set a profit markup and price for the product that strongly influences other businesses (Lee 2013: 473).

(5) depending on the market, administered prices are reviewed and possibly changed from 3 month periods to a year (Lee 2013: 474), and even then changes in price will generally be driven by costs of factor inputs.

(6) the most recent empirical evidence suggests that many modern administered price businesses often do not reduce their prices when factor input prices decrease, if they can avoid it. Instead, the business will increase its profit markup and maintain prices – a factor that tends to re-enforce the downward rigidity of prices in modern market economies (Lee 2013: 475; Álvarez et al. 2006).

BIBLIOGRAPHY
Álvarez, L. J., Dhyne, E., Hoeberichts, M., Kwapil, C., Le Bihan, H., Lünnemann, P., Martins, F., Sabbatini, R., Stahl, H., Vermeulen, P. and J. Vilmunen. 2006. “Sticky Prices in the Euro Area: A Summary of New Micro-Evidence,” Journal of the European Economic Association 4.2–3: 575–584.

Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Lee, Frederic S. 2013. “Post-Keynesian Price Theory: From Pricing to Market Governance to the Economy as a Whole,” in G. C. Harcourt and Peter Kriesler (eds.), The Oxford Handbook of Post-Keynesian Economics. Volume 1: Theory and Origins. Oxford University Press, Oxford and New York. 467–484.

Do Modern Austrians ever Read Lachmann?

For example, this passage:

“In neoclassical equilibrium theory the relationship between value and price becomes problematical in a way it was not for classical economists. The difference is one of the knowledge we may attribute to market participants. In the classical world it was reasonable to assume that every trader in a market knew the long-run cost of production of the product traded and was able to make use of this knowledge in dealing with day-to-day price fluctuations. But neoclassical equilibrium rests on a complex interplay of demand and supply in thousands of markets. In the absence of ‘The Auctioneer’ nobody can ‘know’ an equilibrium price until the system as a whole has attained this position. Traders are unable to compare current prices with a ‘long-run normal price’ as they do not know the latter. The problem of price formation arises in a new form. The day-to-day conduct of traders requires a new form of explanation.

It is therefore not surprising that a fairly straight line links Mayer’s position to contemporary discussions of fixprice and flexprice markets, two terms we owe to Sir John Hicks. Once we realise that in our world all prices are disequilibrium prices, the problem mentioned above arises on many levels. It was to be expected that post-Keynesians would seek guidance in the writings of Keynes who, in any case, distrusted neoclassical theory. Chapter 29 of the Treatise on Money may be said to contain a rudimentary theory of price formation in conditions of disequilibrium. A few years ago Professor Davidson made a notable attempt to take Keynes’s thought on price formation in different markets a little further by distinguishing between ‘produce-to-market’ and ‘produce-to-contract’ entrepreneurs (Harcourt (ed.) 1977:313–17).

In different markets prices are formed in different ways. Not all pricefixing agents have the same interests. Here historical change plays its part. The decline of the wholesale merchant, whose dominating role Marshall took for granted, for instance in textile markets, and who naturally aimed at setting such prices as would permit him to maximize his turnover (a short-run consideration), reduced the range of markets with flexible prices. The rise of the industrial cost accountant as a pricefixer, with his interest in ‘orderly marketing’ (a long-run consideration) and his aversion to frequent price changes, has made most prices of industrial goods in our world Hicksian fixprices. In all markets dominated by speculation of course prices must be flexible. On the other hand, all bureaucracies, including those concerned with production planning in large industrial enterprises, naturally abhor flexible prices. ... .” (Lachmann 1994: 165–166; originally published in Lachmann 1982).

And a further observation:

“Hence, while Marshall’s was a world of flexible prices, even though not of ‘perfect competition,’ ours is a ‘fixprice world’ with prices set on a ‘cost plus’ basis and wage rates as ultimate price determinants.

The analytical significance of this historical change lies, on the one hand, in the fact that the ‘Temporary Equilibrium Method’ which Hicks himself, following Lindahl, used in Value and Capital in 1939, has lost much of its validity. ‘The fundamental weakness of the Temporary Equilibrium method is the assumption, which it is obliged to make, that the market is in equilibrium—actual demand equals desired demand, actual supply equals desired supply—even in the very short period.’ (76) Hence we have to look for another method of dynamic analysis. To find it we must move nearer to Keynes and his successors who are here given credit for having understood, earlier than others, that a fixprice world requires a fixprice method of analysis.” (Lachmann 1977: 238–239).

