Vulgar Austrians do not Understand Austrian Price Theory (Updated)

Vulgar internet Austrianism is a plague.

One of the worst aspects of it is that many vulgar Austrians do not even understand Austrian price theory.

That being so, it is time to update an old post showing what actual Austrian economists say about their price theory – as opposed to vulgar Austrians.

According to certain vulgar and ignorant internet Austrians, 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. This is nonsense, of course: that idea is a very important aspect of Austrian economic theory.

A case in point that shows this is this passage from Hayek, in which the fundamental idea is a tendency towards supply and demand equilibrium via flexible prices and wages, which are supposed to be adjusted in trades towards market clearing levels by market agents.

Here is another 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.

Let us now turn to how Austrian economists themselves describe their price theory:

(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 2008a: 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 2008a: 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).

(32) “At a price higher than the intersection [sc. of the supply and demand curves], then, supply is greater than demand, and market forces will then impel a lowering of price until the unsold surplus is eliminated, and supply and demand are equilibrated. These market forces which lower the excessive price and clear the market are powerful and twofold: the desire of every businessman to increase profits and to avoid losses, and the free price system, which reflects economic changes and responds to underlying supply and demand changes. The profit motive and the free price system are the forces that equilibrate supply and demand, and make price responsive to underlying market forces.” (Rothbard 2008b: 20).

(33) “Clearly then, the profit-loss motive and the free price system produce a built-in “feedback” or governor mechanism by which the market price of any good moves so as to clear the market, and to eliminate quickly any surpluses or shortages. For at the intersection point, which tends always to be the market price, supply and demand are finely and precisely attuned, and neither shortage nor surplus can exist … . Economists call the intersection price, the price which tends to be the daily market price, the “equilibrium price,” for two reasons: (1) because this is the only price that equilibrates supply and demand, that equates the quantity available for sale with the quantity buyers wish to purchase; and (2) because, in an analogy with the physical sciences, the intersection price is the only price to which the market tends to move. And, if a price is displaced from equilibrium, it is quickly impelled by market forces to return to that point—just as an equilibrium point in physics is where something tends to stay and to return to if displaced.” (Rothbard 2008b: 21–22).

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.

My Posts against the Austrian Theory of Prices
“Hayek on ‘The Flow of Goods and Services,’” March 20, 2013.

“Salerno on Mises’s View of Coordination in Market Economies,” March 23, 2013.

“Kirzner on Hayek on Prices,” May 22, 2013.

“Salerno on Market-Clearing Prices in Austrian Theory,” June 21, 2013.

“William Hutt’s Fantasy World Economics,” October 3, 2013.

“When Austrians Throw Reality to the Wind,” October 11, 2013.

“Do Modern Austrians ever Read Lachmann?,” October 13, 2013.

“Rothbard’s Clueless Statements on Costs of Production and Price,” November 7, 2013.

“Vulgar Austrians do not Understand Austrian Price Theory,” November 7, 2013.

“Böhm-Bawerk had No Theory of Administered Prices,” November 10, 2013.

“A Bibliography on Austrian Price Theory,” November 15, 2013.

“Mises on Market Clearing Prices and Demand Curves: A Critique,” November 26, 2013.

“Mises on the Prices of Factor Inputs: A Critique,” November 27, 2013.

“Why Hayek’s Theory of Prices and Knowledge is Flawed,” November 30, 2013.

“Mises on Marginal Cost: A Critique,” December 3, 2013.

“Reality Refutes Mises on Costs and Prices,” December 9, 2013.

“Administered Prices Discredit the Austrian Economic Theories of Mises,” December 10, 2013.

“Supply and Demand Equilibrium and Menger’s Price Theory,” December 19, 2013.

“Austrians and their Incoherent Views on Administered Prices,” February 5, 2014.

“Rothbard’s Non-Refutation of Administered Prices,” February 1, 2014.

“Does this Passage show that Mises understood Mark-up Pricing?,” February 1, 2014.

“Mises and Rothbard on Communist Prices,” January 5, 2014.

“Firms have No Power to Compel any Buyer?,” February 2, 2014.

“Hayek on Market-Clearing Prices and Wages in his 1975 Talk to the American Enterprise Institute,” February 7, 2014.

