The significance of that discussion is described by the Austrian Ludwig Lachmann in a review of article of Capital and Growth:
“Two other matters of great significance are dealt with in the first part of the book. As others have done before him, Professor Hicks finds it necessary to stress, in his chapter on Marshall’s method, that our world differs from that which Marshall took for granted in that we live in a world of prices ‘administered’ by manufacturers, ‘but in those days even manufactured goods usually passed along a chain of wholesalers and retailers, each of whom was likely to have some independent price-making opportunity.’ (55) Again, like others before him, our author attributes the cause of this change to the virtual disappearance of the wholesale merchant and his price-setting function after 1900. Formerly ‘the initiative would come from the wholesaler or shopkeeper, who would offer higher prices in order to get the goods which, even at the higher price, he could re-sell at a profit. Similarly, when demand fell, it would be the wholesaler who would offer a lower price. The manufacturer would have to accept that price if he could get no better.’ (56) Hence, while Marshall’s was a world of flexible prices, even though not of ‘perfect competition,’ ours is a ‘fixprice world’ with prices set on a ‘cost plus’ basis and wage rates as ultimate price determinants.Lachmann was well aware of the significance of fixprices, and discussed them in The Market as an Economic Process (Oxford, 1986), pp. 122–136.
The analytical significance of this historical change lies, on the one hand, in the fact that the ‘Temporary Equilibrium Method’ which Hicks himself, following Lindahl, used in Value and Capital in 1939, has lost much of its validity. ‘The fundamental weakness of the Temporary Equilibrium method is the assumption, which it is obliged to make, that the market is in equilibrium—actual demand equals desired demand, actual supply equals desired supply—even in the very short period.’ (76) Hence we have to look for another method of dynamic analysis. To find it we must move nearer to Keynes and his successors who are here given credit for having understood, earlier than others, that a fixprice world requires a fixprice method of analysis.” (Lachmann 1977: 238–239).
Lachmann stated:
“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).Lachmann even concluded that his own fellow Austrians had badly neglected the task of studying real world price formation (Lachmann 1986: 130–131).
That is a failing that most Austrians are guilty of to his day, despite some discussion of the issue in Reisman (1996), pp. 414–417, where Reisman does not consider the implications of cost of production plus profit mark-up pricing for Austrian theories of economic coordination.
Links
“Lachmann and Post Keynesianism on Prices,” August 1, 2012.
“Mises versus Lachmann on Equilibrium Prices,” December 17, 2012.
“Caldwell on Lachmann on Equilibrium Prices,” November 6, 2012.
“Kaldor on Economics without Equilibrium,” March 9, 2013.
BIBLIOGRAPHY
Hicks, John Richard. 1965. Capital and Growth. Oxford University Press, Oxford.
Lachmann, Ludwig M. 1966. “Sir John Hicks on Capital and Growth,” South African Journal of Economics 34: 113–123.
Lachmann, Ludwig M. 1977. Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. Walter E. Grinder). Sheed Andrews and McMeel, Kansas City.
Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.
Reisman, George. 1996. Capitalism: A Treatise on Economics. Jameson Books, Ottawa, Ill. and Chicago.
Firstly I'd like to start with a complement - your blog is consistently putting forward challenging material on interesting topics.
ReplyDeleteNow some comments on administered pricing:
There is the tendency that exists in the market for profits to equalized between industries. An industry making above average profits will attract new entrants which will lead to an expansion of production and a reduction of price (and increase in costs) until profits (or mark-up) is at the same level as in other industries. For each good the strength of consumer demand will lead to output expanding to the level where the rate of profit is at the equilibrium rate for the economy as a whole and this level will equate to something that looks like like price = "cost + markup".
To call this "administrated pricing" however is incorrect. If one looks beneath the surface then one needs marginal pricing models to explain the prices of scarce resources and indeed to explain why production expands to the level where price = cost + markup in the first place.