One will look in vain for a discussion of these issues in other Austrian literature, apart from a scant discussion in Reisman (1996: 414–417).

But none of the modern Austrians – not even Lachmann – bothered to properly think through the implications of administered prices.

If they had, they would have seen that the central plank of the Misesian theory of economic coordination – that the market, even an “unhampered” market, has a strong tendency to market clearing and full use of resources – must be abandoned.

BIBLIOGRAPHY
Lachmann, Ludwig M. 1977. Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. Walter E. Grinder). Sheed Andrews and McMeel, Kansas City.

Lachmann, L. M. 1982. “The Salvage of Ideas: Problems of the Revival of Austrian Economic Thought,” Journal of Institutional and Theoretical Economics 138.4: 629–645.

Lachmann, L. M. 1994. “The Salvage of Ideas: Problems of the Revival of Austrian Economic Thought,” in D. Lavoie (ed.), Expectations and the Meaning of Institutions: Essays in Economics. Routledge, London. 159–178.

Reisman, George. 1996. Capitalism: A Treatise on Economics. Jameson Books, Ottawa, Ill. and Chicago.

My Posts Refuting Misesian Apriorism and Praxeology

My posts below explain why Misesian apriorist praxeology is untenable and requires non-existent synthetic a priori knowledge. In particular, Misesians have a badly flawed understanding of the philosophy of mathematics and geometry, which they use to defend their apriorism:

“Mises was Confused about the Analytic–Synthetic Distinction,” September 15, 2013.

“Mises on Kant and Praxeology,” September 15, 2013.

“Hoppe on Euclidean Geometry, Part 2,” September 14, 2013.

“Robert Murphy gets Mises’s Epistemology Wrong,” September 13, 2013.

“Hoppe on Euclidean Geometry,” September 11, 2013.

“Hoppe’s Caricature of Empiricism,” September 10, 2013.

“Mises’s Flawed Deduction and Praxeology,” September 8, 2013.

“Mises versus the Vienna Circle,” September 7, 2013.

“Reply to a ‘Red Herring on Praxeology,’” September 6, 2013.

“Tokumaru on Mises’s Epistemology,” September 3, 2013.

“Mises’s Non Sequitur on synthetic a priori Knowledge,” September 2, 2013.

“Bob Murphy All At Sea on Geometry and Economic Epistemology,” August 31, 2013.

“Mises Fails Philosophy of Mathematics 101,” August 30, 2013.

“Barrotta’s Kantian Critique of Mises’s Epistemology,” July 28, 2013.

“What is the Epistemological Status of Praxeology and the Action Axiom?,” July 27, 2013.

When Austrians Throw Reality to the Wind

I am sternly lectured here by an internet Austrian commenting on my last post that my empirical evidence supporting the statement that many businesses use administered prices is all for naught, because, well, empirical reality does not matter:

“First, there is the role of empirical evidence in economic theorising. A chronicler like you will never get that part. Second, there is the important point that what people say is irrelevant to an economic theorist. It may be to an accountant (which you seem to be) but not to a person dabbling in Economics.”
http://socialdemocracy21stcentury.blogspot.com/2013/10/lavoie-on-administered-prices.html?showComment=1381482208666#c8603208885956595634

The words highlighted in yellow say it all: vulgar Austrians do not care about empirical reality. If an Austrian economic theory is contradicted by reality, then reality is irrelevant.

For example, if one wants to create a theory about how prices are actually set in the real world, then obviously surveys of how business people actually do set prices must be “irrelevant to an economic theorist.”

Thus the findings of the Oxford Economists’ Research Group (OERG) in the 1930s, on real world price setting, confirmed by numerous studies since then (Andrews 1964; Means 1972; Okun 1981; Blinder et al. 1998, with Downward and Lee 2001; Fabiani et al. 2006), must be totally irrelevant to how prices are set:

“For several years a group of economists in Oxford have been studying problems connected with the trade cycle. Among the methods adopted is that of discussion with business men, a number of whom have been kind enough to submit to questioning on their procedure in various circumstances: and among other matters in the questionnaire were inquiries about the policy adopted in fixing the prices and the output of products.” (Hall and Hitch 1939: 12).

