Reality Refutes Mises on Costs and Prices

In a passage that should simply provoke hilarity to any person knowledgeable about real world prices, Mises shows us how far his economic theory is from reality:

“Any price determined on a market is the necessary outgrowth of the interplay of the forces operating, that is, demand and supply. Whatever the market situation which generated this price may be, with regard to it the price is always adequate, genuine, and real. It cannot be higher if no bidder ready to offer a higher price turns up, and it cannot be lower if no seller ready to deliver at a lower price turns up. Only the appearance of such people ready to buy or to sell can alter prices.

Economics analyzes the market process which generates commodity prices, wage rates, and interest rates. It does not develop formulas which would enable anybody to compute a ‘correct’ price different from that established on the market by the interaction of buyers and sellers.

At the bottom of many efforts to determine nonmarket prices is the confused and contradictory notion of real costs. If costs were a real thing, i.e., a quantity independent of personal value judgments and objectively discernible and measurable, it would be possible for a disinterested arbiter to determine their height and thus the correct price. There is no need to dwell any longer on the absurdity of this idea. Costs are a phenomenon of valuation. Costs are the value attached to the most valuable want-satisfaction which remains unsatisfied because the means required for its satisfaction are employed for that want-satisfaction the cost of which we are dealing with. The attainment of an excess of the value of the product over the costs, a profit, is the goal of every production effort. Profit is the pay-off of successful action. It cannot be defined without reference to valuation. It is a phenomenon of valuation and has no direct relation to physical and other phenomena of the external world.

Economic analysis cannot help reducing all items of cost to value judgments. The socialists and interventionists call entrepreneurial profit, interest on capital, and rent of land ‘unearned’ because they consider that only the toil and trouble of the worker is real and worthy of being rewarded. However, reality does not reward toil and trouble. If toil and trouble is expended according to well-conceived plans, its outcome increases the means available for want-satisfaction. Whatever some people may consider as just and fair, the only relevant question is always the same. What alone matters is which system of social organization is better suited to attain those ends for which people are ready to expend toil and trouble. The question is: market economy, or socialism? There is no third solution. The notion of a market economy with nonmarket prices is absurd. The very idea of cost prices is unrealizable. Even if the cost price formula is applied only to entrepreneurial profits, it paralyzes the market. If commodities and services are to be sold below the price the market would have determined for them, supply always lags behind demand. Then the market can neither determine what should or should not be produced, nor to whom the commodities and services should go. Chaos results.” (Mises 2008: 393).

Let us look through the litany of errors in this passage:

(1) Mises says that:

“Any price determined on a market is the necessary outgrowth of the interplay of the forces operating, that is, demand and supply.”

The word “necessary” in this sentence should raise eyebrows. And what type of “market” is Mises speaking of?

Is Mises referring to (1) real world markets or (2) imaginary, hypothetical markets that exist only in his head and where his “necessary outgrowth of the interplay of the forces … [sc. of] demand and supply” hold true? If the latter, then his analysis is irrelevant to reality, since the real world obviously departs from Mises’s ideal.

If Mises refers to the real world, then he is straightforwardly wrong.

To see this, we need only review what Mises means by “the interplay of the forces … [sc. of] demand and supply.” This is quite clear from the rest of his writings, such as the following:

(1) “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).

(2) “It is ultimately always the subjective value judgments of individuals that determine the formation of prices …. . Market prices are entirely determined by the value judgments of men as they really act.

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.” (Mises 2008: 329–330).

(3) “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).

(4) “Competitive prices are the outcome of a complete adjustment of the sellers to the demand of the consumers. Under the competitive price the whole supply available is sold, and the specific factors of production are employed to the extent permitted by the prices of the nonspecific complementary factors. No part of a supply available is permanently withheld from the market, and the marginal unit of specific factors of production employed does not yield any net proceed. The whole economic process is conducted for the benefit of the consumers.” (Mises 2008: 354).

So real world prices must be determined by the “interplay of the forces ... [sc. of] demand and supply” in this sense. (That is, Mises is not simply using “demand and supply” in a weak and trivial sense of saying that a good must be demanded and valued by a consumer as a precondition of him buying it and physically supplied for him to do so.)

