Prices and Production: Hayek's Assumption

Published Mon, Feb 9 2009 4:59 PM | laminustacitus

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.