Robert P. Murphy, “Problems with the Cost Theory of Value,” Mises Daily, May 23, 2011.A reading of these posts shows that when many Austrians attack what they call the “cost theory of value” they are attacking a Classical, Marxist or quasi-Marxist theory: they simply do not understand nor do they refute modern Post Keynesian and non-neoclassical Institutionalist mark-up pricing theory (which can also be called the cost-plus/administered price theory).
Robert P. Murphy, “Subjective-Value Theory,” Mises Daily, May 30, 2011.
Modern mark-up/cost-plus pricing theory has the following important characteristics:
(1) it is not the Marxist or Classical Economics labour theory of value. Virtually all Post Keynesians reject the labour theory of value. Nor is mark-up pricing theory a quasi-Marxist “cost theory of value” where value is equated with price;Now Austrian economics is fundamentally dependent on the idea of flexible prices and wages moving towards their market clearing values in a way that allegedly coordinates markets.
(2) following from (1), a fundamental distinction must be made between (i) value and (ii) price. Mark-up/cost-plus pricing theory is explaining price of some commodities, not their value;
(3) following from (2), most Post Keynesians and non-neoclassical Institutionalists can and do accept that value defined as the satisfaction or utility derived from the consumption of a good is subjective. The argument is not about subjective value/utility, which does exist, but about how certain market prices are actually determined, even though the utility derived from a good is subjective;
(4) Mark-up/cost-plus pricing theory does not dispute or deny the existence of flex-price markets in modern economies (such as in stock markets, primary commodities, auction markets for works of art, antiques etc.), and that when these markets involve goods with well-behaved demand curves and prices really are flexible, the prices can be explained, more or less, by conventional supply and demand dynamics. Mark-up/cost-plus pricing theory does not claim to be a universal theory of price formation, but merely an important theory that does explain many prices.
(5) Mark-up/cost-plus pricing theory does, however, dispute the extent and significance of flex-price markets in modern economies.
Empirical evidence in many surveys throughout the developed world and even in developing nations shows us that most prices are set by businesses through their cost accounting conventions in an ex ante manner before transactions take place, on the basis of (1) total average unit costs plus (2) a profit mark-up, at a given, estimated, projected or target quantity of output or level of sales (from which of course the ex post or actual quantity of output produced or sold in a given time period might differ).
Empirical evidence shows us that these mark-up prices are generally inflexible with respect to demand, but tend to change – though it is by no means a necessary or universal process – when total average unit costs change or when the business wants to change its profit mark-up.
In addition, there is a strong bias – or asymmetry – towards upwards rather than downwards price adjustments in modern mark-up price markets.
(6) in many mark-up pricing businesses, when demand changes, there will be no price adjustment, but adjustment in capacity utilisation and changes in buffer stocks/inventories.
When demand slumps, for example, firms will fire workers, cut production, and cut costs, and generally leave prices unchanged. When demand surges, firms will expand production, increase overtime and hire workers, and generally leave prices unchanged too.
That there are exceptions to this general type of firm behaviour, where, for example,(i) some firms might temporarily cut their mark-up in a recession,simply does not refute the evidence that most mark-up pricing businesses do not generally adjust prices in response to demand changes in the way required by conventional supply and demand dynamics.
(ii) cut their mark-up for customers who make bulk purchases, or
(iii) where some retail businesses do indeed hold clearance sales of certain items that they have difficulty selling
But if the majority of prices are mark-up prices and simply not very responsive to demand, many Austrian theories fall apart or are severely undermined.
There is no strong tendency to Misesian “economic coordination” by price adjustment, because such price adjustment does not happen in most markets. The idea that rapid and smooth recoveries from recessions/depressions happen by price adjustment (and by wage adjustment) is untrue: recovery will happen in most mark-up pricing markets by changes in demand and production, and because of the prevalence of such markets, this means that throughout most of the economy changes in demand cause direct changes in employment, production and output.
Unless Austrians properly understand modern mark-up/cost-plus pricing theory and actually engage with it, they are doomed to be intellectually irrelevant and an embarrassment.
Further Reading
Mark-up Pricing in 20 Nations and the Eurozone: the Empirical Evidence.
Post Keynesian Price Theory 101.
“Kaldor on Economics without Equilibrium,” March 9, 2013.
You go out of your way to explain that "cost+markup" is a theory of pricing not value.