But real world capitalist economies have many prices – and in many cases a majority of prices – that are set by price administration. Such “administered prices” (or mark-up prices, average-cost prices, full-cost prices, normal cost prices, or cost-plus prices) are set by businesses based on average costs of production per unit plus a profit mark-up. For the empirical evidence on this, see the links in Appendix 1 below.

Administered prices (or mark-up prices) are not set by the conventional forces of supply and demand. They are not even intended to be market-clearing prices. They remain relatively inflexible with respect to demand, especially downward. Often they will not be changed for up to a year. When costs do rise, they might change or they might not: even price rises need not necessarily happen if businesses feel their competitors will not raise prices.

Such mark-up prices can be found in both consumer goods markets and intermediate goods and wholesale markets (Parker, pp. 6–7).

In short, these are prices that do not confirm to Mises’s strident statement about how prices are determined. And the empirical evidence shows that they normally account for the majority of business prices in most first world nations.

(2) Mises states that

“At the bottom of many efforts to determine nonmarket prices is the confused and contradictory notion of real costs. If costs were a real thing, i.e., a quantity independent of personal value judgments and objectively discernible and measurable, it would be possible for a disinterested arbiter to determine their height and thus the correct price.”

According to Mises, the notion of “real costs” is “confused and contradictory.” But it seems that Mises is inventing a straw man.

Even though any given costs as measured in money prices might well be related in some sense to subjective personal value judgments, it is still the case that money prices are an objective phenomenon that are “discernible and measurable.” If two people see the price of a good displayed, they might well disagree profoundly about why or if they subjectively value it, but they cannot disagree about the stated money price, without one of them being wrong or both being wrong. The money price is an objective thing in this sense.

Moreover, Mises’s statements here seem to contradict what he says elsewhere.

For example, Mises says that “[e]conomic calculation always deals with prices, never with values” (Mises 2008: 332). Prices are always money prices, and effective calculation of profit and loss via costs occurs via money prices:

“Prices are always money prices, and costs cannot be taken into account in economic calculation if not expressed in terms of money.” (Mises 2008: 349).

But that requires that money prices have a type of objectivity.

(3) Finally, we get this gem:

“The question is: market economy, or socialism? There is no third solution. The notion of a market economy with nonmarket prices is absurd. The very idea of cost prices is unrealizable. Even if the cost price formula is applied only to entrepreneurial profits, it paralyzes the market. If commodities and services are to be sold below the price the market would have determined for them, supply always lags behind demand. Then the market can neither determine what should or should not be produced, nor to whom the commodities and services should go. Chaos results.”

The idea of “cost prices” is definitely not “unrealizable.”

Such “cost prices” – prices based on total average unit costs plus profit mark-up – have long existed throughout the capitalist world. The existence of widespread administered prices has been documented since the 1920s.

It follows from Mises’s analysis that all advanced capitalist economies from at least the 1920s onwards should be in a permanent state of “chaos”: for in most of them probably the majority of prices are relatively inflexible, not properly set by supply and demand, nor set to converge to market-clearing levels.

According to Mises, we should have “chaos” where “supply always lags behind demand” in these markets.

But we do not have chaos, nor do we see such chronic supply problems in capitalist nations.

Mises is contemptibly ignorant of real world capitalism: a world where most firms set their mark-up price based on average unit money costs of production, and then adjust production to match demand, while keeping inventories and significant unused capacity at factories and plants available to meet increases in demand. When demand falls, businesses fire workers and cut production.

Businesses generally determine what to produce via demand and quantity signals.

Mises – and modern Austrians – are guilty of fantasy world economics.


APPENDIX 1
“Two Marketing Studies on US Administered Prices,” November 16, 2013.
This cites two marketing surveys that found that from the 1980s to the 1990s mark-up pricing accounted for roughly 70% to 85% of US industrial prices.

“Administered Prices in the Eurozone: Some Empirical Data,” October 16, 2013.
This cites the wide-ranging survey of Fabiani et al. (2006) on prices in the Eurozone. The average for mark-pricing throughout the Eurozone is 54%.

