Monday, December 17, 2012

Mises versus Lachmann on Equilibrium Prices

Here is Mises on equilibrium prices:
“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).
This is a strident statement, and not just limited to Mises’s entirely fictitious evenly rotating economy (ERE), for Mises invokes the “plain state of rest,” a temporary state in which all desired transactions are completed and no further trades are conducted (e.g., the end of a trading day in the stock market).

For Mises, the “unhampered market” would produce prices caused by the dynamics of supply and demand curves, and deviations would lead to self-liquidation and market-clearing prices.

Yet even this vision is little more than ideological fantasy. Even in undergraduate economic classes, students will usually learn that the law of demand cannot really be universal, for Veblen goods and Giffen goods (perhaps often perceived as anomalies) already rule out an absolutely universal law of demand. And, even if government “distortions” could be eliminated, what about businesses that engage in price setting/price administration?

Prices set by businesses are not equilibrium prices. As Lee says, “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).

Matters are different when we turn from Mises to Ludwig Lachmann, who did indeed understand the existence of fixprice markets. First, an anecdote Bruce Caldwell tells about Lachmann is quite instructive:
“I first met Ludwig M. Lachmann on February 4, 1982 at the first spring semester meeting of the Colloquium in Austrian Economics at New York University. ….

During that first meeting I had an exchange with Mario Rizzo about the concept of market-clearing. I argued that though the speed of adjustment problem was an empirical issue, it was not something that could be tested as a general proposition. I drew the implication that one’s view of the rapidity of clearing was a matter of faith, nothing more than a metaphysical assumption, though obviously a crucial one. Lachmann nodded his head vigorously as I was finishing up, which pleased me immensely.” (Caldwell 1991: 140).
Secondly, Lachmann’s own judgement on the usefulness of equilibrium prices:
“Those who glibly speak of ‘market clearing prices’ tend to forget that over wide areas of modern markets it is not with this purpose in mind that prices are set. They seem unaware of the important insights into the process of price formation, an Austrian responsibility, of which they deprive themselves by clinging to a level of abstraction so high that on it most of what matters in the real world vanishes from sight.” (Lachmann 1986: 134).
This is yet another divergence between Lachmann’s brand of Austrian theory and the other branches of Austrian economics.


Caldwell, Bruce J. 1991. “Ludwig M. Lachmann: A Reminiscence,” Critical Review 5.1: 139–144.

Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.

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.

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


  1. I get the increasing impression that either Lachmann was not an Austrian theorist, he was inconsistent or, most likely, thought that the doctrine was a normative "matter of faith".

    1. He was very much an Austrian, though he did believe that the school was headed for disaster if they kept in line with libertarian philosophy. If anything, his whole career consisted of trying to demolish the libertarian influence in Austrian economics.

    2. I'm struck by how, in the video I link to and discuss here, Lachmann's characterisation of the Austrian school is really far from modern Rothbardians/Misesians:

      E.g., when he says from about 56.20 onwards:

      “The question is to be welcomed, because we historically have [?] certain points. In the British situation of 1932, Hayek and his friends rejected the proposals of Keynes and some non-Keynesian British economists – that at the bottom of the depression the government should take certain steps, and so on. Hayek has now realised that that was wrong. That is to say, I think Austrians today would not reject all measures to relieve unemployment and increase employment, in a situation in which nothing really is scarce. And in this respect I think Austrians … would have … have ... learned.”

      What on earth happened to all those Austrians who "would not reject all measures to relieve unemployment and increase employment, in a situation in which nothing really is scarce"?

    3. It seems they don't believe in "a situation in which nothing really is scarce". Their reaction to the phrase "idle resources" in the Free Advice blog is quite revealing. Hayek did believe it was possible to have "spare factors of productions of all kinds" in an economy, although he thought it was unusual. That's why he called Keynesian economics 'The economics of abundance'.