Firms will build this empirically observed reality into into their planning. Rather than incurring the costs of constantly adjusting prices for each day-to-day change in demand they will keep the price fixed in the short term by varying inventories and production levels. It is not clear to me why prices maintained in this would not be equilibrium prices. Firms are in effect adjusting their demand to hold based on market conditions and this leads to stable short-term prices.
The above features of the pricing system is likely to contribute to the observed reality of "sticky-pricing". Changes in demand are likely to lead to changes in quantity produced rather than changes in price. If aggregate demand changes due to changes in th4e demand to hold money then this can have large macro-economic effects.
It is understanding this reality that is at the heart of monetary dis-equilibrium theory.
"Changes in demand are likely to lead to changes in quantity produced rather than changes in price. If aggregate demand changes due to changes in th4e demand to hold money then this can have large macro-economic effects. "
DeleteRight. But what are the implications of this?
If one accepts:
(1) that the Austrian business cycle theory is false,
(2) that the idea that price adjustment as the main method by which demand is equated with supply is wrong,
(3) that quantity adjustment is generally what happens in
the real world,
(4) that investment is subject to incalculable, non-probabilistic risk (uncertainty)
(5) that business expectations are subjective, and
(6) that the investment level will not simply be a function of the rate of interest or labour costs (although no these things have influence),
then the Keynesian model is confirmed. Aggregate demand via the extensive fixprices markets drives employment and output.
It is only a short step to understand the role of the multiplier and that Keynesian stimulus ought to work.
Monetary stimulus -- whether done by a central bank or even free banks wishing to increase lending -- is not likely to be really effective in serious cases of recession/depression.
Fiscal stimulus is called for.
Correction:
Delete"(6) that the investment level will not simply be a function of the rate of interest or labour costs (although these things CAN AND DO have an influence),"
"There is the tendency that exists in the market for profits to equalized between industries. An industry making above average profits will attract new entrants which will lead to an expansion of production and a reduction of price (and increase in costs) until profits (or mark-up) is at the same level as in other industries. "
DeleteNo, the real world is too messy and uneven for this. Very different degrees of competition between industries, barriers to new entry, patents, labour issues will thwart the process. Differences in market power are too strong.
However, it is most curious that neo-Ricardians/Sraffians -- whom some think of as a kind of sub-school of Post Keynesians -- do adhere to the uniform long run rate of profit idea.
Also, in a convergence to some neoclassical general equilibrium state or Mises's final state of rest, prices are supposed to fall to their cost of production -- or equilibrium -- level, which should eliminate the profit mark-up! That is clearly contrary to the marginalist theory you're trying to use to dismiss "administered pricing".
Delete"Mises's final state of rest, prices are supposed to fall to their cost of production -- or equilibrium -- level, which should eliminate the profit mark-up!"
DeleteI think this is just a terminological thing. Mises uses "interest" to refer to what might more commonly be called "profit" , and "profit" to mean anything in excess of "interest".
So in final state of rest there will be interest but no profit.
"No, the real world is too messy and uneven for this. Very different degrees of competition between industries, barriers to new entry, patents, labour issues will thwart the process. Differences in market power are too strong"
DeleteAll of this is true and to the extent it is true it weakens the degree to which prices reflect real costs.
An industry making above average profits will attract new entrants which will lead to an expansion of production and a reduction of price (and increase in costs) until profits (or mark-up) is at the same level as in other industries.
DeleteRob is right. Look at the tablet market. I think we all can agree that Apple is the dominant technology company of our time, with fanatical brand loyalty and a keen willingness to use patents as a weapon (just ask Samsung). After the iPad, most analysts predicted Apple would comfortably outsell Android tablets until around 2016.
Yet the outcome has been very different.
"Apple’s global tablet market share has dropped from over 60 percent in Q2 2012 to around 40 percent in each of the third and fourth quarters of 2012 and the first quarter of 2013."
http://venturebeat.com/2013/05/03/android-tablets-will-hit-60-market-share-this-quarter-as-ipad-shipments-dip-analyst-says/#5cLS3OPCtkt2UWRV.99
How have Android tablet makers toppled the iPad? Simply put: price cuts. First came the Kindle Fire at $199 (to iPad at $500). The Nexus 7 kept the $199 price tag but upped the hardware specs and software. Now we have HP and Acer at $169. Is there any doubt $149 is just around the corner?