“Administered Pricing in the United Kingdom,” October 19, 2013.
This cites a survey from the UK that found that cost-based pricing with variable mark-ups accounted for 58% of firms surveyed.

“Mark-up Pricing in Norway,” November 23, 2013.
This cites a survey of 725 Norwegian firms that found that 69% of Norwegian businesses use mark-up pricing.

“Mark-up Pricing in Ireland,” November 22, 2013.
This cites a survey of 1000 Irish firms and finds that the largest type of pricing is mark-up pricing at 44% of firms. Other evidence suggests that the real percentage is higher than this.

“Mark-up Prices in Iceland,” November 25, 2013.
This cites a survey of 580 Icelandic firms and finds that mark-up pricing is the largest type of pricing at 45%. Evidence suggests that more mark-up prices are concealed in the other categories in the survey, so that real percentage is higher than this.

“Mark-up Pricing in Japan,” November 29, 2013.
This cites a survey of 630 Japanese companies. As interpreted by Fabiani et al. (2007: 190), the data suggests that least 54% of Japanese firms use mark-up pricing.

“Mark-up Pricing in New Zealand,” November 30, 2013.
This cites a survey of 5,300 New Zealand firms that finds that mark-up prices account for about 54% of business prices.

“Mark-up Pricing in Australia,” November 30, 2013.
This cites a survey of around 700 Australian firms that finds that mark-up prices account for at least 49% of firm prices. Once we add likely mark-up prices concealed in the other categories in the survey, the percentage possibly rises to 60%.

“Downwards Rigidity of Prices and Mark-up Pricing,” November 22, 2013.

“Lee on Post Keynesian Price Theory in The Oxford Handbook of Post-Keynesian Economics,” October 15, 2013.


BIBLIOGRAPHY
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.

Mises, L. von. 2008. Human Action: A Treatise on Economics. The Scholar’s Edition. Ludwig von Mises Institute, Auburn, Ala.

Mises, L. von. 2011. A Critique of Interventionism. Mises Institute, Auburn, Ala.

Murphy, Robert P. and Amadeus Gabriel. 2008. Study Guide to Human Action. A Treatise on Economics: Scholar’s Edition. Ludwig von Mises Institute, Auburn, Ala.

Parker, Miles. “Price-Setting Behaviour in New Zealand”
https://cama.crawford.anu.edu.au/amw2013/doc/Parker,Miles.pdf

A Bibliography on Austrian Price Theory

Since I have been concerned with Post Keynesian price theory in recent months, here below is a short bibliography of Austrian price theory for the interested reader.

Austrian price theory – like the worst forms of neoclassical price theory – is flawed by its inability to understand real world administered price setting and the consequences of this.

General
High, J. 1994. “The Austrian Theory of Price,” in Peter J. Boettke (eds.), The Elgar Companion to Austrian Economics. E. Elgar, Aldershot. 151–155.

Miller, Stephen C. 2010. “Price: The Ultimate Heuristic,” in Peter J. Boettke (ed.), Handbook on Contemporary Austrian Economics. Edward Elgar, Cheltenham and Northampton, Mass. 67–76.

Callahan, Gene. 2004. Economics for Real People. Ludwig von Mises Institute, Auburn, Ala.

Taylor, Thomas C. 1980. An Introduction to Austrian Economics. Ludwig von Mises Institute, Auburn, Ala. pp. 52–62.

Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition. Cambridge University Press, Cambridge and New York.

Menger
Endres, A. M. 1995. “Carl Menger’s Theory of Price Formation Reconsidered,” History of Political Economy 27.2: 261–287.

Endres, A. M. 1997. Neoclassical Microeconomic Theory: The Founding Austrian Vision. Routledge, London. 60–84.

Kirzner, I. 1978. “The Entrepreneurial Role in Menger’s System,” Atlantic Economic Journal 6.3: 31–45.

Menger, C. 2011. Principles of Economics (trans. Grundsätze der Volkswirtschaftslehre [1st edn. 1871] by J. Dingwall and B. F. Hoselitz), Terra Libertas, Eastbourne, UK. pp. 191–225.