“Reality versus Rothbard: Prices, Demand and Production in the Real World,” May 27, 2014.

“Why most Austrians do not Understand Modern Mark-up Pricing Theory,” May 25, 2014.

“Misesian Economic Calculation and Coordination in Market Economies: An Overview and Critique,” May 11, 2013.

“Administered Prices Discredit the Austrian Economic Theories of Mises,” December 10, 2013.

“Kirzner on the Law of Supply and Demand in Austrian Economics,” January 24, 2014.

“Austrians and the Market’s Tendency to Equilibrium,” December 21, 2013.

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.

Mises, Ludwig von. 2002a [1931]. “The Economic Crisis and Capitalism,” 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. 169–173.

Mises, Ludwig von. 2002b [1933]. “Planned Economy and Socialism,” in Richard M. Ebeling (ed.). 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. 208–212.

Mises, Ludwig von. 2002c [1932]. “The Myth of the Failure of Capitalism,” in Richard M. Ebeling (ed.), 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. 182–191.

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.

Mises, Ludwig von. 2006 [1931]. “The Causes of the Economic Crisis,” in Percy L. Greaves (ed.). The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression. Ludwig von Mises Institute, Auburn, Ala. 155–182.

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

Mises, Ludwig von. 2010 [1944]. Omnipotent Government: The Rise of the Total State and Total War. Ludwig von Mises Institute, Auburn, Ala.

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

Murphy, Robert P. 2006. Study Guide to Man, Economy, and State: A Treatise on Economic Principles with Power and Market: Government and the Economy. Scholar’s Edition (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Murphy, Robert P. 2010. Lessons for the Young Economist. Ludwig von 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.

Rothbard, Murray N. 2006a. For a New Liberty: The Libertarian Manifesto (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Rothbard, Murray N. 2006b. Making Economic Sense (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Rothbard, Murray N. 2008a. America’s Great Depression (5th edn.). Ludwig von Mises Institute, Auburn, Ala.

Rothbard, Murray N. 2008b. The Mystery of Banking (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

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

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

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

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

Hayek on Market-Clearing Prices and Wages in his 1975 Talk to the American Enterprise Institute

On April 9, 1975, Hayek gave a talk to the American Enterprise Institute in Washington DC, where he was introduced by Gottfried von Haberler (Hayek 1975: 1–2), and was asked to speak on the early stagflationary crisis then affecting Western economies.

In that talk, Hayek attacked the idea that employment is “a direct and simple function of what is called aggregate demand” (Hayek 1975: 4), even though he proceeded to concede two important instances where aggregate demand was the “dominating factor in determining the level of employment” (Hayek 1975: 4), as I mention in the previous post.

Hayek then returns to the pre-Keynesian explanation of unemployment as mainly a consequence of the supply and demand mismatches in and between individual labour markets and the deviation of prices and wages from their market clearing values.

But for Hayek you cannot statistically prove this:

“The alternative explanation of extensive unemployment—which, until the middle of the ’30s, was fairly widely accepted and which, I believe, is still the true and correct one—has the unfortunate property of not being verifiable by statistical methods. To an economist today, however, only that is true which can be proved statistically, and everything that cannot be demonstrated by statistics can be neglected; hence, the true theory has been disregarded.

You may be puzzled by the assertion that there should be a true theory which cannot be statistically confirmed. The explanation is somewhat complex and I can indicate it only very briefly. I have made the subject the main content of my Nobel Memorial lecture, which I delivered in Stockholm four months ago, but I will try to put it concisely. It is a very good illustration of a more general phenomenon, namely, that with modern scientistic prejudices about what is to be accepted a valid argument, it can happen that a false theory is regarded as true because there is some statistical evidence in its favor, and that the true theory is rejected because, by its very nature, it cannot be supported by statistical evidence—which is the only kind of observation which counts for that point of view.

That’s a point on which you probably have some doubt. Can there be a theory the conclusion of which cannot, by its nature, be statistically supported? I believe I can give you, in this case, an example which, to me, is fairly convincing.