So while Apple is the still the single largest tablet manufacturer, don't expect this to last much longer. Even Apple has been forced to cut prices, in the form of the iPad mini. Out of the 19 million iPads sold last quarter, 12 million were minis, priced at $329.
A similar story can be seen in LCD TVs. Ten years ago, a 40-inch model cost around $5-7,000. Today? Less than $500, with better picture quality and a thinner, lighter screen to boot. Have profits fallen among the early leaders? Well, let's just say Sony isn't making 40% margins anymore.
http://www.hdtvtest.co.uk/news/sony-8th-straight-year-losses-201105261166.htm
Re: patents--yes, they are barriers to entry. This is an excellent reason to abolish the patent system. At the very least, patent length should be limited to less than 5 years.
DeleteIn an age when product life cycles are measured in months, it makes no sense to grant govt-backed monopolies on key technologies for 20 years (or 14 years for design patents).
See Boldrin and Levine, Against Intellectual Monopoly (the entire book is available for free online, natch):
http://levine.sscnet.ucla.edu/general/intellectual/againstfinal.htm
And copyright. Copyright in particular is vastly too long. Five years would be too long.
DeleteI don't fully accept any of your 1-6 in the form they are stated, I'm just trying to understand what they mean in terms of monetary v fiscal policy.
ReplyDeleteIf (1), (2) and (3) alone were true then monetary policy would be all that is needed. Keep AD constant via monetary policy and you will have no problem maintaining constant full employment.
(4), (5) and (6) seem to be related to "animal spirits" affecting I. I'm not sure what this means in a "price = cost+markup" world. Does it mean that the qty produced will vary for a given price depending upon business confidence ? If so , then as long as qty produced still increases with increased demand then surely AD can still be increased to full employment levels via monetary policy alone. I don't see why fiscal policy would ever be needed.
Because once business confidence takes a severe blow, lowering the interest rate won't necessarily revive it.
DeleteThe money multiplier idea of credit creation is false and broad money is endogenous: it is created in response to demand for it.
When demand for credit collapses and expectations are shattered, increasing base money does not create sufficient credit demand. Witness the failure of QE1, QE2 and QE3.
It's all related to fundamental uncertainty and subjective expectations -- which are Austrian concepts, by the way.
As well as the invalidity of the notion of a universal law of demand.
What will restore confidence in fixprice goods markets is direct quantity signals: surges in sales orders or sales volume.
But new demand depends on new credit and investment in these circumstances where monetary policy is already impotent.
Government spending G is the remedy.
"What will restore confidence in fixprice goods markets is direct quantity signals: surges in sales orders or sales volume."
ReplyDeleteSo why wouldn't increasing the money supply cause sales volume to increase as people get bigger cash balances than they want to hold and they start to spend to reduce them ?
The only way banks can increase the money supply is by debt.
DeleteTell me: did QE1, QE2 and QE3 induce the necessary debt and investment to restore full employment in the US?
Why would over indebted households take on more debt? Why would businesses with poor sales and stagnant demand take on more debt if they get no signals from increased demand?
To add : I think you overly focused on the role of credit in monetary expansion. When the money supply increases (by central bank purchases or when new money is used to fund things like tax-cuts) the new money does not have to be lent out through the credit markets, but ends sup directly in people's cash balances. This will cause people to have higher cash-balances than they wish to hold and they will spend to reduce them. This increased spending may then cause businesses to start borrowing but this is a secondary step.
ReplyDelete"When the money supply increases (by central bank purchases or when new money is used to fund things like tax-cuts) the new money does not have to be lent out through the credit markets, but ends sup directly in people's cash balances."
DeleteHow does a central bank "fund things like tax-cuts"??
Conventional central bank open market operations can ONLY induce greater broad money supply growth by further private debt.
If you're thinking of having a central bank print money and just give it to people to spend without debt, that is not conventional monetary policy, but the functional equivalent of fiscal policy.