Moss, L. S. 1978. “Carl Menger’s Theory of Exchange,” Atlantic Economic Journal 6: 17–29.

Streissler, E. 1972. “To What Extent was the Austrian School Marginalist?,” History of Political Economy 4.2: 426–461.

Tieben, Bert. 2012. The Concept of Equilibrium in Different Economic Traditions: An Historical Investigation. Edward Elgar, Cheltenham, UK and Northampton, MA. pp. 315–319.

Böhm-Bawerk
Böhm-Bawerk, Eugen von. 1930 [1891]. The Positive Theory of Capital (trans. William Smart). G. E. Stechert & Co. New York. pp. 193–234.

Mises
Mises, L. von. 2008. Human Action: A Treatise on Economics. The Scholar’s Edition. Mises Institute, Auburn, Ala. pp. 201–232, 324–394.

Rothbard
Rothbard. M. 2009. Man, Economy, and State: A Treatise on Economic Principles. Scholar’s Edition (2nd edn.), Ludwig von Mises Institute, Auburn, Ala. pp. 103–317.

Kirzner
Kirzner, Israel M. 1985. “Prices, the Communication of Knowledge, and the Discovery Process,” in Kurt R. Leube and Albert H. Zlabinger (eds.), The Political Economy of Freedom: Essays in Honor of F.A. Hayek. Philosophia Verlag, Munich. 193–206.

Kirzner, Israel M. 2000. The Driving Force of the Market: Essays in Austrian Economics. Routledge, London and New York.

Kirzner, Israel M. 2007 [1963]. Market Theory and the Price System. Ludwig von Mises Institute, Auburn, Ala.

Greaves
Greaves, Bettina B. 1984. Free Market Economics: A Syllabus. Foundation for Economic Education, Irvington-on-Hudson, NY. pp. 37–53.

Shapiro
Shapiro, Milton M. 1985. Foundations of the Market Price System. University Press of America, Inc. Lanham, MD and London.

Vulgar Austrians do not Understand Austrian Price Theory

Certain vulgar and ignorant internet Austrians actually seem to believe that Austrian price theory does not have a fundamental role for the idea of flexible prices and wages that, in market trades by buyers and sellers, are moved towards their market-clearing levels to clear product markets by equating quantities demanded with quantities supplied, so that economic coordination and full use of resources are achieved.

Well, here is a clear statement of the Austrian view of prices by Thomas C. Taylor in his An Introduction to Austrian Economics (1980), a book republished by Ludwig von Mises Institute:

“The day-to-day tendency in the market is toward the establishment of an equilibrium price for each particular consumer good. Prevailing prices tend toward that price at which quantity supplied and quantity demanded are equal, a movement that attests to the price system’s capacity to coordinate the actions of persons engaged in different activities. The typical depiction of this tendency on a graph shows the equilibrium price at the point at which the market supply-and-demand curves intersect. Any price above or below the equilibrium price cannot persist because such a price will result, respectively, in either frustrated sellers or frustrated buyers. Prices are reduced by sellers if the market price is too high to clear the quantity offered; prices are bid upward by buyers if the price is too low to induce sellers to offer a quantity ample enough to satisfy the buyers’ demand.” (Taylor 1980: 56).

This passage appears to be a straightforward descriptive statement of how Austrians view real world prices.

Of course, Austrians no doubt see a good deal of rigidity and inflexibility of real world prices, but they attribute this to “evil” interference by government and the deleterious influence of trade unions, so that no doubt Austrians can also see the passage above as a prescriptive vision of how a free market should set prices.

But there isn’t really any serious contradiction here: it can function both as a rough descriptive statement of how prices are set in a modern market economy (with qualifications to explain some price rigidities) and an ideal prescriptive statement of how prices ought to be set in a free market.

I could cite many other passages confirming this. A sample follow below:

(1) “In fact, pricing on the market is not an act of will by sellers. Businessmen do not determine their selling prices on the basis of whether they feel greedy or ‘responsible’ that morning. The entire apparatus of economic theory, built up over centuries, is devoted to demonstrating a great truth: that prices are set only by the demand of purchasers (how much of a good or service purchasers will buy at any given price), and by the supply or stock of the good.