What was the traditional pre-Keynesian view about the causes of extensive unemployment? Generally speaking, it was the assumption of a discrepancy between the distribution of demand among different industries and the distribution of labor and other resources among these industries. As the result of that discrepancy, there will be a lack of correspondence between demand and supply in many sectors, an insufficient demand in some of them and an excessive demand in others; and, as always happens in the case of a discrepancy between demand and supply, resources of all kinds will be idle.

These discrepancies of demand and supply in different industries, discrepancies between the distribution of demand and the allocation of the factors of production, are in the last analysis due to some distortion in the price system that has directed resources to false uses. It can be corrected only by making sure, first, that prices achieve what, somewhat misleadingly, we call an equilibrium structure, and second, that labor is reallocated according to these new prices.

Lacking such price readjustment and resource reallocation, the original unemployment may then spread by means of the mechanism I have discussed before, the “secondary contraction,” as I used to call it. In this way, unemployment may eventually become general.

The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.

The theory which asserts that unemployment is an effect of a deviation of the actual price structure from the equilibrium structure is thus a theory that cannot be confirmed by statistics. It’s the kind of theory which I believe you find in many other fields of economics. What we can confirm from daily observation are the elements from which a theory is built up, our knowledge of the behavior of individuals in various situations. But we cannot test statistically the resulting conclusions, which are derived from these empirical data about individual behavior.

In contrast, the modern fashion demands that a theoretical assertion which cannot be statistically tested must not be taken seriously and has to be discarded. As a result of this belief, a theory which, in my opinion, is the true explanation has been discarded as not adequately confirmed, and a false theory has been generally accepted merely because it happens to be the only one for which statistical evidence, even though very inadequate evidence, is available.” (Hayek 1975: 6–7).

This passage is one that is grossly misunderstood by vulgar Austrians, or, to be specific, one astonishingly ignorant one.

The central concept above is the notion of a tendency towards a set of wages and prices that clears markets, despite what vulgar Austrians say. In such a price vector, flexible wages will clear the labour market too.

For Hayek, as for other Austrians, market agents will attempt to find such market clearing values that will equate demand and supply by a learning and trial-and-error process, and people cannot necessarily know what such equilibrium prices will be in advance, as described by Kirzner, Shapiro and Greaves:

“As Austrian economist F. A. Hayek emphasized, the market process we have been describing in entrepreneurial terms can also usefully be understood in terms of learning. The process through which the market tends to generate the ‘right’ quantity of a commodity, and the ‘right’ price for it, can be seen as a series of steps during which market participants gradually tend to discover the gaps or errors in the information on which they had previously been basing their erroneous production and/or buying decisions. Buyers who had overestimated the willingness of producers to produce and sell the commodity had been ‘incorrectly’ refusing to offer higher prices (that they would indeed have been prepared to pay); those who had underestimated that willingness were ‘incorrectly’ offering higher prices than were in fact needed to inspire sellers to produce. Sellers who had overestimated the willingness of buyers to buy were ‘incorrectly’ asking higher prices (and were producing more units of the commodity than it was ‘really worthwhile’ to produce), and so on. The market process is one in which, driven by the entrepreneurial sense for grasping at pure profit opportunities (and for avoiding entrepreneurial losses), market participants, learning more accurate assessments of the attitudes of other market participants, tend toward the market-clearing price-quantity combination.”
Kirzner, Israel M. 2000. “Entrepreneurial Discovery and the Law of Supply and Demand,” February 1, 2000
http://www.fee.org/the_freeman/detail/entrepreneurial-discovery-and-the-law-of-supply-and-demand#axzz2rJCWXRKy

“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).

“ … no real-world firm really has the ‘power’ to suspend the law of demand and supply—that is, to avoid ending up with a surplus for overpricing its product, or to avoid less-than-maximum profits by underpricing its product and realizing a shortage.

Sooner or later, after trial-and-error searching for the market-clearing price, every real-world firm finds itself eventually having to ‘take’ the market price that actually clears its supply. Thus real-world firms are ‘price-takers’ no less than firms in pure competition, the only difference being this: [perfect competition] firms ‘take’ their [price] from the market right from the start (they have perfect knowledge!), whereas real firms ‘take’ their [price] only after trial-and-error search in the market. Irony of ironies: real firms are, in an ultimate sense, pricetakers, too!” (Shapiro 1985: 365–366).

