“It is ultimately always the subjective value judgments of individuals that determine the formation of prices. Catallactics in conceiving the pricing process necessarily reverts to the fundamental category of action, the preference given to a over b. In view of popular errors it is expedient to emphasize that catallactics deals with the real prices as they are paid in definite transactions and not with imaginary prices. The concept of final prices is merely a mental tool for the grasp of a particular problem, the emergence of entrepreneurial profit and loss. The concept of a ‘just’ or ‘fair’ price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. Market prices are entirely determined by the value judgments of men as they really act.What Mises is saying here is as follows:
If one says that prices tend toward a point at which total demand is equal to total supply, one resorts to another mode of expressing the same concatenation of phenomena. Demand and supply are the outcome of the conduct of those buying and selling. If, other things being equal, supply increases, prices must drop. At the previous price all those ready to pay this price could buy the quantity they wanted to buy. If the supply increases, they must buy larger quantities or other people who did not buy before must become interested in buying. This can only be attained at a lower price.
It is possible to visualize this interaction by drawing two curves, the demand curve and the supply curve, whose intersection shows the price. It is no less possible to express it in mathematical symbols. But it is necessary to comprehend that such pictorial or mathematical modes of representation do not affect the essence of our interpretation and that they do not add a whit to our insight. Furthermore it is important to realize that we do not have any knowledge or experience concerning the shape of such curves. Always, what we know is only market prices – that is, not the curves but only a point which we interpret as the intersection of two hypothetical curves. The drawing of such curves may prove expedient in visualizing the problems for undergraduates. For the real tasks of catallactics they are mere byplay.” (Mises 2008: 329–330).
(1) the formation of prices on markets is “ultimately always” caused by the subjective value judgments of individuals, and prices are “entirely determined” by value judgements of people who “really act.”Let us now expand on point (4). It is a serious problem: the idea that, generally speaking, goods have well behaved downward sloping demand curves is both theoretically and empirically questionable.
(2) prices in product markets tend towards a point where total demand by buyers is equal to total supply offered for sale by sellers. This, of course, is a market clearing price. However, this is immediately qualified by the observation that if supply increases, prices must drop “other things being equal”: the ceteris paribus assumption that allows the usual exceptions Austrians like Mises invoke to explain rigid prices, such as government price controls, labour unions, and so on, as this passage confirms:“The market interaction brings about a price at which demand and supply tend to coincide. The number of potential buyers willing to pay the market price is large enough for the whole market supply to be sold. If government lowers the price below that which the unhampered market would set, the same quantity of goods faces a greater number of potential buyers who are willing to pay the lower official price. Supply and demand no longer coincide; demand exceeds supply, and the market mechanism, which tends to bring supply and demand together through changes in price, no longer functions.” (Mises 2011: 101).(3) If there is any doubt that Mises has in mind market clearing prices in this passage this completely removes the doubt:“It is possible to visualize this interaction by drawing two curves, the demand curve and the supply curve, whose intersection shows the price.”This “point” is nothing but the market clearing price.
(4) but then Mises says this:“Furthermore it is important to realize that we do not have any knowledge or experience concerning the shape of such curves.”One can presume that Mises is here saying that we cannot know the real shape of real world downward-sloping demand curves, but Mises is not questioning the general assumption that well-behaved downward-sloping demand curves are the norm, because if he really were implying the latter, his whole argument would be badly undermined.
The theoretical evidence is discussed here and here.
If we turn to the empirical evidence, it has been known for a long time that reductions by suppliers in the prices of factor inputs do not necessarily induce more purchases of a factor by a producer if the latter’s sales are stagnant or falling (Lee 1998: 108).
And as Lee notes:
“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).With the understanding that demand curves can in theory have any shape at all and the empirical evidence that many goods do not have well behaved demand curves, it follows that the whole idea that real world markets have a strong tendency to market clearing becomes implausible.
This is before we get to real world price setting behaviour such as mark-up pricing, which also utterly discredits the idea that product markets in real world market economies tend to have flexible prices that move towards their market clearing values.
And I have yet to see one shred of evidence that Mises ever discussed administered/mark-up pricing and its consequences.
BIBLIOGRAPHY
Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.
Mises, L. von. 2008. Human Action: A Treatise on Economics. The Scholar’s Edition. Mises Institute, Auburn, Ala. pp. 201–232, 324–394.
Mises, L. von. 2011. A Critique of Interventionism. Mises Institute, Auburn, Ala.
"...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."
ReplyDeleteI don't see evidence for upward-sloping, or any other exotic-shaped demand curves in this statement. Moreover, firms usually won't change prices at random, but in response to events that may affect demand as well. In that case simply comparing change in quantity to change in price is incorrect due to simultaneity bias.
Lee is thinking of price changes in response to demand, not just as some "random" unexplained behaviour!
DeleteExactly. For example, a profit-maximizing monopolist may respond to demand shock by increasing or decreasing its price (depending on specific elasticities etc.), even when demand curve is perfectly downward-sloping. So I'm not sure what this observation is supposed to prove.
