Why most Austrians do not Understand Modern Mark-up Pricing Theory

The proof is right here in these posts by the Austrian economist Robert Murphy:

Robert P. Murphy, “Problems with the Cost Theory of Value,” Mises Daily, May 23, 2011.

Robert P. Murphy, “Subjective-Value Theory,” Mises Daily, May 30, 2011.

A reading of these posts shows that when many Austrians attack what they call the “cost theory of value” they are attacking a Classical, Marxist or quasi-Marxist theory: they simply do not understand nor do they refute modern Post Keynesian and non-neoclassical Institutionalist mark-up pricing theory (which can also be called the cost-plus/administered price theory).

Modern mark-up/cost-plus pricing theory has the following important characteristics:

(1) it is not the Marxist or Classical Economics labour theory of value. Virtually all Post Keynesians reject the labour theory of value. Nor is mark-up pricing theory a quasi-Marxist “cost theory of value” where value is equated with price;

(2) following from (1), a fundamental distinction must be made between (i) value and (ii) price. Mark-up/cost-plus pricing theory is explaining price of some commodities, not their value;

(3) following from (2), most Post Keynesians and non-neoclassical Institutionalists can and do accept that value defined as the satisfaction or utility derived from the consumption of a good is subjective. The argument is not about subjective value/utility, which does exist, but about how certain market prices are actually determined, even though the utility derived from a good is subjective;

(4) Mark-up/cost-plus pricing theory does not dispute or deny the existence of flex-price markets in modern economies (such as in stock markets, primary commodities, auction markets for works of art, antiques etc.), and that when these markets involve goods with well-behaved demand curves and prices really are flexible, the prices can be explained, more or less, by conventional supply and demand dynamics. Mark-up/cost-plus pricing theory does not claim to be a universal theory of price formation, but merely an important theory that does explain many prices.

(5) Mark-up/cost-plus pricing theory does, however, dispute the extent and significance of flex-price markets in modern economies.

Empirical evidence in many surveys throughout the developed world and even in developing nations shows us that most prices are set by businesses through their cost accounting conventions in an ex ante manner before transactions take place, on the basis of (1) total average unit costs plus (2) a profit mark-up, at a given, estimated, projected or target quantity of output or level of sales (from which of course the ex post or actual quantity of output produced or sold in a given time period might differ).

Empirical evidence shows us that these mark-up prices are generally inflexible with respect to demand, but tend to change – though it is by no means a necessary or universal process – when total average unit costs change or when the business wants to change its profit mark-up.

In addition, there is a strong bias – or asymmetry – towards upwards rather than downwards price adjustments in modern mark-up price markets.

(6) in many mark-up pricing businesses, when demand changes, there will be no price adjustment, but adjustment in capacity utilisation and changes in buffer stocks/inventories.

When demand slumps, for example, firms will fire workers, cut production, and cut costs, and generally leave prices unchanged. When demand surges, firms will expand production, increase overtime and hire workers, and generally leave prices unchanged too.

That there are exceptions to this general type of firm behaviour, where, for example,

(i) some firms might temporarily cut their mark-up in a recession,
(ii) cut their mark-up for customers who make bulk purchases, or
(iii) where some retail businesses do indeed hold clearance sales of certain items that they have difficulty selling

simply does not refute the evidence that most mark-up pricing businesses do not generally adjust prices in response to demand changes in the way required by conventional supply and demand dynamics.

Now Austrian economics is fundamentally dependent on the idea of flexible prices and wages moving towards their market clearing values in a way that allegedly coordinates markets.

But if the majority of prices are mark-up prices and simply not very responsive to demand, many Austrian theories fall apart or are severely undermined.

There is no strong tendency to Misesian “economic coordination” by price adjustment, because such price adjustment does not happen in most markets. The idea that rapid and smooth recoveries from recessions/depressions happen by price adjustment (and by wage adjustment) is untrue: recovery will happen in most mark-up pricing markets by changes in demand and production, and because of the prevalence of such markets, this means that throughout most of the economy changes in demand cause direct changes in employment, production and output.

Unless Austrians properly understand modern mark-up/cost-plus pricing theory and actually engage with it, they are doomed to be intellectually irrelevant and an embarrassment.

Further Reading
Mark-up Pricing in 20 Nations and the Eurozone: the Empirical Evidence.

Post Keynesian Price Theory 101.

“Kaldor on Economics without Equilibrium,” March 9, 2013.