To sum up, both Austrians and Walrasian neoclassicals have similar ideas about the need for flexible wages and prices, but the Austrian view about the tendency to market clearing is different in the following ways:

(1) market agents cannot necessarily know the market clearing prices in advance;

(2) Austrians do not think market agents have perfect knowledge or “rational expectations”;

(3) most prices are not market-clearing prices nor equilibrium prices (in the sense of being equal to marginal cost) but disequilibrium prices, but there exists a tendency for prices and wages to move towards market clearing values by arbitrage, the action of alert entrepreneurs, and a learning and trial-and-error process;

(4) according to Hayek, the involuntary unemployment caused by the “deviation of the actual price structure from the equilibrium structure … cannot be confirmed by statistics.”

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

Hayek, Friedrich A. von. 1975. A Discussion with Friedrich A. von Hayek. American Enterprise Institute, Washington.

Kirzner, Israel M. 2000. “Entrepreneurial Discovery and the Law of Supply and Demand,” February 1, 2000
http://www.fee.org/the_freeman/detail/entrepreneurial-discovery-and-the-law-of-supply-and-demand#axzz2rJCWXRKy

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.

Mises, Ludwig von. 2002a [1931]. “The Economic Crisis and Capitalism,” 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. 169–173.

Mises, Ludwig von. 2002b [1933]. “Planned Economy and Socialism,” in Richard M. Ebeling (ed.). 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. 208–212.

Mises, Ludwig von. 2002c [1932]. “The Myth of the Failure of Capitalism,” in Richard M. Ebeling (ed.), 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. 182–191.

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.

Mises, Ludwig von. 2006 [1931]. “The Causes of the Economic Crisis,” in Percy L. Greaves (ed.). The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression. Ludwig von Mises Institute, Auburn, Ala. 155–182.

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

Mises, Ludwig von. 2010 [1944]. Omnipotent Government: The Rise of the Total State and Total War. Ludwig von Mises Institute, Auburn, Ala.

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

Murphy, Robert P. 2006. Study Guide to Man, Economy, and State: A Treatise on Economic Principles with Power and Market: Government and the Economy. Scholar’s Edition (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Murphy, Robert P. 2010. Lessons for the Young Economist. Ludwig von 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.

Rothbard, Murray N. 2006a. For a New Liberty: The Libertarian Manifesto (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Rothbard, Murray N. 2006b. Making Economic Sense (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.

Rothbard, Murray N. 2008. America’s Great Depression (5th edn.). Ludwig von Mises Institute, Auburn, Ala.

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

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

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

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

Vulgar Austrians, Economic Calculation and Capitalist Economies

Updated

Ignorant internet Austrians have a habit of invoking the “socialist calculation debate” and the idea of economic (mis)calculation as if these provide some irrefutable argument against Keynesian macroeconomic management of a capitalist economy. I am principally thinking of this person.

There are two issues here:

(1) the alleged “economic (mis)calculation problems” that a capitalist economy with modern monetary and fiscal policy and some degree of government intervention might be subject to in Austrian theory, and

(2) the core issue of Mises’s socialist calculation debate from the 1920s–1940s.

The original core idea, or problem, of Mises’s socialist calculation debate was that “rational economic calculation” was impossible in a planned, command economy, because the lack of market prices for capital goods eliminated those markets which produce prices for the means of production, and capitalists need these prices to calculate profit and loss. That is to say, a command economy has completely abolished private ownership and production of capital goods, yet the prices of those goods (and other factor inputs) are required to establish costs of production and whether you have made a profit from sales of goods produced.

But it is obvious how that issue cannot be a serious one for modern nations with Keynesian economics, because in these systems the vast majority of capital goods are owned and produced privately, and prices do exist for these means of production and factor inputs. Profit and loss is obviously calculable in the way that it is not in a Communist command economy.

I will repeat this important concept: the point here was, and always has been, that the original issue in the socialist calculation problem (no market prices at all for capital goods eliminating producers’ goods markets) is not what modern Austrians must mean when they complain about “economic (mis)calculation” in a Keynesian economy, for prices for capital goods and factor inputs do exist, and even if Austrians think some of those prices might be “distorted” that is a different issue from saying that there are no prices whatsoever with which to calculate profit and loss.

