Saturday, February 1, 2014

Rothbard’s Non-Refutation of Administered Prices

Murray Rothbard penned what at first sight looks like an interesting article here:
Rothbard, Murray N. 1959. “The Bogey of ‘Administered Prices,’” The Freeman, September 1, 39–41.
Unfortunately, it strongly suggests that Rothbard had no proper understanding of what an administered price even is, and certainly could not refute the view that such prices are prevalent throughout modern market economies.

Rothbard’s comment here shows this:
“The point is that every seller, in a free society, whoever he is, has absolute control over the price he charges for his commodity. If I wish to set a price of $2,000 an hour for my services as a consulting economist, I am perfectly free to do so. I, the farmer, and General Motors all have this degree of control.

But this is all the control any of us have. The farmer can charge whatever he wants, but (in the free market) he cannot force anyone to buy his goods at that price. Neither can I, and neither can General Motors! All of us sellers are in the same boat. We have absolute control over the price we ask for our services, but we have no control whatever over the price the buyer is willing to pay. If we set our prices too high, people will not buy our products.

And so every producer, whatever his field, is constantly engaged in trying to discover his market, in trying to determine how much buyers are willing to pay for his product. And we each set our prices, in the real world, according to our estimates. The fact that the farmer has his market all ready and waiting for him and General Motors does not, is a purely institutional matter which in no way alters the principle. The point is that both producers can set any price they wish, but neither can compel a sale. And, therefore, either no price or all prices are ‘administered,’ depending on how you choose to define the term.”
Rothbard, Murray N. 1959. “The Bogey of ‘Administered Prices,’” The Freeman 39–41.
This implies that Rothbard thinks an “administered price” is simply one set by the seller (without any specific detail about how it is set), forced on the consumer, and possibly even at an unrealistically high level.

This is not even an accurate view of what an administered price is.

An administered price or mark-up price is as follows:
(1) a price set by businesses through their cost accounting conventions in an ex ante manner before transactions take place, on the basis of total average unit costs plus a profit mark-up, at a given, estimated, projected or target quantity of output or level of sales (from which of course the actual quantity of output produced or sold in a given time period might differ);

(2) a price that is generally inflexible with respect to demand, but tends to change – though by no means necessarily or universally – when total average unit costs change or when the business wants to change its profit mark-up;

(3) a price that is not governed by supply and demand dynamics in the usual economics sense, and which is not adjusted towards market clearing levels to create supply and demand equilibrium, and

(4) a price that is usually constrained by competition with other mark-up pricing businesses and often a price leader, and that will not be set at a level so high that it is unreasonable.
The existence of prices as above is an empirical fact with overwhelming evidence in support of it.

Rothbard’s point that if prices are “too high, people will not buy our products” is ultimately a trivial observation that has no force against administered price theory, since no administered price theorist claims that mark-up prices can be set at any level whatsoever, or that they are never constrained in some sense by competition.

Matters are no better if we turn to Rothbard’s Man, Economy, and State (Rothbard 2009: 662–664), which has a brief discussion of administered prices (apparently based on Rothbard 1959), but neither properly understands what an administered price even is nor refutes the reality that such prices are widespread.

And, finally, another libertarian attack on mark-up pricing does no better. Paul L. Poirot (1971) simply begs the questions and assumes that prices must ultimately be determined by supply and demand:
“Every selller of a commodity or service wants to cover his costs of production and receive something over and above such costs if pos­sible. He spends long hours keep­ing records and, with rare excep­tion, believes that he actually sets the price of his goods and services by adding a margin above his expenditures.

The truth, however, is that all recorded costs of an item are washed out and rendered irrele­vant by the actual market price at which that item is traded—a price determined by the competitive forces of supply and demand.”

Poirot, Paul L. 1971. “Cost-Plus Pricing,” The Freeman, January 1: 48–50
At least Poirot acknowledges that many a business person “spends long hours keep­ing records and, with rare excep­tion, believes that he actually sets the price of his goods and services by adding a margin above his expenditures,” but Poirot’s ideology simply blinds him and renders him totally unable to accept what is actually true.

Poirot, Paul L. 1971. “Cost-Plus Pricing,” The Freeman, January 1: 48–50

Rothbard, Murray N. 1959. “The Bogey of ‘Administered Prices,’” The Freeman, September 1: 39–41.

Rothbard, M. N. 2009 [1962]. Man, Economy, and State, The Scholar’s Edition. Ludwig von Mises Institute, Auburn, Ala.


  1. You talk as though firms that make quantity adjustments rather than price adjustments in response to a change in demand must be using administered pricing.

    Such behavior is however also consistent with profit-maximization. A firm that is a price taker on the input side, faces low storage costs and elasticity of demand such that it would have to reduce price by a lot to "clear" its stock will clearly maximize profit by increasing inventories when demand falls and reducing output in the next period

    If (by chance) the maximizing rate of profit such a firm could make happened to be equal to the mark-up desired by a company that practiced AP then an outside observer would not easily be able to tell what kind of pricing algorithm a firm used just by watching it's pricing and quantity decisions.

    A firm that always faces low storage and elasticity and knows the average rate of profit in its industry may in fact choose administered pricing BECAUSE this is a profit-maximizing strategy - constantly changing prices and output levels would simply add to its costs.

    1. When -- to pick one of the many surveys at random that report much the same findings around the world -- a well-sampled survey of 725 firms in Norway finds that about 69% of Norwegian businesses and firms set their prices as a mark-up over costs (Langbraaten, Nina, et al. 2008. “Price-setting Behaviour of Norwegian Firms – Results of a Survey,” Norges Bank Economic Bulletin 79.2, p. 26), this is very strong evidence that my position is right.

      We don't need to remain "outside observers" when such very good empirical evidence is available.

    2. You don't address my last point: A firm may choose to adopt AP because this is the profit maximizing strategy given the parameters it faces.

      Have any of the various studies that you like to quote that indicate that a majority of firms practice AP gone on to analyze the reasons why firms choose the pricing strategy they do?

  2. Sorry, I'm still generally learning this stuff. But if firms decide they wish to use mark up pricing, and hold prices constant, by adjusting their inventories, wouldn't an Austrian say that this is just an EXAMPLE of dynamic changes in supply? Aka if demand increases/decreases, firms change their subjective valuation of what quantity they would supply, thereby offsetting the potential change in price due to demand, and holding it at a constant "mark up" price? Please correct me if I'm wrong, I am just learning this stuff and want to understand!