“In different markets prices are formed in different ways. Not all pricefixing agents have the same interests. Here historical change plays its part. The decline of the wholesale merchant, whose dominating role Marshall took for granted, for instance in textile markets, and who naturally aimed at setting such prices as would permit him to maximize his turnover (a short-run consideration), reduced the range of markets with flexible prices. The rise of the industrial cost accountant as a pricefixer, with his interest in ‘orderly marketing’ (a long-run consideration) and his aversion to frequent price changes, has made most prices of industrial goods in our world Hicksian fixprices. In all markets dominated by speculation of course prices must be flexible. On the other hand, all bureaucracies, including those concerned with production planning in large industrial enterprises, naturally abhor flexible prices.” (Lachmann 1994: 166).In Classical economics (from Smith to Mill), the equilibrium value of prices in the long run was essentially the cost of production. With the marginalist revolution, value was held to be subjective, and prices a consequence of the marginal utilities of market participants (Lachmann 1994: 165).
Yet, with the existence of “fixprices” in many markets, it is obvious that cost of production plus the profit markup must explain how prices are set in the real world.
That nobody can sell a product for which there is no subjective demand is obviously true, but after that the subjective theory of value has its limitations.
While economic “value” defined simply as the pleasure, utility or satisfaction we derive from commodities is subjective, it is a mistake to think that prices are therefore all subjective, or just determined by subjective utilities. One has to distinguish “price theory” from “value theory,” but curiously modern neoclassical economics has largely dispensed with “value theory.” As I. A. Kerr has pointed out,
“[m]ore recently, the attitude of neoclassical economists to the value/price distinction has been one of indifference, rather than hostility … value theory is virtually synonymous with price theory and many economists would be hard pressed to explain the difference between the two. In fact, the two terms are widely conflated by neoclassical economists” (Kerr 1999: 1218).Yet that conflation is a mistake.
The existence of price setting/price administration is real.
You might wonder: where does this leave the idea held by neoclassicals and some Austrians of an economy with a strong tendency to a general equilibrium, in which prices gravitate to their equilibrium, market clearing levels? It leaves the idea looking highly suspect, to say the least.
From the perspective of Walrasian general equilibrium theory, all real world prices are “disequilibrium prices” (Lachmann 1994: 165).
While one can point to certain flexprice markets where eliminating excess stock leads to some flexibility in price, and we regularly see “clearance sales” by retailers to liquidate unsold stock, the notion of a general “market clearing, equilibrium price” in many other markets with fixprices/administered prices must be judged a myth. The empirical reality is discussed by F. S. Lee:
“Where reported … business enterprises stated that variations in their prices within practical limits, given the prices of their competitors, produced virtually no change in their sales and that variations in the market price, especially downward, produced little if any changes in market sales in the short term. Moreover, when the price change is significant enough to result in a non-insignificant change in sales, the impact on profits has been negative enough to persuade enterprises not to try the experiment again … The absence of any significant market price-sales relationship in the short term has also been noted in various industry studies … Consequently, business enterprises do not utilize an inverse price-sales relationship when making pricing decisions and nor do they set their prices to achieve a specific volume of sales. Instead, the prices they set are maintained for a variety of sales volumes over time.” (Lee 1994: 319–320).Lee concludes that this “necessarily means that administered prices are not market-clearing prices and nor do they vary with each change in sales (or shift in the virtually non-existent market or enterprises ‘demand curve’)” (Lee 1994: 320, n. 18).
The inference from this and empirical reality is, of course, that with really large falls in demand, businesses fire workers and cut production. Prices are not adjusted to clear markets with excess volume.
Kerr, I. A. 1999. “Value foundation of Price,” in P. A. O’Hara (ed.), Encyclopedia of Political Economy, Routledge, London and New York. 1217–1219.
Lachmann, L. M. 1982. “The Salvage of Ideas: Problems of the Revival of Austrian Economic Thought,” Journal of Institutional and Theoretical Economics 138.4: 629–645.
Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.
Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. Don Lavoie). Routledge, London.
Lee, F. S. 1994. “From Post Keynesian to Historical Price Theory, Part 1: Facts, Theory and Empirically Grounded Pricing Model,” Review of Political Economy 6.3: 303–336.