Anyway, what central banks actually do just print money and give it to people? None.
The money supply can always be increased by CB purchases of private assets. This will increase people's cash holding and induce extra spending as they try and reduce these balances. In a fix-price world (with the 6 features you describe) it is hard to see why this would not induce output to expand.
DeleteThe above would be true even if banks never increased lending by even $1.
You mean if the central bank bought non-financial sector, non-bank assets, and gave that money directly to those agents, then this would increase the money supply.
DeleteYes, but that is not conventional monetary policy. As I said, it is merging into de facto fiscal policy. And it is not what central banks normally do. I think the Bank of England has done some of this, but it does not seem to be very significant.
http://www.telegraph.co.uk/finance/economics/9324565/Central-banks-should-buy-assets-other-than-government-bonds-says-Bank-of-Englands-Adam-Posen.html
Also, even with this policy, it is likely that over-indebted private agents will pay down debt, which is not necessarily going to stimulate AD.
If the CB buys assets (no matter what kind) from the non-banking sector then it increases the money supply (and increasing cash balances) by means other than increasing bank reserves. Hard to see why this would be called fiscal policy, but that's just a minor matter of definition.
DeleteEven if the new money was used to pay down debt then this will still increase spending as with lower debt people will spend more out of income.
"Hard to see why this would be called fiscal policy,"
DeleteI didn't call it fiscal policy in the strict sense; I called it "de facto fiscal policy." It is functionally equivalent to the government buying your asset out of its budget deficit, with money created by the central bank. That is de facto fiscal policy.
"Even if the new money was used to pay down debt then this will still increase spending as with lower debt people will spend more out of income."
Right. But large scale fiscal policy does it better by employing the unemployed and doing something useful with idle resources, like public works.
And what you're describing is most certainly NOT conventional monetary policy. How many central banks are doing this? How many are making very large scale private non-bank asset purchases?
DeleteAlso, how on earth would a free banking system do anything like this? Free banks can't just create their own gold monetary base from nothing, as any modern CB can create fiat money from nothing.
And even if they printed up their own private banknotes to buy assets, they would still need massive more monetary base to make final clearing when people spent their banknotes.
Right, if CBs were doing this now we wouldn't be in such a deep recession.
DeleteGood question about free banking: The idea of monetary equilibrium is to stabilize the value of money so if (for example) the free bank tied its value to gold (or more likely a basket of commodities) it would (if demand to hold money was increasing) buy enough assets to stabilize the value and this would increase the monetary supply so that the increased demand is satisfied. Analysis will show that this will prevent any clearing problems.
"Right. But large scale fiscal policy does it better by employing the unemployed and doing something useful with idle resources, like public works."
DeleteTo my mind increased private spending will drive a optimal outcome based on market forces. I know that you disagree with this, and I can't think of any arguments that will work so we will just have to agree to differ on this one.
" the free bank tied its value to gold (or more likely a basket of commodities) it would (if demand to hold money was increasing) buy enough assets to stabilize the value and this would increase the monetary supply so that the increased demand is satisfied. Analysis will show that this will prevent any clearing problems."
DeleteI find this statement inexplicable.
How would a free bank buy extra gold when its reserves are limited and needed for its own clearing?
Will it buy with its own printed banknotes? And what happens when it has to clear those banknotes? All its bought gold is just gone again.
Net result: zero increase in its reserves of gold.
A private currency issuer announces that it will fix the value if its currency units at a certain value in terms of other commodities and has enough capital to make its statement credible.
DeleteAs demand to hold that currency increases it creates more currency units and uses the new money to buy more assets. If demand to hold the currency falls it sells assets for currency units and reduces the number of currency units.
This currency could also be used as the base of fractional reserve banking.
This is a different scenario to a gold standard. It doesn't have to actually hold the commodities it is pinning its value to - just enough assets to credibly maintain its currency units value should demand to hold fall.
Hahaha, that was really hilarious! That's what I call a new way of doing monetary policy!
ReplyDelete