Supply and Demand Equilibrium and Menger’s Price Theory

Carl Menger’s price theory can be read in an English translation in Principles of Economics (2011 [1st edn. 1871]; Eastbourne, UK), pp. 191–225.

But a debate has raged about whether Menger had a clear notion of economic equilibrium and tendencies to equilibrium (Tieben 2012: 315).

Some few have that held that Menger had some notion of supply and demand equilibrium via price coordination (Moss 1978), but most argue that Menger did not have any such theory (Streissler 1972, Kirzner 1978; Endres 1995). Indeed, even Hayek remarked on “the absence in Menger’s work of the conception of a general equilibrium” (Hayek 1992: 104).

So, fundamentally, compared to both modern neoclassical and modern Austrian price theory, Menger’s price theory appears undeveloped (and it is also different from Marshallian partial equilibrium analysis).

Streissler (1972: 276) contends that “market clearing by price adjustment was inessential to … [sc. Menger’s] theory of price formation.” (And, as an aside, nor does Menger seem to conceive of the competitive entrepreneurial process as operating with a tendency to drive profits to zero [Kirzner 1978: 33].)

Indeed, Tieben contends that

“[sc. Menger] … rejected the static notion of economic equilibrium – the equality between quantities supplied and demanded – as a starting point for theoretical analysis.

But also as a dynamic conception there was no role for the conception of economic equilibrium in Menger’s theory of prices. Menger addressed the relationship between competition and prices as a secular trend, but there is hardly any reference in his theory of price to the capacity of competitive markets to establish equilibrium between supply and demand. Surprisingly, Menger never stressed the capacity of the market process to safeguard the relative harmony of the exchange mechanism, a function that is usually associated with the tendency of prices to move towards a supply and demand equilibrium.” (Tieben 2012: 319).

Furthermore, Menger’s own analysis of multilateral exchange shows that negotiated prices can cause excess demand to persist (Tieben 2012: 322) – which is contrary to modern price theory in which flexible prices cause equilibration of supply and demand.

Moss argues that Menger thought of true “equilibrium prices” as the price that emerges when completely determined by the preferences of economic agents and not influenced by their relative bargaining strengths (Moss 1978: 28; Tieben 2012: 320) – a definition contrary to the usual idea of an “equilibrium price” as a price that equates quantity demanded with total quantity supplied for sale.

Menger’s actual process of market “equilibration” is also quite different from modern Walrasian general equilibrium theory or even Mises’s market coordinating tendency towards the “final state of rest”: Menger thinks that economic progress consists in transformation of monopolistic markets into competitive ones, which boosts economic welfare via greater supply, less abuse of market power, and a more equitable distribution of wealth (Tieben 2012: 323). (Menger, it should be noted, held that monopoly was a quite significant market phenomenon, perhaps even the rule rather than the exception [Kirzner 1978: 41; Streissler 1973: 168].)

Arguably, it was Eugen von Böhm-Bawerk who extended Menger’s price theory to stress the idea of demand and supply equilibrium in prices (a concept which was called Gleichgewicht in German), and the (alleged) tendency of the market process via price formation to equilibrate demand and supply in auction-like markets (Endres 1996: 96; Tieben 2012: 323), even if Böhm-Bawerk’s view is that market clearing in this sense occurs in a given range of possible equilibrium prices rather than a unique Walrasian point price (Endres 1996: 96).

This concept of market clearing is central to modern Austrian economics: it cannot be stressed how dependent modern Austrian theory is on this idea. Without a tendency towards demand and supply equilibrium via flexible prices, so much of Austrian economics – such as the belief in rapid and smooth recovery from recessions and Misesian economic coordination – is undermined and left without foundation.

But it is strange indeed that Menger – the founder of Austrian theory – did not conceive of the price system as equilibrating supply and demand.

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

Endres, A. M. 1996. “Some Microfoundations of Austrian Economics: Böhm-Bawerk’s Version,” European Journal of the History of Economic Thought 3.1: 84–106.