DeleteFrederic Lee: What if there are no conventional price mechanisms?
ReplyDeletehttp://neweconomicperspectives.org/2013/11/conventional-price-mechanisms.html
Great link.
DeleteThanks.
I find the idea of downward sloping curves entirely plausible as an average over a large set of (good,time) pairs. It clearly fits a lot of things, like beer in the pub where I currently sit. I'd say it fits most things most of the time actually. But smooth curves are a mathematical convenience not a reality. I think Mises et al take this plausible intuition and make of it a law. Like creatures from a planet without water who decide everything shrinks when it freezes and think this a priori too.
ReplyDeleteAre you suggesting that demand can rise, ceteris paribus with a rise in price? or are you suggesting that demand can stay the same, ceteris paribus with a rise in price?
ReplyDeleteRegardless of what Mises ever actually said about market clearing prices, I took the theory to be that even if the market gets no closer to clearing, it certainly would be an impossibility for it to have a tendency away from clearing, ceteris paribus. Rothbard does a better job of explaining a praxeological approach to the curves themselves. How its not a continuous curve at all, but one of many discrete building blocks of individual preferences. Actual curved lines on paper are for simplicity. It then becomes much easier to grasp that they never were really concerned with "well-behaved" demand curves. just that they either stay flat or fall, but never rise with price. It's also of critical importance to note these curves are instantaneous and cannot be applied to empirical data over the course of time in a changing world(this fails the ceteris paribus requirement).
I really do appreciate all the work you put in to demonstrate the opposing view, I just see it differently and disagree. Or sometimes I feel you don't make your point explicitly enough to be sure what you even think you proved.
"Are you suggesting that demand can rise, ceteris paribus with a rise in price?
DeleteVeblen goods?
And yes I do not think there is any strong tendency to market clearing, e.g.,:
"Moreover, from the 1980s, wage rate stickiness has been a major concern of mainstream economists; and since the early 1990s, numerous empirical studies have shown its widespread existence, thus, as in the case of price stability, making it an irrefutable economic fact. Other studies show that wage rates are of minor importance when enterprises make hiring decisions. On the other hand, studies in how wage rates are actually determined are few; but what can be gleaned from the human resource literature is that the marginal product of labor has no role in the determination process whatsoever. Altogether, the implication is that there is no connection between the wage rate and the demand for labor.
Finally there is the question of the interest rate and its connection to investment decisions in plant and equipment and research and development. Again, the empirical evidence on the investment decision process shows that enterprises take a great many variables into account, including the interest rate. But in the end, the significance of the interest rate in the final decision is almost reduced to nothing. This is in part due to the fact that enterprises finance their investment from retained earnings (thus avoiding the financial markets) and that going enterprises do not view part financial assets as substitutes for ‘real investment’.".
http://neweconomicperspectives.org/2013/11/conventional-price-mechanisms.html
Just had a thought on this today, Veblen goods are a unique case and aren't really defying the law of demand, they're simply different goods. They serve different utility. This goes back to the idea that a good is only good in that it satisfies a demand for a specific utility, and veblen goods serve a different utility than what SEEMS to be their substitute. For instance, a consumer seeking a Rolls Royce will not be satisfied with a Kia. In fact its not the utility in commuting they're paying for, its the utility in something else entirely that provides the reason for preferring a $300,000 car. I cannot know their mind, but I can guess its status, ego, whatever. In the case of those goods, price going up actually affects the utility it provides. They don't take the $50,000 Mercedes, because it doesnt provide enough of this utility. whereas the $400,000 Rolls does. Even the $250,000 ferrari doesn't cut it for this consumer.
DeleteIt still flows from basic subjective value theory. Do you agree with subjective value theory?
"Are you suggesting that demand can rise, ceteris paribus with a rise in price?
ReplyDeleteHello Bitcoins? The prices must always rise but the demand seems to be going up. As a laymen who simply watches business practice and consumers in action one rarely finds any demand that is anything but random and totally irrational on all levels.
I've personally observe people refuse to buy items simply because you dropped the price economic theory be damned. I've seen the opposite as well in fact it's practicely on a weekly basis. Price is rarely determines anything about the consumer preference.
Perception, Status, Athestics and never price determine behavior. Price and Market clearing is bullshit.
"I've personally observe people refuse to buy items simply because you dropped the price economic theory be damned"
DeleteRight: because some people might think that if the price was lowered, then there must be something wrong with the good.
"some people think that if the price was lowered, then there must be something wrong with the good"
ReplyDeleteso the good moves loses value in their subjective preferences. This is why neither of those examples actually still fit the ceteris paribus requirement. I'm probably newer to this than you, but I see why you're going after praxeology and a priori knowlege as a basis for economics. It is the crux of the issue. But its really hard to have someone breakdown in language an attempt to describe why I personally cannot know what I'm am so certain to be true. However I'd have to devote a lot more time than this to explaining my position. And you'd still ultimately disagree with the synthetic a priori and action axiom. right?