“The most striking feature of the answers was the number of firms which apparently do not aim, in their pricing policy, at what appeared to us to be the maximization of profits by the equation of marginal revenue and marginal cost. In a few cases this can be explained by the fact that the entrepreneurs are thinking of long-run profits, and in terms of long-run demand and cost curves, even in the short run, rather than of immediate profits. This is expressed to some extent by the phrase commonly used in describing their policy – ‘taking goodwill into account’. But the larger part of the explanation, we think, is that they are thinking in altogether different terms; that in pricing they try to apply a rule of thumb which we shall call ‘full cost’, and that maximum profits, if they result at all from the application of this rule, do so as an accidental (or possibly evolutionary) by-product.

An overwhelming majority of the entrepreneurs thought that a price based on full average cost (including a conventional allowance for profit) was the ‘right’ price, the one which ‘ought’ to be charged. In some cases this meant computing the full cost of a ‘given’ commodity, and charging a price equal to cost. In others it meant working from some traditional or convenient price, which had been proved acceptable to consumers, and adjusting the quality of the article until its full cost equalled the ‘given’ price. A large majority of the entrepreneurs explained that they did actually charge the ‘full cost’ price, a few admitting that they might charge more in periods of exceptionally high demand, and a greater number that they might charge less in periods of exceptionally depressed demand. What, then, was the effect of ‘competition’? In the main it seemed to be to induce firms to modify the margin for profits which could be added to direct costs and overheads so that approximately the same prices for similar products would rule within the ‘group’ of competing producers. One common procedure was the setting of a price by a strong firm at its own full cost level, and the acceptance of this price by other firms in the ‘group’; another was the reaching of a price by what was in effect an agreement, though an unconscious one, in which all the firms in the group, acting on the same principle of ‘full cost’, sought independently to reach a similar result.” (Hall and Hitch 1939: 18–19).

However, for those of us not blinded by Mises’s crazy methodology, empirical reality must ground all economic theories.


BIBLIOGRAPHY
Andrews, P. W. S. 1964. On Competition in Economic Theory. Macmillan, London.

Blinder, A. S. et al. 1998. Asking about Prices: A New Approach to Understanding Price Stickiness. Russell Sage foundation, New York.

Downward, Paul and Frederic Lee. 2001. “Post Keynesian Pricing Theory ‘Reconfirmed’? A Critical Review of Asking about Prices,” Journal of Post Keynesian Economics 23.3: 465–483.

Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2 (May): 12–45.

Means, G. C. 1972. “The Administered Price Thesis Reconfirmed,” American Economic Review 62: 292–306.

Okun, A. 1981. Prices and Quantities: A Macroeconomic Analysis. Blackwell. Oxford.

Lavoie on Administered Prices

Short and concise, but insightful:

“… prices set by [sc. fixprice] firms in the short run are not market-clearing prices, and are not even intended to be so. According to Lee …, this was the most striking lesson to be drawn both from Mean’s administered prices and from the surveys conducted by Hall and Hitch (1939). The novel and radical feature of the classic article of the latter was that prices are not designed to clear markets. Prices are not such that they equate supply and demand schedules. In a context where supply is flexible, firms do not necessarily attempt to equate demand to the normal use of capacity when they set prices.” (Lavoie 1992: 95).

It is also clear that administered prices are not simply a phenomenon confined to monopolistic or oligopolistic markets, but are widespread in modern market economies and found throughout many other markets where competition exists amongst numerous small or medium-sized firms (Lavoie 1992: 95–96).

The consequences of this are the following:

(1) one of the major (alleged) mechanisms driving an economy to Walrasian full employment equilibrium collapses and the whole notion that market economies have a strong tendency to general equilibrium must be abandoned, and

(2) the Austrian (or Misesian) notion that market economies have a strong tendency to economic coordination effected by firms’ adjusting their prices towards market clearing values is fundamentally flawed and wrong.

BIBLIOGRAPHY
Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2: 12–45.

Lavoie, Marc. 1992. Foundations of Post-Keynesian Economic Analysis. Edward Elgar Publishing, Aldershot.

Lee’s Post Keynesian Price Theory: Chapter 6

Chapter 6 of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) examines developments in the doctrine of administered prices.

