Is it prices that are the true market information or is it profit?
Imagine two industries: luxury sports cars and cancer pharmaceuticals. Lets say that the total revenue of the sports car industry is $1 million and the pharmaceutical industry is $1.1 million. Lets also say that the luxury car company has a total cost of $500,000 and the pharmaceuticals has a total cost of $750,000. That would make the profits of the car industry $500,000 and pharmaceuticals $350,000.
Now lets say that I am a potential investor, which company am I likely to invest my money in?
I would rather invest with the car company. Why is it that Austrians say "the signaling function of prices"?
tir38: Is it prices that are the true market information or is it profit? Imagine two industries: luxury sports cars and cancer pharmaceuticals. Lets say that the total revenue of the sports car industry is $1 million and the pharmaceutical industry is $1.1 million. Lets also say that the luxury car company has a total cost of $500,000 and the pharmaceuticals has a total cost of $750,000. That would make the profits of the car industry $500,000 and pharmaceuticals $350,000. Now lets say that I am a potential investor, which company am I likely to invest my money in? I would rather invest with the car company. Why is it that Austrians say "the signaling function of prices"?
Look at the profit percentage.
To paraphrase Marc Faber: We're all doomed, but that doesn't mean that we can't make money in the process. Rabbi Lapin: "Let's make bricks!" Stephan Kinsella: "Say you and I both want to make a German chocolate cake."
well then i'd still go with the car company: 200% return versus 146% return
tir38: well then i'd still go with the car company: 200% return versus 146% return
That just reflects effective consumer demand. Sometimes luxury demand is relatively higher than mass consumption.
“Laws: We know what they are, and what they are worth! They are spider webs for the rich and mighty, steel chains for the poor and weak, fishing nets in the hands of the government.” - Proudhon
Yes. You want to go where the profit margins are higher.
tir38:Why is it that Austrians say "the signaling function of prices"?
Profit & loss are calculated on the basis of prices. They are comprised of prices.
I agree that profits and losses are the DISPARITY between price for the producer (his costs) and the price he sells at (his revenue). But its still this disparity that he (the producer) relies on to guide his actions. Its not cost; its not revenue; its profit.
tir38: I agree that profits and losses are the DISPARITY between price for the producer (his costs) and the price he sells at (his revenue). But its still this disparity that he (the producer) relies on to guide his actions. Its not cost; its not revenue; its profit.
Yes, and profit is the average rate of return caused by this disparity.
Why does the necessity for an arithmetic operation between different prices somehow make the statement that prices guide market behavior any different?
because price and profit are two different things.
I'm saying that prices DON'T guide market behavior. Price is an outcome of being guided by profit.
To illustrate my point, imagine that a small number of people start producing X*. Because they are the only ones producing X (initially) and X is in high demand, their profit will be high. The price might be high or low, but its is only judged against something else. The point is that their profit will be high. This will in turn lead other investors to start producing X. Now, as more people produce X, the price of X will go down because supply will increase and each producer will compete to take over market share.
The point is that initial high profits led to low prices in the future.
* X can be a new product, for example the iPhone, or it could be an innovative way of doing something already done, for example moving from manual to automatic cow milking.
you can't have monetary profit without monetary prices. neither is prime over the other. they are both essential for the market economy. trying to 'pick a favourite' is plain silly.
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
tir38: because price and profit are two different things. I'm saying that prices DON'T guide market behavior. Price is an outcome of being guided by profit. To illustrate my point, imagine that a small number of people start producing X*. Because they are the only ones producing X (initially) and X is in high demand, their profit will be high. The price might be high or low, but its is only judged against something else. The point is that their profit will be high. This will in turn lead other investors to start producing X. Now, as more people produce X, the price of X will go down because supply will increase and each producer will compete to take over market share. The point is that initial high profits led to low prices in the future. * X can be a new product, for example the iPhone, or it could be an innovative way of doing something already done, for example moving from manual to automatic cow milking.
tir38,
I see what you're saying, and I believe the thing to keep in mind is that your example only considers things from the producers point of view. But Prices are about co-ordinating the decisions of both *consumers* and *producers*, not just one or the other.
Let's illustrate these this point with a simpler example. Say that there was a huge rock slide in the Big Rock Candy Mountains that cuts the United States off from its primary candy supply, thus reducing the supply of hard candy in the US to a fixed supply. If we had a benevolent central planner, she would want to allocate the remaining supply of hard candy to where it would generate the most value. However because valuations are subjective and information is dispersed, she could never properly make this determination.
By contrast, a market system could easily solve this problem through prices. Specifically, the price of hard candy will increase relative to other goods, which will lead to only those individuals that value the candy (relative to other goods) to consume it, while others conserve. Here the primary signal is to consumers regarding how much to candy to eat.
Of course, over a longer time horizon, as your example illustrates, entrepreneurs will certainly notice if the price of candy exceeds the costs of producing it again. And if that difference is large enough (relative to other investment opportunities) they will go back to the candy mountains to mine for more. But, you have to remember that costs here are only prices paid by producers for inputs into their production process. So the combination of the two prices are telling entrepreneurs whether returning to the candy mines is worth it. That is where they are getting their information. Profits is simply a function of prices.
Now, if the candy miners do return, the price of hard rock candy will likely fall. So business decisions based on profits certainly do influence the price as you suggest, but this shouldn't surprise us because prices are simultaneously determined in the market place by both producers and consumers. The reason they are important is because they coordinate the decisions of both sets of people.
Hope this helps. :)
Ambition is a dream with a V8 engine - Elvis Presley
yes, thanks. that does clarify things. i didn't think about both producers and consumers.
tir38:I would rather invest with the car company. Why is it that Austrians say "the signaling function of prices"?
Profits are nothing but a linear transformation of prices (sales PRICES minus cost PRICES). The signalling function of prices flows through directly into your profits. If sports cars were indeed such a no-brainer choice over pharmaceuticals (in terms of risk/reward and margins) then free market agents (just like yourself) would flock to invest into that sector resulting in increased supply of sports cars (thus lowered prices, hence lower profits for everyone in the industry). It is THIS signalling function that would make sports cars less of a no-brainer proposition for all potential investors looking to invest there. So then the equation (lowered reward/risk, lowered margins) changes in favor of pharmaceuticals, until it doesn't... And the cycle continues -- PRICES being the ultimate signal for optimal allocation of investment/capital.
Z.