Friday, October 11, 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.

29 comments:

  1. It's a normative theory. The methodology makes it a sort of ethics. Thus, of course, empirical reality and what people say doesn't matter. They don't "know".

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    1. And in this case it entails that business people do not actually "know" how they set prices.

      Yet mysteriously Austrian armchair praxeologists can magically know how the real world functions and "what people say is irrelevant".

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    2. Not just Austrians. Remember that the Lucas Critique in neo-classical economics infers that they, and only that, can determine the 'deep parameters' that govern individual behaviour - and therefore divine the correct policy approach

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    3. But that's the point, LK. Does a preacher who tells man that the only True path is to live in God/Christ/whatever mean that people never live outside of these teachings? Not really. The term "True" there means something entirely different than it does in day-to-day discourse, scientific discourse, legal discourse and so on. The Austrians are literally not on the same planet as us in this regard. For them the word "True" means something different entirely.

      Neil, yes, I think that there is an element of this in marginalist theory too. Especially marginalist micro. But it functions in a far less zealous and dogmatic way. It's much rarer to get a truly foaming-at-the-mouth New Classical than it is to encounter a rabid Austrian.

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    4. Indeed, most New Classicals seem like such a mind-numbingly boring, tedious and vapid bunch.

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    5. "It's much rarer to get a truly foaming-at-the-mouth New Classical than it is to encounter a rabid Austrian."

      But that's the point. All you need to make your position look reasonable is somebody further out on a limb ranting.

      Austrians might be Talibanesque in their attitude, but that doesn't mean that New Classical people are acting in any less religious manner.

      Be careful of the relative assessment trap. The beliefs of the New Classical group - in that they can stroke their beards and determine the true nature of the clockwork economy - are likely more dangerous than the ranting Austrians.


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    6. LK, you probarly already seen this,but in any case here is a attack and list of errors of Mises Austrian econ when compared with Mengerian.Some split in the "Church" it seems.
      Austrian was diseq school.
      http://www.professorfekete.com/articles%5CAEFNewAustrianEconomicsManifesto.pdf

      Delete
  2. "empirical reality does not matter"

    Ha! Ha! Ha! That's priceless. Typical LK twisting. The issue is about the sheer idiocy of the empirical approach to economic theorising. But then how is any whatever-Keynesian to ever get this?

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    1. I rest my case:

      "The issue is about the sheer idiocy of the empirical approach to economic theorising."

      So "economic theorising" is not based on empirical reality?

      Delete
  3. Austrian theory states ONLY that people will determine the terms of their exchanges based upon their subjective values. What exactly that subjective valuation/evaluation might be should not be part of Austrian theory. If firms set prices in the manner you describe, it is because of their subjective evaluation that such a method is most conducive towards the accomplishment of their plans which is completely in line with humans conducting exchanges based upon their subjective evaluations. To claim a prior that humans will necessarily choose to slash prices as opposed to production in bad times violates the theory which holds that the terms of exchanges are based upon subjective evaluations which no one can know in advance.

    You are such a monstrous liar, LK.

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    1. So I stand accused of being a "monstrous liar" because I have not understood that "Austrian theory states ONLY that people will determine the terms of their exchanges based upon their subjective value". Note the emphasis "only".

      Unfortunately, bob roddis is wrong. Austrian price theory says much more than this:

      "“The characteristic feature of the market price is that it equalizes supply and demand. The size of the demand coincides with the size of supply not only in the imaginary construction of the evenly rotating economy. The notion of the plain state of rest as developed by the elementary theory of prices is a faithful description of what comes to pass in the market at every instant. Any deviation of a market price from the height at which supply and demand are equal is – in the unhampered market – self-liquidating.” (Mises 2008: 756–757).

      “Mises conceives the market process as coordinative, ‘the essence of coordination of all elements of supply and demand.’ This means that the structure of realized (disequilibrium) prices, which continually emerges in the course of the market process and whose elements are employed for monetary calculation, performs the indispensable function of clearing all markets and, in the process, coordinating the productive employments and combinations of all resources with one another and with the anticipated preferences of consumers.” (Salerno 1993: 124).

      “prices that are generated by the market process and serve as the data for economic calculation. These are realized prices; or, in other words, they are the actual outcome of the historical market process at each moment in time and are determined by the value scales of the marginal pairs in each market. They are, therefore, also market-clearing prices the establishment of which coincides with a momentary situation, what Mises calls the ‘plain state of rest’ (PSR), in which no market participant, given his existing marginal-utility rankings of goods and money and knowledge of prevailing prices, can enhance his welfare by participating in further exchange.” (Salerno 1990: 121).

      Bob Roddis shows us that he does not understand Austrian price theory.

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    2. Roddis has demonstrated time and again that as well as not having the slightest clue about real economics, he doesn't even understand the make-believe austrian so-called "economics" he pretends to have some knowledge of.

      Roddis' arguments are always circular, they simply boil down to: "whatever happens in my imaginary free market economy is best - whatever that outcome might be, it doesn't matter - because whatever happens in my imaginary free market economy is best by definition"

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  4. Bala, still using pure deduction and logical reasoning, what's illogical about markets not clearing, prices being set by cost + markup, involuntary unemployment, etc?