Lee looks at the work of Harry Edwards, Paolo Sylos-Labini, Wilford John Eiteman (1949), and John Williams (1967), Jack Downie, George Richardson, and Romney Robinson on the idea of the costing margin and sequential production (Lee 1998: 120–125).

I will merely focus below on Wilford Eiteman and George Richardson, since there are some interesting points to be noted.

The experience of Wilford Eiteman is worth quoting:

“Around 1940, Eiteman was teaching marginalism in principles of economics classes at Duke University when it occurred to him that as treasurer of a construction company he had set prices and talked with others who set prices and yet had never heard of any price-setter mentioning marginal costs. He quickly came to the conclusion that a price-setting based on equating marginal costs to marginal revenue was nonsense. Eiteman then began to piece together a critique of marginalism aimed at its production and cost foundations.” (Lee 1998: 125).

Thus Eiteman’s book Price Determination: Business Practice versus Economic Theory (1949) was born. In this, Eiteman argued that a firm that wishes to survive and engage in continued production will aim at generating revenue that covers their cost of production. This is generally achieved by creating a price based on costs of production and a markup for profit (Lee 1998: 126–127).

George Richardson produced a critique of Hayek’s paper “Economics and Knowledge” (1937). Richardson argued that flexible prices, as in neoclassical and Hayekian theory, convey considerably less information than conventional theory thinks precisely because the continually changing nature of such prices severely impairs long-term business investment decisions (Lee 1998: 135). By contrast, a relatively stable administered price in the medium term allows business to calculate better estimates of future profits and sales trends, which allows far better planning in investment decisions (Lee 1998: 136; Richardson 1960 and 1965). Thus administered prices are very much part of business and corporate planning that actively gives stability to markets: in this sense, administered prices are a private sector way to reduce the degree of uncertainty they face in the market economy.

Finally, an important point made by Sylos-Labini is that variations in normal cost prices through an economy require careful empirical investigation of each particular market (Lee 1998: 139), since many factors are involved.

BIBLIOGRAPHY
Eiteman, Wilford John. 1949. Price Determination: Business Practice versus Economic Theory. Bureau of Business Research, Ann Arbor.

Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.

Richardson, G. B. 1960. Information and Investment: A Study in the Working of the Competitive Economy. Oxford University Press, London and New York.

Richardson, G. B. 1965. “The Theory of Restrictive Trade Practices,” Oxford Economic Papers 17: 432–449.

Williams, John Burr. 1967. “The Path to Equilibrium,” The Quarterly Journal of Economics 81.2: 241–255.

Steve Keen on Non-Equilibrium Economics: Lecture 5

This is Lec­ture 5 (“Mod­el­ing Minsky’s Finan­cial Insta­bil­ity Hypothesis”) of a series of 5 lectures by Steve Keen on non-equilibrium economics, given in Quito (Ecuador) at FLACSO (the Latin American Social Sciences Institute) in September, 2013.

This final lecture looks at bank­ing and endogenous money.

Steve Keen on Non-Equilibrium Economics: Lecture 4

This is Lec­ture 4 (“Mod­el­ing Minsky’s Finan­cial Insta­bil­ity Hypothesis”) of a series of 5 lectures by Steve Keen on non-equilibrium economics, given in Quito (Ecuador) at FLACSO (the Latin American Social Sciences Institute) in September, 2013.

Here Steve Keen models the “Great Mod­er­a­tion” and subsequent eco­nomic breakdown with Hyman Minsky’s finan­cial insta­bil­ity hypothesis.

William Hutt’s Fantasy World Economics

William Hutt’s The Theory of Idle Resources (1939) is touted by libertarians as some kind of authoritative refutation of the idea that resources can be “idle.”

In fact, Hutt simply redefines what is generally called (1) involuntary unemployment, and (2) unused (but potentially useable) capital goods as types of “pseudo-idleness.” Hutt’s analysis consists of serial use of the fallacy of equivocation. Hutt simply re-defines terms at will and implies that he has made some substantive point that refutes Keynesianism. But his arguments do no such thing.

For example, for Hutt, an unemployed man actively searching for work is really “employed,” because he is “working on his own account without immediate remuneration” (Hutt 2011 [1939]: 24). But such an eccentric definition of “employment” does not change the fact that the man in question remains unemployed in the sense of not being employed in work for which he receives money wages which can be used to buy output, and where he creates goods and services for sale in the community. Hutt refutes no substantive idea in Keynesian economics with his hare-brained re-definition of “employment.”

