Reality versus Rothbard: Prices, Demand and Production in the Real World

If one reads Rothbard’s Man, Economy, and State with Power and Market: The Scholar’s Edition (2nd edn.; 2009), one finds a long discussion of prices, but so often the discussion is stated in terms of exchange ratios of goods in barter economies. The absurdity of such “barter” analysis is that it is simply irrelevant to a modern monetary economy, certainly one where extensive mark-up pricing exists.

But, more than this, at times when Rothbard was dimly aware of the reality of prices and production, he was still living in a fantasy world:

“The specific feature of the ‘clearing of the market’ performed by the equilibrium price is that, at this price alone, all those buyers and sellers who are willing to make exchanges can do so. At this price five sellers with horses find five buyers for the horses; all who wish to buy and sell at this price can do so. At any other price, there are either frustrated buyers or frustrated sellers. Thus, at a price of 84, eight people would like to buy at this price, but only two horses are available. At this price, there is a great amount of ‘unsatisfied demand’ or excess demand. Conversely, at a price of, say, 95, there are seven sellers eager to supply horses, but only three people willing to demand horses. Thus, at this price, there is ‘unsatisfied supply,’ or excess supply. Other terms for excess demand and excess supply are ‘shortage’ and ‘surplus’ of the good. Aside from the universal fact of the scarcity of all goods, a price that is below the equilibrium price creates an additional shortage of supply for demanders, while a price above equilibrium creates a surplus of goods for sale as compared to demands for purchase. We see that the market process always tends to eliminate such shortages and surpluses and establish a price where demanders can find a supply, and suppliers a demand.

It is important to realize that this process of overbidding of buyers and underbidding of sellers always takes place in the market, even if the surface aspects of the specific case make it appear that only the sellers (or buyers) are setting the price. Thus, a good might be sold in retail shops, with prices simply ‘quoted’ by the individual seller. But the same process of bidding goes on in such a market as in any other. If the sellers set their prices below the equilibrium price, buyers will rush to make their purchases, and the sellers will find that shortages develop, accompanied by queues of buyers eager to purchase goods that are unavailable. Realizing that they could obtain higher prices for their goods, the sellers raise their quoted prices accordingly. On the other hand, if they set their prices above the equilibrium price, surpluses of unsold stocks will appear, and they will have to lower their prices in order to ‘move’ their accumulation of unwanted stocks and to clear the market.

The case where buyers quote prices and therefore appear to set them is similar. If the buyers quote prices below the equilibrium price, they will find that they cannot satisfy all their demands at that price. As a result, they will have to raise their quoted prices. On the other hand, if the buyers set the prices too high, they will find a stampede of sellers with unsalable stocks and will take advantage of the opportunity to lower the price and clear the market. Thus, regardless of the form of the market, the result of the market process is always to tend toward the establishment of the equilibrium price via the mutual bidding of buyers and sellers.” (Rothbard 2009: 117–119).

Rothbard must think that this really is a fundamental and universal (or near universal) state of real world markets, in order for his reasoning to work:

“It is important to realize that this process of overbidding of buyers and underbidding of sellers always takes place in the market, even if the surface aspects of the specific case make it appear that only the sellers (or buyers) are setting the price. Thus, a good might be sold in retail shops, with prices simply ‘quoted’ by the individual seller. But the same process of bidding goes on in such a market as in any other. If the sellers set their prices below the equilibrium price, buyers will rush to make their purchases, and the sellers will find that shortages develop, accompanied by queues of buyers eager to purchase goods that are unavailable. Realizing that they could obtain higher prices for their goods, the sellers raise their quoted prices accordingly. On the other hand, if they set their prices above the equilibrium price, surpluses of unsold stocks will appear, and they will have to lower their prices in order to ‘move’ their accumulation of unwanted stocks and to clear the market.”

This is simply untrue as either a (1) universal or (2) even general description of what happens in the real world.

Now you can certainly find some markets where what Rothbard is saying does actually happen. But the extent of these markets is grossly exaggerated.

Try walking into any number of supermarkets or department stores that sell newly-produced goods, and attempting to haggle with the staff to bring the price of goods down. You might be able to do it in some limited cases (especially in second hand goods stores or where retail businesses try and match their competitors’ prices), but everyone knows it is a grossly unrealistic strategy and likely to be a waste of time in most cases. Most prices are not set in auction-like markets or by a mutual haggling process between buyers and sellers. The price displayed is the price you pay, or you cannot have the good.

Moreover, in the real world, most firms are mark-up pricing firms and as producers they have excess capacity and inventories to deal with demand changes so that they can, generally speaking, leave prices unchanged: if demand rises, many firms can simply ramp up production by increasing capacity utilisation, and draw down inventories, and leave the price unchanged.

The empirical evidence overwhelmingly confirms this. In a recent survey of 654 UK businesses, the firms were asked: what do you do when there is a boom in demand which cannot be met from stocks or inventories? Most UK firms said they simply increase overtime of workers (as reported by 62% of firms), hire more workers (12%), or increase capacity (8%), in order to produce more output, rather than increase the price of their product. Only 12% said they would increase the price of their product (Hall, Walsh and Yates 2000: 442).

Most service industries, too, experience fluctuations in demand on a daily basis that may not be trivial, but they leave prices unchanged. Excess demand in hair salons, dentists, doctors, locksmiths etc. does not normally induce businesses to change prices: instead, people simply wait their turn in line, and pay the same price for any given service. Temporary “shortages” in the economic sense are common in services, but hardly anyone thinks this is some disastrous crisis of production or some terrible economic “problem” that should be solved by flexible prices to clear markets. In fact, if you arrived at your local hair salon and found 10 people waiting in line and the barber announced he was going to auction off the next 5 haircuts for the next hour to the highest bidders, it would be bizarre and utterly atypical behaviour.

Furthermore, in many retail stores, if things get sold out, the store will maintain the price and will simply order more of the good and put up a sign: “Out of stock,” “Sold out,” or “This product is temporarily unavailable” – or words to that effect.

If the typical firm faces a period of slack demand during a recession, the normal action is to cut production, fire workers, and cut costs, while leaving the price unchanged.

During a recession, mark-up prices can stay the same or even increase. The proof of this can be seen in how, in virtually every recession since WWII, in most nations inflation continues during recessions: deflation is rare, and recessions tend to have disinflation (which is still a form of inflation).

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

Rothbard, M. N. 2009. Man, Economy, and State with Power and Market: The Scholar’s Edition (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.