Prices are set so as to ‘clear the market’ by equating supply and demand; at the market price the supply of a good will exactly equal the amount of the good that people are willing to buy or hold. If the demand for the good increases, purchases will bid the price up; if the supply increases, the price will fall. Demanders consist of consumers, whose purchases are determined by the values they place on the goods, and various producers or businessmen, whose demands are determined by how much they expect consumers to pay for the final product.” (Rothbard 2006: 390).

(2) “We know from ‘microeconomic’ analysis that if there is a ‘surplus’ of something on the market, if something cannot be sold, the only reason is that its price is somehow being kept too high. The way to cure a surplus or unemployment of anything, is to lower the asking price, whether it be wage rates for labor, prices of machinery or plant, or of the inventory of a retailer.” (Rothbard 2006b: 44).

(3) “A worse problem is that, since the 1930s, government and its privileged unions have intervened massively in the labor market to keep wage rates above the market-clearing wage, thereby insuring ever higher unemployment.” (Rothbard 2006b: 45).

(4) “Similarly, most economists would readily admit that keeping the price of any good above the amount that would clear the market will cause unsold surpluses to pile up. Yet, they are reluctant to admit this in the case of labor. …. In a free market, wage rates will tend to adjust themselves so that there is no involuntary unemployment, i.e., so that all those desiring to work can find jobs. Generally, wage rates can only be kept above full-employment rates through coercion by government, unions, or both.” (Rothbard 2008: 43).

(5) “Private business prices its goods and services to ‘clear the market,’ so that supply equals demand, and there are neither shortages nor goods going unsold.” (Rothbard 2006a: 259).

(6) “There is no reason why prices cannot fall low enough, in a free market, to clear the market and sell all the goods available. If businessmen choose to keep prices up, they are simply speculating on an imminent rise in market prices; they are, in short, voluntarily investing in inventory. If they wish to sell their ‘surplus’ stock, they need only cut their prices low enough to sell all of their product. But won’t they then suffer losses? Of course, but now the discussion has shifted to a different plane.” (Rothbard 2008: 56).

(7) “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).

(8) “The driving force of the market process is provided neither by the consumers nor by the owners of the means of production – land, capital goods, and labor – but by the promoting and speculating entrepreneurs. These are people intent upon profiting by taking advantage of differences in prices. Quicker of apprehension and farther-sighted than other men, they look around for sources of profit. They buy where and when they deem prices too low, and they sell where and when they deem prices too high. They approach the owners of the factors of production, and their competition sends the prices of these factors up to the limit corresponding to their anticipation of the future prices of the products. They approach the consumers, and their competition forces prices of consumers’ goods down to the point at which the whole supply can be sold.” (Mises 2008: 325).

(9) “It is ultimately always the subjective value judgments of individuals that determine the formation of prices …. . Market prices are entirely determined by the value judgments of men as they really act.

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.” (Mises 2008: 329–330).

(10) “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).

(11) “Rothbard presumed that in individual markets, the law of one price dominated, and that market clearing happened rapidly and smoothly … . Just as in conventional neoclassical economics, general equilibrium, the evenly rotating economy (ERE), was the direction in which the economy was headed.” (Vaughn 1994: 97).

(12) “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).

(13) “The market process will tend to establish a price that clears the market: all sellers willing to sell at the market price will be able to do so, and all buyers willing to buy at that price will also be able to do so. …. If these dynamics of supply and demand change, the market process will adjust the price to the new realities.” (Callahan 2004: 76).

(14) “The modern, subjectivist theory of prices does not assume that people have ‘perfect knowledge’ of the market. On the contrary, catallactics can explain the formation of actual prices in the real world. Indeed, those mainstream economists who study static ‘equilibrium’ outcomes ignore the crucial process in which speculative entrepreneurs drive the market toward equilibrium. By spotting disequilibrium (but real-world) prices and acting to seize the profit opportunities that they entail, it is the entrepreneurs who move the whole system toward the equilibrium state that the mathematical economists take for granted as the starting point of analysis. By buying ‘underpriced’ goods or factors of production, and selling ‘overpriced’ ones, the entrepreneurs push up the former and push down the latter prices, earning profits and equilibrating the economy.” (Murphy and Gabriel 2008: 133–134).