Amongst Hutt’s other inane observations we find the statement that humans who are sleeping are not economically “idle” resources (Hutt 2011 [1939]: 23). Yet no Keynesian, or any other economist for that matter, has ever regarded sleeping human beings as an economic problem requiring government intervention. So what’s the point of Hutt’s trivial comment?

With regard to capital goods, Hutt says that idle capital goods maintained by their owners but not used in production are only “pseudo-idle,” because the owners are preserving the availability of the capital goods for future use (Hutt 2011 [1939]: 25). This does not change the fact that the capital goods in question would be of greater social and economic use if they were actually employed in production. During recessions, that can be brought about by government policy to create more demand for final output.

One can only marvel at the stupidity of Hutt’s verbal legerdemain and the awe with which he is treated by equally deluded libertarian ideologues.

Finally, this statement by Hutt gives us an example of the level of his economic analysis:

“If we consider the actual ‘unemployed,’ it is impossible to regard them as ‘valueless resources.’ They are not unemployed for that reason. At low enough wage-rates they could practically all be profitably absorbed into some task, even if their earnings were insufficient in many cases to pay for physically or conventionally necessary food, let alone clothing and housing. In a slave economy, such people might be allowed to die off; or they might, for sentimental reasons, be kept alive.” (Hutt 2011 [1939]: 19).

There you have it.

In Hutt’s imaginary world, all involuntary unemployment can just be eliminated by lowering wages and prices, and employment is reduced to a simple function of well-behaved supply and demand curves for labour. Unfortunately, some equilibrium wages might be below subsistence level, so that people working for such wages can expect to starve to death – a state of affairs that will no doubt provide a “final solution” to all those pesky unemployed people.

In the set of assumptions required for Hutt’s imaginary world to work, there are no complex causes of unemployment. If only wages and prices were near perfectly flexible, economic problems would disappear. Hutt’s fantasy world economics requires that businesses and households can just magically change fixed nominal debt or wage contracts. Businesses do not prefer to administer prices. Business inducement to investment is not strongly influenced by expectations, demand, expected demand, the level of consumption in the community, or the state of the financial system, and so on.

In short, William Hutt’s economics has virtually zero relevance to a real world market economy. And it doesn’t inspire much confidence in the rest of his analysis.


BIBLIOGRAPHY
Hutt, William Harold. 2011 [1939]. The Theory of Idle Resources (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Steve Keen on Non-Equilibrium Economics: Lecture 3

This is Lec­ture 3 (“Minsky’s Finan­cial Insta­bil­ity Hypothesis”) of a series of 5 lectures by Steve Keen on non-equilibrium economics, given in Quito (Ecuador) at FLACSO (the Latin American Social Sciences Institute) in September, 2013.

This third lecture looks at Minsky’s Finan­cial Insta­bil­ity Hypothesis.

Steve Keen on Non-Equilibrium Economics: Lecture 2

This is Lec­ture 2 (“Lec­ture 2: The Found­ing Fathers of Dis­e­qui­lib­rium Economics”) of a series of 5 lectures by Steve Keen on non-equilibrium economics, given in Quito (Ecuador) at FLACSO (the Latin American Social Sciences Institute) in September, 2013.

In this second lecture, Keen examines Marx, Schum­peter, Fisher, Keynes, Michał Kalecki, and Min­sky as dis­e­qui­lib­rium economists.

Steve Keen on Non-Equilibrium Economics: Lecture 1

This is Lec­ture 1 (“Why Eco­nom­ics Must be a Dis­e­qui­lib­rium Discipline”) of a series of 5 lectures by Steve Keen on non-equilibrium economics, given in Quito (Ecuador) at FLACSO (the Latin American Social Sciences Institute) in September, 2013.

Perhaps the title is meant to evoke the classic monograph of Nicholas Kaldor called Economics Without Equilibrium (Armonk, N.Y., 1985), and Steve Keen does not disappoint in his discussion of why economics needs to reject neoclassical Walrasian equilibrium theory and be a social science that deals with dis­e­qui­lib­rium.







BIBLIOGRAPHY
Kaldor, Nicholas. 1985. Economics Without Equilibrium. M.E. Sharpe, Armonk, N.Y.