Böhm-Bawerk had No Theory of Administered Prices

Occasionally Austrian economists or internet Austrians assert that the theory of administered prices (whether normal cost, mark-up or target rate of return pricing) was actually anticipated or pioneered by Eugen von Böhm-Bawerk.

It is alleged that The Positive Theory of Capital was the source of this, but a reading of the relevant sections of that book shows no such thing. Böhm-Bawerk had no theory of administered or mark-up pricing as this is understood in Post Keynesian economics.

On the contrary, Böhm-Bawerk’s “law of costs” and statements about the role of costs of production in determining prices are marginalist in nature (perhaps with some influence from Classical Economics).

In Book IV, Chapter VII (“The Law of Costs”) of The Positive Theory of Capital, Böhm-Bawerk shows us quite clearly that he had no understanding of mark-up pricing as in Post Keynesianism, and that his idea that, in the long-run, prices will tend to equal costs is nothing but standard Classical Political Economy reborn in Austrian marginalist theory:

“In the sphere of price, as in the theory of subjective value, we find a law firmly rooted in economic literature and accredited by common experience. It tells us that the market price of goods reproducible at will tends to equalise itself, in the long-run, with Costs of Production. The following perfectly valid line of argument is usually adduced in proof of this. The market price of goods reproducible at will cannot, in the long-run, be maintained either much above or much below their cost. If at any time the price of an article rises appreciably above the cost, its production will be particularly profitable to the undertakers. This will not only induce the latter to extend their already nourishing businesses, but will encourage new undertakers to enter the same remunerative branch of industry. Thus the amount of product brought to market will be increased, and finally—according to the law of supply and demand—a fall in price will ensue. If, conversely, at any time the market price falls below costs, continued production will show a loss; many undertakers will reduce their output; the supply of the commodities will be reduced; and this, finally, in virtue of the law of supply and demand, must lead to a raising of the market price.

Round this law of costs has gathered a great mass of theoretical detail, which may, for our purposes, be left entirely on one side. Our whole interest is centred in the question as to the position which the law, so well accredited by experience, takes in the systematic theory of price. Does it run counter to our law of marginal pairs or not ?

Our answer is that it does not. It is as little of a contradiction as we before found to exist between the proposition that the marginal utility determines the height of subjective value, and the other proposition that the costs determine it. The line of thought which, in both cases, leads to the solution of the apparent contradiction is the same, feature for feature; except that, in the present case, in virtue of the intervention of exchange,—in virtue, that is, of the translation of the phenomena out of individual economy into social economy,—there appear richer developments at every station on the line of thought.

In what follows I shall try, as briefly and clearly as possible, to describe the concatenation between Value, Price, and Costs; and I think I am not exaggerating when I say that, to understand clearly this connection, is to understand clearly the better part of Political Economy.

The formation of value and price takes its start from the subjective valuations put upon finished products by their consumers. These valuations determine the demand for those products. As supply, over against this demand, stand, in the first instance, the stocks of finished commodities held by producers. The point of intersection of the two-sided valuations, the valuation of the marginal pairs, determines, as we know, the price, and, of course, determines the price of each kind of product separately. Thus, for instance, the price of iron rails is determined by the relation of supply and demand for rails; the price of nails, by the relation of supply and demand for nails; and, similarly, the price of every other product made out of the productive good iron—such as spades, ploughshares, hammers, sheet-iron, boilers, machines, etc.—is determined by the relation between the supply and demand which obtains for these special kinds of products.” (Böhm-Bawerk 1930: 223–224).

This is nothing but the view that (1) prices tend to be determined by supply and demand and (2) entrepreneurial competition will, in the long run, tend to eliminate profits and losses and drive prices to the costs of production. Furthermore, I see no evidence that Böhm-Bawerk’s expression “costs of production” means anything other than “marginal cost”: that is, the idea that there is a tendency for marginal cost and market price to be equalised.

But that is not administered pricing theory at all. On the contrary, real world mark-up pricing and imperfect competition mean that there cannot be any strong tendency towards a uniform rate of profit or zero profits in a modern capitalist economy (Lee 1998: 226, n. 17). Administered prices are set on average costs of production, not on marginal costs (which many businesses regard as of little interest or irrelevant).

The average costs of production in mark-up prices are direct factor input costs and overhead costs. Businesses then add a profit mark-up to this, and often the set the price of a good before the sale or even production takes place. The administered price is therefore not set by some haggling process between buyers and sellers or in an auction-like market.

The main point of Austrian price and value theory appears to be that costs of production do not determine the utility of a good: that is, the costs of production do not cause or determine the subjective value derived by a consumer from the consumption of a good, since the utility in this sense is subjective and variable between people. But this idea is perfectly consistent with administered price theory and in no way contradicts it, since the latter is a theory of price and not subjective value per se.

The confusion about what early Austrians said seems related to the statements about administered prices in George Reisman’s Capitalism: A Treatise on Economics (1996), where administered prices are mentioned on p. 417 in a context that suggests that Böhm-Bawerk somehow anticipated the doctrine.

But Böhm-Bawerk did no such thing.

BIBLIOGRAPHY
Böhm-Bawerk, Eugen von. 1930 [1891]. The Positive Theory of Capital (trans. William Smart). G. E. Stechert & Co. New York.

Catalán, Jonathan Finegold. 2012. “Something to Ponder,” Economic Thought, 30 April
http://www.economicthought.net/blog/?p=1322

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

Reisman, George. “A Little Known Essential Aspect of Austrian Economics: Böhm-Bawerk and Wieser on the Determination of Price by Cost of Production,”
http://www.capitalism.net/BOEHM_Q.htm

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