(15) “Competitive prices are the outcome of a complete adjustment of the sellers to the demand of the consumers. Under the competitive price the whole supply available is sold, and the specific factors of production are employed to the extent permitted by the prices of the nonspecific complementary factors. No part of a supply available is permanently withheld from the market, and the marginal unit of specific factors of production employed does not yield any net proceed. The whole economic process is conducted for the benefit of the consumers.” (Mises 2008: 354).

(16) “The market is always tending quickly toward its equilibrium position, and the wider the market is, and the better the communication among its participants, the more quickly will this position be established for any set of schedules. Furthermore, a growth of specialized speculation will tend to improve the forecasts of the equilibrium point and hasten the arrival at equilibrium. However, in those cases where the market does not arrive at equilibrium before the supply or demand schedules themselves change, the market does not reach the equilibrium point. It becomes continuous, moving toward a new equilibrium position before the old one has been reached. ⁽²⁹⁾

[note]
⁽²⁹⁾ This situation is not likely to arise in the case of the market equilibria described above. Generally, a market tends to ‘clear itself’ quickly by establishing its equilibrium price, after which a certain number of exchanges take place, leading toward what has been termed the plain state of rest—the condition after the various exchanges have taken place.” (Rothbard 2009: 143, with n. 29).

(17) “Price control measures paralyze the working of the market. They destroy the market. They deprive the market economy of its steering power and render it unworkable.

The price structure of the market is characterized by its tendency to bring supply and demand into balance. If the authority attempts to fix a price different from the market price, this situation cannot prevail. In the case of maximum prices, there are potential buyers who cannot buy although they are ready to pay the price fixed by the authority, or even to pay a higher price. Or there are—in the case of minimum prices—potential sellers who cannot find buyers even though they are willing to sell at the price established by the authority, or even to sell at a lower price. The price is no longer the means of segregating those potential buyers and sellers who may buy or sell from those who may not. A different principle of selection has to come into operation. It may be that only those who come first or those who occupy a privileged position due to particular circumstances (personal connections, for instance) will actually buy or sell. But it may also be that the authority itself takes over the regulation of distribution. At any rate the market is no longer able to provide for the distribution of the available supply to the consumers. If chaotic conditions are to be avoided, and if neither chance nor force is to be relied upon to determine distribution, the authority has to undertake this task by some system of rationing.” (Mises 1998 [1940]: 26).

(18) “The price structure of the market decides what will be produced, how, and in what quantity. Through the structure of prices, wages, and interest rates the market brings supply and demand into balance and sees to it that each branch of production will be as fully occupied as corresponds to the volume and intensity of the effective demand. Thus capitalist production derives its meaning from the market. Of course, a temporary imbalance between production and demand can occur, but the structure of market prices makes sure that the balance is reestablished in a short time. Only when the mechanism of the market is disturbed by external interventions is the effect of market prices on the regulation of production prevented; they are disturbances that no longer can be remedied by the automatic reactions of the market, disturbance that are not temporary but prolonged.” (Mises 2002a [1931]: 170).

(19) “Entrepreneurs try to supply those goods whose sale promises them the highest possible profit. But it is the market that decides where profits are earned and losses suffered. If consumers demand more of a product, then its price rises; if they demand less, then the price falls. If entrepreneurs produce only those goods whose sale promises to bring them profits, then that means they are following the wishes of the consumers. It is the market, therefore, that directs a capitalist economy, based on the private ownership of the means of production. The changing prices of the market bring supply and demand into equilibrium. The market price—called the ‘natural price’ by the Classical economists and the ‘static price’ by modern economists—finds its level at a point at which no prospective buyer who is ready to pay the market price leaves the market unsatisfied, and no prospective seller who is willing to accept the market price leaves the market with unsold goods.” (Mises 2002b [1933]: 209).