ReplyDeleteThe 2 articles you link too are explicitly about theories of value.
Its not at all clear to me how you draw the conclusion that Murphy has no clue about "cost+markup" pricing from reading (what seem to be correct) critiques of cost theories of value.
To quote Murphy:
"In summary, the cost theory of value provided a coherent explanation for a genuine empirical regularity in a market economy. It really is the case that retail prices bear a strong correlation to the costs of production for various goods and services. The cost theory of value gave a plausible mechanism to explain this phenomenon. The development of the cost theory of value was a definite advance in economic science."
Seems like he agrees that cost+markup has some empirical validation, right ?
He then goes on to explain that for some goods (raw materials and non-reproducible goods.) the cost theory of value is pretty useless. Seems like this critique also applies to "cost+markup" pricing.
Seems to me that Murphy is saying: OK, we can accept that costs form the prices, but it merely shifts the problem earlier in time by relating the item's price to the prices of items that went into its production. What is in the start of this bootstrapping process?
ReplyDeleteThe problem is he is asking a metaphysical question, and the answer (whether it is LTV or subjective utilities) is going to be vague and/or stupid. Why should we even care? What is so superior about Austrian marginalism straight from the 1870's textbooks? One is better off reading GAAP standards (at least they are useful for real life).
You must modify point (4). Although it's not well articulated (yet!) most Post-Keynesians would assume that flex-price markets are usually driven by speculation and not by fundamentals. Kalecki was pretty clear on this in his example of primary good markets...
ReplyDelete"With supply inelastic in the short periods, an increase in demand causes a diminution of stocks and a consequent increase in price. The initial price movement may be enhanced by the addition of a speculative element… A primary rise in demand which causes an increase in prices is frequently accompanied by secondary speculative demand. This makes it even more difficult in the short run for production to catch up with demand." (Kalecki 1965, Theory of Economic Dynamics: An Essay on Cyclical and Long-Run Changes in Capitalist Economies, p11)
How does an Austrian attacking cost theories of value show they don't understand mark-up price theory?
ReplyDeleteBesides, you are creating a false dichotomy, the fact that businesses set prices through cost + markup does not refute the concept of the equilibrium price anyway; both the cost and the markup are influenced by supply and demand and tend toward the equilibrium price. Businesses don't set their prices really high because they know that if they were to do so there would be insufficient demand, so they set their prices as close as possible to the equilibrium price. As Rothbard says in page 118 of Man, Economy and State:
"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."
Your comment is incoherent.
DeleteFirst, you say that businesses are so good at setting prices that many of them miraculously manage to set prices "as close as possible to the equilibrium price". Yet at the same time they maintain inventories and often ones with a significant quantity of the product, which entails the price cannot be "as close as possible to the equilibrium price".
Yet in a recession the equilibrium prices of many goods would change, and prices would have to be lowered to find new equilibrium prices -- but this is precisely what does not generally happen in mark-up pricing sectors: prices will be held the same or some might even be increased.
The proof of this can be seen in how, in virtually every recession since WWII, in most nations inflation continues: deflation is rare.
"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."
Nah, you do not live in the real world, and neither did the idiot Rothbard.
Yes, this sometimes happens, but its significance and scale is vastly exaggerated.
In the real world, many firms have excess capacity and inventories: if demand rises they simply ramp up production and draw down inventories, and leave the price unchanged.
In many retail stores, if things get sold out, they will maintain price, and the businesses will simply order more of the good and put up a sign: "This product is temporarily unavailable" or something to that effect.
Actually you have completely misunderstood my argument. I said 'as close AS POSSIBLE' meaning businesses try to set it as close as possible (and without having to change it too much) even though it is incredibly difficult to set it exactly right. I admit that prices are almost never the exact equilibrium price. My point that a business would rarely set the price at, say, double or half the equilibrium price, they would deliberately set it much closer, even if they are a bit off most of the time.
ReplyDeleteAs for inflation and deflation, the fact that significant inflation and deflation happens at all refutes any argument that prices are fixed. Yes, most prices do not constantly change, everyone knows that, but that does not disprove the argument that prices tend toward equilibrium. Also, the reason why deflation is rare after WWII is because of monetary policy. Even then, many prices have still been consistently going down, such as the price of computers and the price of milk.