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

Hayek, Friedrich A. von. 1992. “Carl Menger (1840–1921),” in P. G. Klein (ed.), The Collected Works of F. A. Hayek. Volume IV. The Fortunes of Liberalism: Essays on Austrian Economics and the Ideal of Freedom. University of Chicago Press, Chicago. 61–107.

Jaffé, William. 1976. “Menger, Jevons and Walras De-homogenized,” Economic Inquiry 14: 511–524.

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

Streissler, Erich. 1973. “Menger’s Theories of Money and Uncertainty—A Modern Interpretation,” in J. R. Hicks and W. Weber (eds.), Carl Menger and the Austrian School of Economics. Clarendon Press, Oxford. 164–189.

Streissler, Erich. 1990. “The Influence of German Economics on the Work of Menger and Marshall,” in Bruce J. Caldwell (ed.), Carl Menger and His Legacy in Economics. Duke University Press, Durham.

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

Tomo, S. 1987. Early Lectures on Economics by Böhm-Bawerk. Series no. 13, Centre for Historical Social Science Literature, Hitotsubashi University.

Salerno on Market-Clearing Prices in Austrian Theory

Joseph T. Salerno describes it here in his comments on the role of “price coordination”:

“Price coordination must not be confused with plan coordination, a concept originally formulated by Friedrich von Hayek. In his article ‘Economics and Knowledge,’ which has heavily influenced modern Austrian writers, Hayek suggested a concept of equilibrium based on ‘coordination of plans’ as a substitute for the concept of equilibrium based on ‘constancy of the data.’ In contrast, price coordination, as I elaborate the concept below, is the indispensable complement to the concept of an evenly rotating economy based on constant data. As Ludwig von Mises has repeatedly emphasized, the evenly rotating economy, although an imaginary state which can never be realized in the unfolding of the historical market process, is yet indispensable to the identification and analysis of the entrepreneurial function of the real world.

Entrepreneurs, however, can formulate and execute production plans only in a world in which economic calculation is possible, that is, in which catallactic competition generates market-clearing prices which, at every moment of calendar time and without fail, reflect, promote, and coordinate those uses of the available scarce resources that are expected to be the most highly valued by consumers. Price coordination, therefore, is not a phenomenon associated with an unrealizable state of equilibrium, however the latter is conceived; rather, price coordination is the essential characteristic of the plain state of rest, which, as Mises tells us, ‘… is not an imaginary construction but the adequate description of what happens again and again on every market.’” (Salerno 2010: 182–183).

The absurdity of this passage takes one’s breath away.

First, although there is sometimes confusion about whether Austrian price theory is meant to be merely an ideal or prescriptive vision of economic coordination, here it seems that flexible prices moving towards their market clearing values is meant to be a descriptive theory describing how real world markets actually function (although of course it can be a prescriptive and ideal vision at the same time, as, for example, when Austrian think governments or unions are supposed to interfere with the system of flexible prices).

Secondly, can entrepreneurs “formulate and execute production plans only in a world in which economic calculation is possible, that is, in which catallactic competition generates market-clearing prices”? Of course, Salerno’s phrase “generates market-clearing prices” can be understood to mean prices that move towards their market-clearing values (or the “equilibrium prices” at which demand and supply are equal), and not that all prices do indeed reach such equilibrium values, since he rejects the real world existence of equilibrium states (such as Walrasian general equilibrium or the Misesian final state of rest).

But is successful capitalist production only possible in a world generating and moving towards market-clearing prices? The answer is, of course, no.

So much of any real world capitalist economy consists of fixprice markets with administered prices, where private businesses shun flexible prices in the conventional sense. Yet production continues, economies can have strong and indeed historically unprecedented real GDP growth, employment can be high, living standards and real wages can rise significantly, and productivity growth can be strong. We need only think of the golden age of capitalism from the 1946–1970s period.

The Austrian notion that capitalist economies can only work successfully with flexible prices and a tendency to market clearing prices is wrong, absurd and contrary to empirical reality.

BIBLIOGRAPHY
Salerno, Joseph T. 2010. Money, Sound and Unsound. Ludwig von Mises Institute, Auburn, Ala.