(20) “The crisis from which the world is suffering today is the crisis of interventionism and of national and municipal socialism; in short, it is the crisis of anticapitalist policies. Capitalist society—there is no difference of opinion about this—is governed by the workings of the market process. Market prices bring supply and demand into balance and determine the direction and extent of production. The capitalist economy gets its meaning from the market. If the function of the market as regulator of production is permanently undermined by an economic policy that attempts to set prices, wages, and interest rates other than in the way the market forms them, then a crisis will surely occur.” (Mises 2002c [1932]: 191).

(21) “The aim of price control is to decree prices, wages, and interest rates different from those fixed by the market. Let us first consider the case of maximum prices, where the government tries to enforce prices lower than the market prices.

The prices set on the unhampered market correspond to an equilibrium of demand and supply. Everybody who is ready to pay the market price can buy as much as he wants to buy. Everybody who is ready to sell at the market price can sell as much as he wants to sell. If the government, without a corresponding increase in the quantity of goods available for sale, decrees that buying and selling must be done at a lower price, and thus makes it illegal either to ask or to pay the potential market price, then this equilibrium can no longer prevail. With unchanged supply there are now more potential buyers on the market, namely, those who could not afford the higher market price but are prepared to buy at the lower official rate. There are now potential buyers who cannot buy, although they are ready to pay the price fixed by the government or even a higher price.” (Mises 2010 [1944]: 61).

(22) “In the capitalistic economy, it is consumer demand that determines the pattern and direction of production, precisely because entrepreneurs and capitalists must consider the profitability of their enterprises.

An economy based on private ownership of the factors of production becomes meaningful through the market. The market operates by shifting the height of prices so that again and again demand and supply will tend to coincide. If demand for a good goes up, then its price rises, and this price rise leads to an increase in supply. Entrepreneurs try to produce those goods the sale of which offers them the highest possible gain. They expand production of any particular item up to the point at which it ceases to be profitable. If the entrepreneur produces only those goods whose sale gives promise of yielding a profit, this means that they are producing no commodities for the manufacture of which labor and capital goods must be used which are needed for the manufacture of other commodities more urgently desired by consumers.” (Mises 2006 [1931]: 156–157).

(23) “Entrepreneurs, capitalists, landowners, and workers are participants in the market, and they demand prices for their services. The consumers answer these price demands through their buying or abstention from buying on the market. From this interaction there results the market, on the basis of which supply and demand are brought into balance. Through the process of price formation the market performs its function as regulator of production.” (Mises 2002d [1932]: 201).

(24) “Persons with goods or services they hope to sell must continually experiment to discover the ‘market price’ of any particular item. As the students will have learned from the classroom auctions, it is possible to determine, by continued bargaining, the price at which an item will ‘clear the market’ at any particular moment. At that price, determined by the relative eagerness and subjective values of owners or potential sellers and would-be buyers, the number of units of a good or service wanted and the number offered will be the same. But no one can know in advance what this price will be.” (Greaves* 1984: 51).

* Bettina Bien Greaves was a student of Mises.

(25) “… selling prices will tend toward the market-clearing level, and need not hit the mark every time the firm sets it price. Despite the firms’ lack of perfect knowledge of [demand] and [supply] conditions, they are motivated to seek market-clearing outcomes and avoid disequilibrium outcomes.

For one thing, there is the economic incentive to maximize profits. As we have seen, surplus and shortage outcomes cause the firm less profit than otherwise under the given demand and supply conditions. Thus, in the case of a surplus, the firm will have to slash its [price] below the planned level, whereas in the case of a shortage the firm has missed an opportunity for greater profits by setting its [price] too low or producing less than the market was ready to absorb.

On the other side of this coin is the fact that, of the three possible market outcomes—market-clearing, surplus, or shortage—only market-clearing outcomes validate the firm’s expectations and strengthen its confidence in its ability to judge market conditions. In contrast, surpluses and shortages are truly disappointments—sources of regret and diminished confidence.” (Shapiro* 1985: 208).

* We told at the Mises Institute that “Murray Rothbard just loved this Austrian text on microeconomic theory. In fact, he thought it was the best text available.”