As for calling Rothbard an idiot for disagreeing with your position, the words speak for themselves, quite frankly. In addition, Rothbard never denied that firms build up or draw down inventories instead of constantly changing prices, in page 156 of Man, Economy and State, he says:
"It seems more likely, however, that a price below
equilibrium will tend to call forth a reservation demand to hold by the producers in anticipation of a higher price (called “building up inventory”), and that a price above equilibrium will result in the unloading of old stock that had been accumulated as a result of past reservation demand (called “drawing down inventory”)."
The point is that if firms consistently get out of stock, they will either raise prices (hence the existence of price inflation) or increase production or both, and if firms consistently have surpluses, they will either cut prices, curtail production or both. Besides, shops change prices lots of times anyway, whenever I to the supermarket there are almost always a special offer on something.
(1) "My point that a business would rarely set the price at, say, double or half the equilibrium price, they would deliberately set it much closer, even if they are a bit off most of the time."
DeleteDarius1295, most businesses simply do not care about hypothetical market clearing prices: they set the price based on total average unit costs plus a profit mark-up.
The fact that Austrians like you cannot -- and will not -- look facts in the face explains why your school is intellectually bankrupt.
(2) "As for inflation and deflation, the fact that significant inflation and deflation happens at all refutes any argument that prices are fixed."
I did not say mark-up prices are eternally fixed and never change: you're just making things up. You need to read up on the straw man fallacy:
http://en.wikipedia.org/wiki/Straw_man
Also, it is clear you're simply ignorant about what mark-up prices even are. Mark-up prices do change, but they tend to change when firms' total average unit costs change or when they want to change their profit mark-up.
(3) "Also, the reason why deflation is rare after WWII is because of monetary policy. Even then, many prices have still been consistently going down, such as the price of computers and the price of milk."
Price reductions in certain individual goods -- owing, say, to productivity growth and falling fixed unit costs -- does not prove such prices are market clearing prices at all.
(4) Rothbard's understanding of inventories is badly flawed. Most mark-up businesses are not speculating on price rises or price falls when they hold stock: they use their inventory as hedge against uncertainty to meet changes in demand so that they do not have to without change price.
(3) "The point is that if firms consistently get out of stock, they will either raise prices (hence the existence of price inflation) or increase production or both, and if firms consistently have surpluses, they will either cut prices, curtail production or both."
Once again you are grossly ignorant of the real world: the price changes you postulate are generally shunned by private businesses: they prefer stable prices.
Here is a dose of reality for you: in a recent survey of 654 UK businesses, they 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%) to produce more output, rather than increase the price of their product.
Only 12% said they would increase the price of their product (Hall, S., Walsh, M. and A. Yates. 2000. “Are UK Companies’
Prices Sticky?,” Oxford Economic Papers 52.3: 425–446, at p. 442).
"Besides, shops change prices lots of times anyway, whenever I to the supermarket there are almost always a special offer on something."
DeleteRetail trade does indeed often have sales, but the extent and economic significance of such "sales" are often grossly overestimated.
Often "sales" are just psychological tricks, the price is reduced by trivial amounts or only some items are reduced and even then it is only a modest cut to the mark-up, not an attempt to clear the market by really flexible price adjustment.
Even when retail firms really do engage in market clearing sales, this simply does not refute the overwhelming evidence that this is not how most firms work.
"Also, the reason why deflation is rare after WWII is because of monetary policy"
DeleteNo, mark-up prices existed long before modern monetary policy was established in the late 1930s/1940s.
And one of the reasons why there is a strong tendency to inflation in the modern world is precisely because mark-up pricing sectors are so extensive and significant.
Even in the 1930s depression, mark-up pricing existed and caused highly uneven deflation: Gardiner Means found that the administered pricing sector of the US economy had price declines of only about 10% during the depression, whereas the more competitive or flexprice sectors had seen price falls of about 40 to 60% (Means, Gardiner C. 1975. “Simultaneous Inflation and Unemployment: A Challenge to Theory and Policy,” in Gardiner C. Means et al., The Roots of Inflation: The International Crisis. Wilton House Publications, London) — already a clear disparity that strongly thwarted the alleged market clearing tendency from price flexibility that you are positing.
1) You have completely missed my point, and it seems you are deliberately doing so since you simply cannot accept you're wrong. I know that business set prices using cost + markup, everyone knows that, it is common sense. My point is you are creating a false dichotomy; business try to set prices as close as possible to the average long term equilibrium price. That is why you don't see businesses selling products at twice or three times the average price on the market; they know that putting prices that high will create a shortage in demand.