  2. "Yet even this vision is little more than ideological fantasy. Even in undergraduate economic classes, students will usually learn that the law of demand cannot really be universal, for Veblen goods and Giffen goods (perhaps often perceived as anomalies) already rule out an absolutely universal law of demand. "


    Think again. Veblen and Giffen goods SEEM to violate the law of demand. But consider this. Suppose w have hotshot lawyer making $10 million a year. The lawyer wants a high priced watch, a rolex, to bolster his status and self image. He'll choose an expensive watch, FOR THE REST OF US, a watch worth say, 700,000. That watch might be in his price range. But if the Rolex merchant were to decide to rasie his price to 10million, he would quickly find that even businessmen and lawyers, athletes and celebrities, would reach their limit on how much they want to spend.

    The law of demand IS universal, even considering giffen and veblen goods upon further reflection

    1. "The law of demand IS universal, even considering giffen and veblen goods upon further reflection"

      By stretching the word "universal" a long way, you can of course say this!

      Yes, if you raise the price to something astronomical, then eventually people won't buy it. But that is not what happens in the real world is it?

      What merchant is so stupid as to raise the price of a watch to $900 billion or some such price?

    2. Nope. Sorry. Veblen goods are goods whose desirability increases as their price rises. This implies that price rises have an endogenous effect upon preferences.

      In standard neoclassical/Austrian theory price is an "effect" of true underlying preferences which are independent. Here preference become a function of price. This completely violates what we would usually call the "law of demand" because everything becomes highly elusive. Is the price causing the preference or the preference causing the price etc? This in turn means that the market itself can start to exercise control over individuals desires, which is at odds with the Austrian theory that the market allows free individuals to exercise choices through market mechanisms.

      In order to have a "law" you must have strict causality. X causes Y. Or: preferences lead to demand which is negatively effected by rising prices. Vebelen goods muddy this strict causality and thus overturn the law.

      Because many neoclassicals/Austrians don't seem to understand how scientific laws are actually constructed, they just make amendments when anomalies show up. But these anomalies often overturn their laws by destroying the causality inherent in them. But the neoclassicals/Austrians usually just play semantic games to get around this -- as you've just done.

      Neoclassicals and Austrians don't seem to understand what effect the existence of such goods (and they are legion!) have on their "laws". I think they overturn them completely. And imagine if we say the same about speculation. I.e. rising stock prices cause more demand for stock. Then the justification for free-markets as a rational means for resource distribution becomes patently false.

      The genius of neoclassical/Austrian economics is that it is an ideology in the most refined sense. It is a belief system that is passed off as rational commentary. In order to solidify its hold over the masses it needs to be misunderstood. In that regard its very similar to the ideological system of medieval theology in which Truths were accepted without question and anytime anyone disagreed they were simply battered with quotations and semantic sophistry. As Montaigne said of the scholastics:

      "Let him remove his academic hood, his gown and his Latin; let him stop battering our ears with raw chunks of pure Aristotle; why, you would take him from one of us — or worse. The involved linguistic convolutions with which they confound us remind me of conjuring tricks: their sleight-of-hand has compelling force over our senses but it in no wise shakes our convictions."

      Replace "Aristotle" with "supply and demand analysis" or "marginalism" and you have a very accurate description of economic discourse today.

    3. "I.e. rising stock prices cause more demand for stock. "

      That really is a crucial point. And it can apply to houses and real estate too.

      As the price of houses rises, suddenly more and more people realise they can make a quick buck on houses through the price appreciation; hence more demand for houses as investment properties, second hand houses, or just new houses.

    4. Well, LK, you know my stance on this: it can apply to ANY non-fixed price market good if the conditions are right.

      *Cough* *Cough*

    5. Philip,

      You wrote: Neoclassicals and Austrians don't seem to understand what effect the existence of such [Veblen] goods (and they are legion!) have on their "laws".

      Specifically, which Veblen goods do you see as most damaging to the law of demand? Could you give me a list of, say 5 examples?

      Thank you.

    6. It's a theory being damaged that I'm talking about. If a theory is inconsistent then it should be dropped by all right thinking people. You don't need to "refute" the downward-sloping demand curve based on empirical estimates because it was never constructed using empirical estimates. So, that's just not the nature of the game we're playing.