(26) “As we have indicated, because of uncertainty and ignorance, firms will experience shortages and surpluses about as often as market-clearing. In a free market, such disequilibrium outcomes would tend to be shortlived or temporary. However, if and when the surpluses and shortages become persistent or long-lasting—a situation thoroughly inconsistent with free-market conditions— the cause must be sought elsewhere: (1) in government price-fixing or other interventions, and (2) non-profit pricing policies.” (Shapiro 1985: 209).

(27) “The concept of a glut for a single good is easy enough to understand: there is more supply on the market than demand at the offered price. A glut can be alleviated by a fall in the price of that good. The producers of the good may take a loss if the market price is below their costs, but the market can always clear at some price.”
Blumen, Robert. 2014. “Say’s Law and the Permanent Recession,” Mises Daily, February 28,
http://www.mises.org/daily/6676/Says-Law-and-the-Permanent-Recession

(28) “An equilibrium price is one in which quantity supplied equals quantity demanded. Graphically, it occurs at the intersection of the supply and demand curves. The market tends toward equilibrium: If the current price is above the equilibrium price, there is an excess supply (‘surplus’) and sellers reduce their asking price. If the current price is below the equilibrium price, there is an excess demand (‘shortage’) and buyers increase their offer price.

There is a tendency for one price to rule over a market. If there weren’t, then arbitrage opportunities would exist; a middleman could buy low and sell high.” (Murphy 2006: 19–20).

(29) “Because of diminishing marginal utility, an individual’s demand curve cannot be upward sloping. The summation of each potential buyer’s demand schedule gives the market demand schedule, i.e., the number of units demanded at each hypothetical money price for the good. The determination of the market supply schedule is also comparable to the barter analysis. The equilibrium (money) price is the (money) price at which quantity supplied equals quantity demanded.” (Murphy 2006: 42).

(30) “A surplus (or a ‘glut’) occurs when producers are trying to sell more units of a good or service than consumers want to purchase (at a particular price). A shortage occurs when consumers want to buy more units than producers want to sell (at a particular price). In this context, the equilibrium price (or the market-clearing price) is the one at which the amount supplied exactly equals the amount demanded. If the market is in equilibrium, there is no surplus and no shortage.” (Murphy 2010: 156–157).

(31) “Equilibrium price / market-clearing price: The price at which producers want to sell exactly the number of units that consumers want to purchase. On a graph, the equilibrium price occurs at the intersection of the supply and demand curves. …

Equilibrium quantity: The number of units that producers want to sell, and consumers want to buy, at the equilibrium price. On a graph, the equilibrium quantity occurs at the intersection of the supply and demand curves.” (Murphy 2010: 385).

There is no way to interpret these except as saying that flexible prices and wages converging towards their market-clearing levels have a fundamental role in Austrian economic theory and in the real world.

The only alternative to this is that Austrian price theory is not even meant to describe real world price setting. This bizarre possibility would entail that Austrian price theory is devoid of any serious description of reality. I wonder if vulgar Austrians really think this.

BIBLIOGRAPHY
Blumen, Robert. 2014. “Say’s Law and the Permanent Recession,” Mises Daily, February 28,
http://www.mises.org/daily/6676/Says-Law-and-the-Permanent-Recession

Callahan, Gene. 2004. Economics for Real People. Ludwig von Mises Institute, Auburn, Ala.

Greaves, Bettina B. 1984. Free Market Economics: A Syllabus. Foundation for Economic Education, Irvington-on-Hudson, NY.

High, J. 1994. “The Austrian Theory of Price,” in Peter J. Boettke (eds.), The Elgar Companion to Austrian Economics. E. Elgar, Aldershot. 151–155.

Mises, Ludwig von. 1998 [1940]. Interventionism: An Economic Analysis. The Foundation for Economic Education, Irvington on Hudson, NY.

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Mises, Ludwig von. 2002d [1932]. “The Interventionism of the Entrepreneurs? Reply to the Preceding Remarks of Otto Conrad,” in Richard M. Ebeling (ed.). 2002. Selected Writings of Ludwig von Mises: Between the Two World Wars: Monetary Disorder, Interventionism, Socialism, and the Great Depression (vol. 2). Liberty Fund, Indianapolis, Ind. 200–207.

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