Delete2) That is why I said significant. The irony is that your argument against austrian price theory is a straw man.
3) OK, so business reduce prices just to be generous to their customers then. /sarcasm
4) You have not refuted what Rothbard said, you are actually agreeing with him by repeating what he said in different words. When businesses build up inventory, they are speculating that the equilibrium price will go up and above their fixed price afterwards, causing the surpluses to be sold off, and vice versa.
5) Now you're making the same straw man argument, I never said businesses don't prefer stable prices, and neither did any Austrian I know of. Also, if you actually bothered to read what I quoted, I said "either raise prices OR increase production". It helps to actually read an argument before attacking it.
"Often "sales" are just psychological tricks, the price is reduced by trivial amounts or only some items are reduced and even then it is only a modest cut to the mark-up, not an attempt to clear the market by really flexible price adjustment. "
DeleteOK, so when supermarkets reduce the price of an item by ten percent or do 3 for 2 offers, they are just playing psychological tricks, I see. Nothing to do with the fact that they might want to get rid of food that will reach its sell by date the next day, just psychological trickery.
"No, mark-up prices existed long before modern monetary policy was established in the late 1930s/1940s."
DeleteI know, never said they didn't. In fact, that was my point, deflation occurred far more often not because of lack of mark-up pricing, but because monetary policy was different.
"In fact, that was my point, deflation occurred far more often not because of lack of mark-up pricing, but because monetary policy was different."
DeleteEvidently you have severe difficulty reading: I said "Gardiner Means found that the administered pricing sector of the US economy had price declines of only about 10% during the depression, whereas the more competitive or flexprice sectors had seen price falls of about 40 to 60%".
This confirms that mark-up pricing caused significant price rigidity even under a different monetary regime.
"OK, so when supermarkets reduce the price of an item by ten percent or do 3 for 2 offers, they are just playing psychological tricks, I see"
DeleteThe existence of some real clearance sales, mainly in retail trade, does not refute what I said, Darius1295.
(1) "My point is you are creating a false dichotomy; business try to set prices as close as possible to the average long term equilibrium price.
DeleteNo, they do not. I have the empirical evidence on my side; you are like a religious fundamentalist, asserting things on faith.
(2) I am well aware of Austrians say about price theory; I've read a great many Austrian writings:
http://socialdemocracy21stcentury.blogspot.com/p/below-is-list-of-links-on-my-blog-to.html
(4) “When businesses build up inventory, they are speculating that the equilibrium price will go up and above their fixed price afterwards, causing the surpluses to be sold off, and vice versa."
No, that is not why businesses hold inventory. This is plain nonsense and more faith-based economic nonsense.
(5) if you're saying often mark-up businesses just prefer to cut production and keep prices unchanged, then you have just concede what I said.
How exactly does "business try to set prices as close as possible to the average long term equilibrium price", and how can we know what this price is through some criteria other than the price they set?
DeleteThat a very high price will result in lower profits or losses is fairly obvious. But this says nothing about the proximity of the chosen price to the 'long-term equilibrium price' if we cannot define the 'long-term equilibrium price' independently.
In short in this formulation: "value and price drives behavior, behavior drives price", you dispute the second clause. The Austrians see a simple, direct connection between behavior and price adjustments, and you assert that what actually happens is far enough from their belief to vitiate their analysis.
ReplyDelete"most prices are set by businesses through their cost accounting"
ReplyDeleteMark-up pricing theory is circular.
Don't cost accountants don't use prices to determine their costs?
P = Cost + Markup
Cost = P*Q
P = (P*Q) + Markup
This mark-up pricing theory is not taken seriously by managerial accountants because they use prices to calculate costs. The mark-up theory is circular.
(1) The only "circularity" that is a problem is vicious circularity in logic.
DeleteHowever, the "circularity" you point to is not vicious circularity, and presents no logical or conceptual problem whatsoever.
(2) "This mark-up pricing theory is not taken seriously by managerial accountants"
I see. Not taken seriously? And what is your evidence for this? Magic? Clairvoyance?
Meanwhile when we turn to the real world, we find that any number of managers/ cost accountants of most firms surveyed in dozens of different surveys over decades in 21 different countries say that mark-up pricing is how they set prices:
http://socialdemocracy21stcentury.blogspot.com/p/there-is-mountain-of-empirical-evidence.html
You an idiot.