    I'd say once you consider the real impact of money and uncertainty (and not the Hayekian version, which was a misunderstanding of it), there's no reason to believe that those things won't happen.

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  5. Let me get this straight. If I disagree with Joseph Salerno, then I do not understand Austrian analysis?

    As I recall, I said somewhere that this so-called "schism" between Mises and Hayek that you trumpeted was basically a minor difference of emphasis:

    http://socialdemocracy21stcentury.blogspot.com/2013/03/mises-and-hayek-dehomogenized-note-on.html

    That appears to be what Gene Callahan is getting at here:

    http://gene-callahan.blogspot.com/2013/10/now-im-starting-to-get-it.html

    I disagreed with Salerno there too. Is Salerno the High God of the Austrian School?

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    1. Your ignorance and stupidity know no bounds, roddis. Salerno is just summarising Mises's theories in those quotes. And the first quote is actually Mises, not Salerno, anyway.

      And the schism issue just shows how Mises put the emphasis on the flexible price system as providing market clearing and full use of resources.

      You are ignorant of basic Austrian concepts.
      Most likely, you have never understood basic Austrian concepts.

      Once actual Austrian theory is presented to you, we discover you don't know it and when you talk of "Austrian theories" you're actually referring to your own crazy, idiosyncratic version of Austrianism -- one you dreamed up last month, last week or yesterday night.

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    2. And your hilarious comment over at Freeadvice demonstrates how you clueless you are:

      I fail to see how either the Mises quote or the Salerno quote refute what I said and I fail to see how either quote announces how someone MUST set their prices.
      http://consultingbyrpm.com/blog/2013/10/krazy-krugman-kalls.html#comment-75429

      You say that:

      (1) "Austrian theory states ONLY that people will determine the terms of their exchanges based upon their subjective values"

      (2) But Mises and Salerno are telling you Austrian price theory is much more than that. It says that prices need to be flexible and adjusted in trades towards their market clearing levels to provide an important part of economic coordination and full use of resources.

      But of course you're a such idiot you can't see this.

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  6. LK,

    I hope you realize that you're arguing with a bunch of angry nutcases. For them history is a conspiracy and empirical reality does not matter because there exists an imaginary fantasy land where all of their imaginings and prejudices and hatreds and irrational beliefs somehow add up to a wonderful wonderful utopia. These people have serious psychological problems.

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    1. There are certainly a lot of internet Austrians who come off like that.

      Occasionally one finds more reasonable ones, the radical subjectivists, for example.

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  7. The rule of thumb which the businessmen use does result in flexible prices. If costs rise, the cost plus margin charged to consumers will rise. Consumers might then buy less, causing the businesses to cut output. Hence supply and demand equalise at a lower level and a higher price. On the other hand, if demand rises, businesses will increase output by employing more resources, which may cause the cost of those resources to rise, resulting in price increases as before. Once again, supply and demand equalise at a higher price.

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    1. "On the other hand, if demand rises, businesses will increase output by employing more resources, which may cause the cost of those resources to rise,"

      Or it might not. You appear to have forgotten that even factor inputs might have administered prices.

      And in any case what you're describing is very different from the neoclassical or Austrian price theory.

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  8. You appear to have forgotten that even factor inputs might have administered prices.

    Increasing output doesn't bid up the price of raw materials? Only in a world where there is no such thing as scarcity, which is not the one we live in.

    And in any case what you're describing is very different from the neoclassical or Austrian price theory.

    Not really. The method of price adjustment is a trial-and-error process rather than automatic adjustment implied by the textbooks, but the end result is very similar.

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    1. (1) I am thinking of capital goods when I said "factor inputs" but I suspect if I looked hard enough I could find you examples of even some raw materials with administered prices.

      (2) False. The most doctrinaire neoclassicals (New Classicals) and Austrians think of prices as generally and essentially flexibly moving to market clearing levels, either as a prescriptive ideal or as an actual descriptive model of modern market economies.

      Cite me a passage in Mises's writings that even speaks of administered prices and gives the analysis you give above.

      You will find none. Quantity of output and employment adjustment in response to demand changes is not Austrian theory.
      In fact, this strongly supports the Keynesian idea of stimulus: if you increase demand, then you increase output and employment, not merely prices.

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  9. In fact, this strongly supports the Keynesian idea of stimulus: if you increase demand, then you increase output and employment, not merely prices.

    If consumers want to eat more pork, the amount of pork produced will increase as well as its price. This does not contradict neoclassical pricing theory and follows naturally from supply and demand curves. Whether there is a general increase output will depend on whether resources have been diverted from other lines of production to increase pork output. The extent to which higher demand will increase output is generally limited, because of the problem of scarcity.

    The "administered prices" of which you speak are not fundamentally different from those for commodities where prices change continually to equalise supply and demand. Prices may change less frequently, but they do still change in response to changes in market conditions. True "administered priced" were those in communist economies, where shortages and surpluses of different goods were endemic.

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    1. "If consumers want to eat more pork, the amount of pork produced will increase as well as its price."

      That does not necessarily follow at all.

