Prices and Production: Hayek's Assumption
Hayek realized that many
of the difficulties involved with the first edition of Prices and Production could not be clarified without rewriting the
entire book. Indeed, those obstacles were inherent in the mode of expression
that he decided to utilize in writing the book. All factors considered, Hayek
decided that the best course of action was to warn the reader beforehand about
the difficulties ahead, and to inform him why they were included in the form
that they were.
The first concern of
Hayek’s was in respect to his assumption to treat as one and the same the real
changes in the structure of production that accompanies alterations in the
amount of capital, and the monetary mechanism responsible for them. He did this
because of the time constraints that Hayek had while giving his lectures, made
possible only by the simplified assumptions that noted: “any change in the
monetary demand for capital goods proportional to the change in the total
demand for capital goods that brought it about.” (Hayek 1935, X). In this
sense, demand for capital goods does not only include the demand for them on
the markets, but it also includes the willingness of individuals to hold
capital goods over a period of time, a critical aspect for maintaining the
structure of production. Though there can be no quantitative statements made
about this total demand, and the monetary demand for goods manifesting itself
on the markets, this fact is not particularly relevant for Hayek’s analysis.
What does matter, though, is that changes in the monetary demand for capital
goods cannot be treated as isolated events in the market for capital goods;
rather they must be treated as affecting the general demand for capital goods.
To display this fact, Hayek took the simplest assumption he could: a fixed
relationship between the monetary demand, and the total demand for capital
goods (this relationship, if followed further lead to another premise: “(it
made) the amount of money spent on capital goods during a unit period of time
equal to the vale of the stock of capital goods in existence.” (Hayek 1935, XI).
However, the above
assumption, though it added to both the lucidity and utility of Prices and Production, was
misleading in two senses: it prevented Hayek from discussing the topic of
durable goods, and it lead to the assumption of separate stages of production
of equal length. The latter provides a problem in that it is impossible to
assume that durable goods, ones that embody potential services that are waiting
for the moment to be utilized, will change hands at regular intervals of time.
Because of this, it is impossible to depict with the depiction of the monetary
mechanism that Hayek chose, and he thus decided to jettison the entire concept
from his analysis. He did not perceive this as a major defect for he wanted to
stress the role of circulating capital as opposed to fixed capital; something that
he felt had been previously neglected by other authors. The former imposed a
rather one-sided treatment of the velocity of money’s circulation because it
implied that money circulated at a constant rate through out the structure of
production corresponding to the rate at which goods moved through it. This
assumption prevented considering changes in the velocity of money, or
even balances of it in the different stages of production. It also leads to
strengthening the misrepresentation that the phenomena that Hayek was
describing would only be caused by a quantitative alteration in the amount of
money, and not by a change in money’s flow through the structure of production.
Hayek also received criticism for this assumption, yet against those who
declared that neglecting alterations in the desire to hold money stocks could
not lead to any worthwhile conclusions, he emphasized how small a selection of
monetary theory was actually treated in his book – in reality, to incorporate Prices and Production’s argument into
the edifice of monetary theory was a task that had yet to be taken. Without a
doubt, the assumption that Hayek made created possible misrepresentations, yet
he decided to draw the readers’ attentions to the difficulties and elucidate
what they were, and why they were included
Overall, to
preserve the lucidity, and original form of Prices
and Production, Hayek decided to treat genuine changes in the structure of
production and the monetary mechanism as the same with the simple assumption
that there exists a fixed relationship to monetary demand and total demand for
capital. However, this leads to the difficulties in that Hayek then had to
completely ignore the topic of durable goods, and could not examine the effects
of the velocity of money in the structure of production. Indeed, by warning the
reader beforehand, he hoped that any false conclusions drawn from these could
be prevented.