      As to what are the most prominent Veblen goods in our society, I don't have an estimate. I'd guess that you'd look at those goods which most income is spent on and which display aspects of being Veblen goods. So, at a guess:

      (1) Housing in upmarket areas.
      (2) Upmarket car brands.
      (3) Brand name decor and furniture.
      (4) Brand name clothing.
      (5) The current "fashionable" holiday location.

      Total guesses, of course. I don't study the purchasing habits of rich people because I'm an economist and not a marketer. I'm more concerned with the theory. Once price and preferences become endogenous or dependent the theory falls apart.

    7. "It's a theory being damaged that I'm talking about. If a theory is inconsistent then it should be dropped by all right thinking people."

      Economic theories are not like theories of physics or mathematics. Theories of human behaviour are never universal because some humans in some situations might always behave differently. The law of demand IS valid for the vast majority of goods that are bought for their own use rather than speculation. The exceptions are interesting, but not necessarily important.

  3. Mises invoked a completely fictitious construct ERE as way to study the market when change is removed. Mises clearly states this on page 243 " The evenly rotating economy is a fictitious system in which the market prices of all goods and services coincide with the final prices."
    Do you not think a moment could happen, especially when no data changes as in the ERE, that all transaction would simply stop? This is clearly not possible as the data is always changing but that was Mises' point in invoking the ERE in the first place.
    Here again you are confusing equilibrium price as though it were the market price when in actuality the equilibrium price is the final price which according to Mises is never reached. Market prices are actual prices paid for goods. Final prices are what markets participants are in a constant state of activity to reach but never do due to the constant state of unrest.
    Market prices are indeed set by firms. It would be impractical for them to change their prices on a daily basis and they simply don't need to in order to be profitable. Not every data fluctuation of the market need be a cause for action by the CEO in setting prices. But it is also silly to think that even the most price-settingest firms can forever ignore the market and stay in business. Decisions about pricing in some markets are simply easier to make at longer intervals because it would harm the firm to have many price fluctuations. And they do change their prices based on the changing data of the market but based on many factors not just the momentary final price.
    Again, market price always embodies all the data of the market, including convenience, but the final price is never attained because there is never a time when the data do not change.

    1. ALima,

      I did not say that Mises thinks the ERE or final state of rest are attained in the real world.

      What is stated above is that Mises thinks all prices adjust in accordance with supply and demand dynamics. That suggests that Mises - like Marshall - thinks some markets might attain their equilibrium prices sometimes, but the whole market never does.

      By admitting the existence of price administration at the end of the comment, you have conceded my point.

    2. I concede that businesses set prices at which they would like to sell which become the market price. These are not, however, equilibrium prices. If buyers do not purchase a sufficient quantity of units at the price set by the seller it doesn't matter how fixed the price is, the seller will not make a profit and will have to change their price or risk losing profit on the item. This happens in nearly every store in the world.
      This process is not detached from the forces of supply and demand.

  4. "Evenly rotating economy" - sounds like a setting for your washing machine.

    1. Lol! Mises had a horrible style. If I were to describe it I would call it "uptight, withholding and mean". He would have made a good washing-machine instruction manual writer.

    2. Philip!Mises in my view is unreadabel!Human Action consist of mental stammering,no more no less.I doubt the little "Austro-Turf" trolls read throw that book!I guess their get their education from CATO or Mises pamphlets,or "readers digest" versions of that horrible book!

  5. In 2011, Toyota cut the price on its upcoming 2012 Camry models by $200. From the WSJ:

    "Toyota is trying to retain its dominance in the midsize sedan market as competitors have taken market share."

    Two questions:
    1. If this is not a response to an increased supply of substitutes to its product line, then to what can we attribute Toyota's decision?

    2. If prices have no tendency to move toward equilibrium, then why did Toyota decide to cut prices rather than raise them?

    1. John you make a good point. Many factors contribute to price not just supply and demand. Demand does not increase for luxury goods just because the price is higher than a substitute. These items are simply perceived as more valuable than the substitute by the buyer.
      Prices increase for more demanded items if there is no substitute.