Fundamentally, “rational economic calculation,” in the sense of the original socialist calculation debate, is possible in a market economy with Keynesian policies. To prove this, we need only note how even Mises conceded that a syndicalist system of production was possible:

“Mises agrees that rational economic calculation is possible under syndicalism or under any other producer cooperative-based system where the cooperative bodies are the owners of the means of production. Thus, there is some kind of group-collective private ownership, what the Maoists during the Chinese cultural revolution used to criticise as Yugoslav group-capitalism. Group-capitalism is also capitalism and allows rational calculation.” (Keizer 1987: 113–114).

So Mises admitted that rational economic calculation was possible under syndicalism since he argued that there was a group-collective private ownership of capital goods in such a system.

It follows a fortiori that a modern capitalist state even with Keynesian macro-management where private ownership of capital goods is the norm must also be capable of “rational economic calculation” in the original sense of Mises’s socialist calculation debate.

Now, when confronted with this point, vulgar Austrians will say that it is other alleged “economic (mis)calculation problems” that they are talking about, as follows:

(1) the alleged miscalculation problems caused in the Austrian business cycle theory (ABCT). But even here the issue is alleged price distortions in capital goods, not the non-existence of such prices or lack of private markets for capital goods and other factor inputs.

(2) distortions of prices away from their equilibrium values (as postulated by (4) below) by government spending, deficit spending, central bank fiat money creation, price controls, subsidies etc.

(3) distortions of prices away from their equilibrium values (as postulated by (4) below) by government interventions allegedly leading to Cantillon effects

(4) in general, obstructions to flexible wages and prices and therefore to a price vector that will clear all markets (with flexible wages clearing the labour market), as in this quotation of Hayek:

“The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).

It is obvious how the problems from (2) to (4) are all very similar to ideas from Walrasian neoclassical theory, and its idea of a tendency to a price and wage vector that would clear all markets.

But the most bizarre thing is that the same vulgar Austrian thinks that Hayek’s equilibrium structure of wages and prices “has nothing to do with ‘market-clearing Walrasian price vectors!’” We have here ignorance of the highest order at work.

First, by the late 1920s, Hayek was influenced by neoclassical economics and Walrasian general equilibrium (GE) theory. It was not until 1937 in his paper “Economics and Knowledge” (Hayek 1937) that Hayek discarded the notion of a set of equilibrium prices for the alternative idea of equilibrium he called “plan coordination.” The notion of a set of equilibrium prices (as we see in the quotation of Hayek above) is derived from Hayek’s beliefs during the time he was under the influence of Walrasian theory.

Secondly, Hayek’s remarks in the quotation above were made on April 9, 1975 in a talk that Hayek gave to the American Enterprise Institute in Washington DC. The real paradox here is that Hayek was using ideas broadly similar to those from Walrasian GE theory at a time when in his other written work he was moving away from GE as a useful concept and had already made strong criticisms of it. Even by the time of The Pure Theory of Capital (1941), Hayek asserted that it was necessary to “abandon every pretence that [sc. equilibrium] … possesses reality, in the sense that we can state the conditions under which a particular state of equilibrium would come about” (Hayek 1976 [1941]: 28). If nothing else, the statement of Hayek from 1975 is just further proof that Hayek was inconsistent in his attitude to GE theory, certainly in the 1970s.

One of the reasons that Hayek abandoned GE theory was that his opponents in the socialist calculation debate had used it to counter the arguments of the Austrians, and to argue that rational economic calculation was possible in a socialist state.

Hayek’s ultimate rejection of GE theory in the context of the socialist calculation debate can be seen towards the end of his life in an interview as transcribed in the book Nobel Prize-Winning Economist: Friedrich A. von Hayek (1983, pp. 187-188):

“HIGH: To what extent do you think that general-equilibrium analysis has contributed to the belief that national economic planning is possible?

HAYEK: It certainly has. To what extent is very difficult to say. Of the direct significance of equilibrium analysis to the explanation of the events we observe, I never had any doubt, I thought it was a very useful concept to explain a type of order towards which the process of economics tends without ever reaching it. I’m now trying to formulate some concept of economics as a stream instead of an equilibrating force, as we ought, quite literally, to think in terms of the factors that determine the movement of the flow of water in a very irregular bed.”

