Mises on Market Clearing Prices and Demand Curves: A Critique

The crucial passage is below:

“It is ultimately always the subjective value judgments of individuals that determine the formation of prices. Catallactics in conceiving the pricing process necessarily reverts to the fundamental category of action, the preference given to a over b. In view of popular errors it is expedient to emphasize that catallactics deals with the real prices as they are paid in definite transactions and not with imaginary prices. The concept of final prices is merely a mental tool for the grasp of a particular problem, the emergence of entrepreneurial profit and loss. The concept of a ‘just’ or ‘fair’ price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. 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. It is no less possible to express it in mathematical symbols. But it is necessary to comprehend that such pictorial or mathematical modes of representation do not affect the essence of our interpretation and that they do not add a whit to our insight. Furthermore it is important to realize that we do not have any knowledge or experience concerning the shape of such curves. Always, what we know is only market prices – that is, not the curves but only a point which we interpret as the intersection of two hypothetical curves. The drawing of such curves may prove expedient in visualizing the problems for undergraduates. For the real tasks of catallactics they are mere byplay.” (Mises 2008: 329–330).

What Mises is saying here is as follows:

(1) the formation of prices on markets is “ultimately always” caused by the subjective value judgments of individuals, and prices are “entirely determined” by value judgements of people who “really act.”

(2) prices in product markets tend towards a point where total demand by buyers is equal to total supply offered for sale by sellers. This, of course, is a market clearing price. However, this is immediately qualified by the observation that if supply increases, prices must drop “other things being equal”: the ceteris paribus assumption that allows the usual exceptions Austrians like Mises invoke to explain rigid prices, such as government price controls, labour unions, and so on, as this passage confirms:

“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).

(3) If there is any doubt that Mises has in mind market clearing prices in this passage this completely removes the doubt:

“It is possible to visualize this interaction by drawing two curves, the demand curve and the supply curve, whose intersection shows the price.”

This “point” is nothing but the market clearing price.

(4) but then Mises says this:

“Furthermore it is important to realize that we do not have any knowledge or experience concerning the shape of such curves.”

One can presume that Mises is here saying that we cannot know the real shape of real world downward-sloping demand curves, but Mises is not questioning the general assumption that well-behaved downward-sloping demand curves are the norm, because if he really were implying the latter, his whole argument would be badly undermined.

Let us now expand on point (4). It is a serious problem: the idea that, generally speaking, goods have well behaved downward sloping demand curves is both theoretically and empirically questionable.

The theoretical evidence is discussed here and here.

If we turn to the empirical evidence, it has been known for a long time that reductions by suppliers in the prices of factor inputs do not necessarily induce more purchases of a factor by a producer if the latter’s sales are stagnant or falling (Lee 1998: 108).

And as Lee notes:

“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 sufficiently negative to persuade enterprises not to try the experiment again.” (Lee 1998: 207).

With the understanding that demand curves can in theory have any shape at all and the empirical evidence that many goods do not have well behaved demand curves, it follows that the whole idea that real world markets have a strong tendency to market clearing becomes implausible.

This is before we get to real world price setting behaviour such as mark-up pricing, which also utterly discredits the idea that product markets in real world market economies tend to have flexible prices that move towards their market clearing values.

And I have yet to see one shred of evidence that Mises ever discussed administered/mark-up pricing and its consequences.


BIBLIOGRAPHY
Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.

Mises, L. von. 2008. Human Action: A Treatise on Economics. The Scholar’s Edition. Mises Institute, Auburn, Ala. pp. 201–232, 324–394.

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