      And you do not seem to disputing my statement: this strongly supports the Keynesian idea of stimulus: if you increase demand, then you increase output and employment, not merely prices.

      "Whether there is a general increase output will depend on whether resources have been diverted from other lines of production to increase pork output."

      Even that is not necessarily true. The economy might be in recession and have idle resources used to increase production.

      Even in a boom, there might still be idle resources or imports might be available.

      "The extent to which higher demand will increase output is generally limited, because of the problem of scarcity."

      That does not refute what I said. It reduces to the statement that resources are finite, so therefore output increases will be limited to finite quantities too.

      But since no Keynesian ever claimed that output can be increased to infinity, it's irrelevant,

      "The "administered prices" of which you speak are not fundamentally different from those for commodities where prices change continually to equalise supply and demand"

      Not fundamentally different, huh? You're clearly an idiot, "Anonymous", whoever you are.

      Administered prices are not market clearing prices in the sense of neoclassical economics or indeed Austrianism. They are fundamentally different by that criterion alone.

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    2. "The economy might be in recession and have idle resources used to increase production."

      The economy always has idle resources right up to the very height of a boom - because everybody runs with a shock buffer. People get sick, have holidays, go on maternity leave, etc.

      It's normal to be running with slack.

      The transformation of labour hours into labour services is deliberately imperfect.

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    3. Right, Neil. Business inventories and stocks play a fundamental role in modern capitalist economies -- precisely allowing them to respond to demand changes without constant price changes.

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  10. That does not necessarily follow at all.

    Oh no? Look up what happened to pork prices and pork output in the UK, following the BSE crisis of 1995. Retail pork prices rose by 50%, which led to a growth in pork output of 30%.

    That does not refute what I said. It reduces to the statement that resources are finite, so therefore output increases will be limited to finite quantities too.

    Resources are scarce as well as being finite, which means that increasing the production of one kind of good can divert resources from the production of another kind. It is a nonsense to suggest the only kind of economic problem that matters is utilisation of idle resources.

    You're clearly an idiot

    Name-calling is the classic sign of the inability to make a convincing argument. There are different kinds of markets for different kinds of commodities. In those with perfect competition, prices respond immediately to supply and demand. In other markets, without perfect competition, prices change more infrequently, but still respond to changed in supply and demand so that chronic shortages or surpluses are avoided. The following link shows how the prices of personal computers have fallen in the UK since the mid 1990s. PCs have "administered prices" which change relatively infrequently, yet in the long-run prices are determined by exactly the same forces that apply under perfect competition.

    http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/historical-revisions-to-computer-producer-prices/index.html

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  11. (1) "Oh no? Look up what happened to pork prices and pork output in the UK, following the BSE crisis of 1995. Retail pork prices rose by 50%, which led to a growth in pork output of 30%."

    One contingent historical instance does not refute my statement that your belief that "If consumers want to eat more pork, the amount of pork produced will increase as well as its price" is not a logically necessary outcome -- "logically necessary" here meaning that you think it is absolutely certain it will happen.

    Perhaps you have difficulty understanding basic concepts of logic, which seems common amongst loud-mouthed internet Austrians.

    (2) "Resources are scarce as well as being finite, which means that increasing the production of one kind of good can divert resources from the production of another kind

    I already told you that such diversion does not necessarily have to happen, because capitalist economies often have idle resources and can obtain relief from scarcity via international trade. (And one accepted definition of "scarce" is finite, in point of fact. Yes, another is "insufficient for the demand".)

    In any case, limitations on increases in output because of scarcity do not refute my statement about demand driving output and employment in administered price markets.

    And you've cowardly evaded addressing my implied question: you do not seem to be disputing my statement that administered price markets strongly supports the Keynesian idea of stimulus: if you increase demand, then you increase output and employment, not merely prices.

    Do you agree or not?

    (3) It is a nonsense to suggest the only kind of economic problem that matters is utilisation of idle resources.

    And I never stated or implied that the "only kind of economic problem that matters is utilisation of idle resources". You're dishonestly putting words in my mouth by means of a straw man argument, which suggests your intellectual bankruptcy, and is also "the classic sign of the inability to make a convincing argument".

    (4) the rest of your comment about computers refutes nothing I've said.

    Computer prices fall because of technology improvement, productivity increases, increasing returns to scale, and competition. Administered price theory already fully takes account of all this and computer price trends (and falling prices of manufactured goods in general) are completely consistent with it.

    Nor does it not refute my statement that administered price markets are fundamentally different from flexprice markets (which are quickly responsive to demand changes), because

    (1) administered prices are not market clearing prices, nor are they intended to be,

    (2) administered price setting is not based on equating marginal costs to marginal revenue, and

    (3) administered price firms do not maximise their profits in the neoclassical sense.
    ------

    Finally, I've seen hordes of intellectually incompetent, ignorant and dishonest Austrian trolls come and go in my time.

    I strongly suspect you're just another one, "Anonymous".

    Prove me wrong, my friend. Prove me wrong.

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  12. "The ultimate yardstick of an economic theorem's correctness or incorrectness is solely reason unaided by experience."
    Discussing with austrians is a waste of time.

    ReplyDelete