This issue raises the point that there is a schism in Austrian economics between those who accept the basic view that markets have a tendency to an equilibrium state and those who do not, as I have shown here.


BIBLIOGRAPHY

Hayek, F. A. von. 1937. “Economics and Knowledge,” Economica n.s. 4.13: 33–54.

Hayek, Friedrich A. von. 1975. A Discussion with Friedrich A. von Hayek. American Enterprise Institute, Washington.

Hayek, F. A. von. 1976 [1941]. The Pure Theory of Capital. Routledge and Kegan Paul, London.

Keizer, W. 1987. “Two Forgotten Articles by Ludwig von Mises on the Rationality of Socialist Economic Calculation,” Review of Austrian Economics 1.1: 109–122.

Nobel Prize-Winning Economist: Friedrich A. von Hayek. Interviewed by Earlene Graver, Axel Leijonhufvud, Leo Rosten, Jack High, James Buchanan, Robert Bork, Thomas Hazlett, Armen A. Alchian, Robert Chitester, Regents of the University of California, 1983.

Is This What Vulgar Austrians Mean by “Economic Calculation”?

In a talk on April 9, 1975 that Hayek gave to the American Enterprise Institute in Washington DC, he made the following comment on the nature of the business cycle:

“These discrepancies of demand and supply in different industries, discrepancies between the distribution of demand and the allocation of the factors of production, are in the last analysis due to some distortion in the price system that has directed resources to false uses. It can be corrected only by making sure, first, that prices achieve what, somewhat misleadingly, we call an equilibrium structure, and second, that labor is reallocated according to these new prices.

Lacking such price readjustment and resource reallocation, the original unemployment may then spread by means of the mechanism I have discussed before, the “secondary contraction,” as I used to call it. In this way, unemployment may eventually become general.

The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).

This passage is recycled ad nauseum by certain Rothbardians such as “Bob Roddis,” with the astonishing comment that it contains “simple basic [sc. Austrian] concepts that … all the other anti-Austrians refuse to comprehend.” Speaking of this very quotation, that same Rothbardian declares:

“Like every other non-Austrian, you guys just do not understand the essential concept of economic calculation or the concept of the equilibrium price structure that does not yet exist.”

“[t]here is no essential dispute between Hayek, Mises, Rothbard, Lew Rockwell or me regarding the following which states the basic Austrian understanding of the economic galaxy” [my emphasis – LK].

But, on reading the Hayek quotation, one is struck by the fact that the central concept is the notion of a tendency to a price vector that will clear all markets (with flexible wages clearing the labour market). This is not an “Austrian” idea at all: it is a Walrasian or neo-Walrasian neoclassical idea, straight from general equilibrium theory. The Austrians did not invent this, but simply borrowed it from Walrasian neoclassicals.

A fundamental theoretical point of Post Keynesian economics – and indeed much heterodox economics in general – is the rejection of the notion of a market tendency to general equilibrium, with extensive arguments why there is no such tendency, owing to the presence of fundamental uncertainty, subjective expectations, the failure of Say’s law, the non-neutrality of money, and the falsity of the gross substitution axiom.

Here we have the most astonishing sight of vulgar internet Austrians complaining that the critics do not understand “basic Austrian” concepts, yet these same Austrians are unaware that the very concepts in question they invoke are nothing but mainstream neoclassical equilibrium fictions, which are held by all orthodox economists such as New Classicals, monetarists and (to some extent) even the New Keynesians.

And, more seriously, certain Austrians such as the radical subjectivists do even accept that idea of market tendency to general equilibrium. Other Austrians such as Rizzo and O’Driscoll have substituted the notion of “pattern coordination” for general equilibrium theory.

If this does not prove how absurd and ignorant is this type of internet Austrian, with their endless carping about “not understanding basic Austrian concepts,” then frankly nothing will.

BIBLIOGRAPHY

Hayek, Friedrich A. von. 1975. A Discussion with Friedrich A Von Hayek. American Enterprise Institute, Washington.