Imagine that a generic drug becomes available for the treatment of a condition, no substitute good is available (inslulin might be a good example), and the elasticity of demand is low .Say that there are multiple companies producing this drug and competing with each other for customers.
Assuming no real differences in quality, competition should surely bring the price down to the level at which profits are around zero. So why do Austrians talk of prices being purely about preferences? Obviously a commodity won't sell if it isn't wanted, but that is just stating the obvious. What insight does this statement provide?
what you're really asking is "why do you say prices are set by preferences rather than other prices?
This is a pretty good point actually. You could also ask 'what determines effective demand other than wages, which are simply the price of labour?'. So on and on we go around in circles. "The price of labour sets effective demand, effective demand effects the price of production, the price of production sets the price of the final good, and the price of the final good effects how much is demanded".
I will make an effort to read up the links you provided so that I get a better picture of what AE says about price, but from what I have heard so far I am still bewildered (maybe even more so than when I started the thread ).
Consumariat:You could also ask 'what determines effective demand other than wages, which are simply the price of labour?'. So on and on we go around in circles. "The price of labour sets effective demand, effective demand effects the price of production, the price of production sets the price of the final good, and the price of the final good effects how much is demanded".
No, only the price consumers are willing to pay on the final good determines to what point an entrepeneur would be willing to pay on inputs (labor, steel, factory, tires, etc.) to create the output. The prices of factors of production are imputed backwards from how consumers are willing to pay on the final product. See Rothbard's example on cigars which I quoted.
Consumariat: "The value of steel lies in it's usefulness in making cars and refrigerators" This here is a good example to illustrate my point. Imagine a society with no cars. Someone invents the car and it becomes really popular. People climb over each other to try and get one, and as a result the car manufacturers order more steel to step up production. Here is a clear example of hightened demand leading to a higher price. OK so far. However, the new price of steel makes it more profitable, and so businesspeople are incentivised to enter into the market of steel production. The supply of steel increases and competition between producers lowers the price Yes. again. You are just restating the law of supply and demand. You described a scenario of low supply and low demand changing into high demand and low supply changing into high demand and high supply. And indeed this happens all the time. BTW I hope you are not assuming that the final price of steel will be the same as when your story began. There is no way of knowing that. So the higher price - set by the increased demand - was just a temporary moment of price varience. But this is not a contradiction to the thesis that costs of production are ultimately determined [other things being equal], by the consumer. Of course the supply of steel is a factor. The Austrian thesis is that, aside from supply, the other factor is consumer demand for consumer goods. And this is emphasized in contrast to the other position, that says the opposite, that costs of production are magically determined by who knows what. And of course they too knew that increased supply will lower the price of steel. The claim that price is set by consumer valuation is a static analysis that ignores the effect of current prices on the future behaviour of entrepreneurs. I'm not sure why you say this. BTW I think it was Marx who noticed [correctly] that profit margins tend to be the same in all industries, for the reason you laid out.
"The value of steel lies in it's usefulness in making cars and refrigerators"
This here is a good example to illustrate my point. Imagine a society with no cars. Someone invents the car and it becomes really popular. People climb over each other to try and get one, and as a result the car manufacturers order more steel to step up production. Here is a clear example of hightened demand leading to a higher price.
OK so far.
However, the new price of steel makes it more profitable, and so businesspeople are incentivised to enter into the market of steel production. The supply of steel increases and competition between producers lowers the price
Yes.
again.
You are just restating the law of supply and demand. You described a scenario of low supply and low demand changing into high demand and low supply changing into high demand and high supply. And indeed this happens all the time.
BTW I hope you are not assuming that the final price of steel will be the same as when your story began. There is no way of knowing that.
So the higher price - set by the increased demand - was just a temporary moment of price varience.
But this is not a contradiction to the thesis that costs of production are ultimately determined [other things being equal], by the consumer. Of course the supply of steel is a factor. The Austrian thesis is that, aside from supply, the other factor is consumer demand for consumer goods. And this is emphasized in contrast to the other position, that says the opposite, that costs of production are magically determined by who knows what. And of course they too knew that increased supply will lower the price of steel.
The claim that price is set by consumer valuation is a static analysis that ignores the effect of current prices on the future behaviour of entrepreneurs.
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@consumariat
The subjective theory of value says that things have differenet values to different people. If a merchant sets a price on what he is selling, he puts the price that he thinks is the best.
It is how much that thing is valuable to him. He might consider what others would pay, or what his production cost was, but it is still him who decides what the price will be.
At the same time, the same thing might have lower value to other people - they will not buy it willingly. Some people, on the other hand, might think it is a bargain and will buy.
So while there are enough of the people from the secon group to keep the merchant happy, he will probably not change his prices.
No linear causality.
Consumariat:The supply of steel increases and competition between producers lowers the price again. So the higher price - set by the increased demand - was just a temporary moment of price varience. The claim that price is set by consumer valuation is a static analysis that ignores the effect of current prices on the future behaviour of entrepreneurs. [...] I will make an effort to read up the links you provided so that I get a better picture of what AE says about price, but from what I have heard so far I am still bewildered (maybe even more so than when I started the thread
[...] I will make an effort to read up the links you provided so that I get a better picture of what AE says about price, but from what I have heard so far I am still bewildered (maybe even more so than when I started the thread
You're still missing it. Lemme put it another way...What is "demand" but a representation of market valuation? Individuals each have a level of demand for various things, and the prices are simply a result of the relative demand for those things...relative to the supply. Prices are a metric by which the preferences of all individuals participating in the economy (i.e. "the market") are communicated. And by "preferences" we mean the subjective priority values placed on all resources (and their respective uses) within the economy. In other words, prices are a mechanism that allows the coordination of all available resources to be utilized in the most efficient and effective ways...based on the preferences of all the individuals in the market.
Put more simply, as long as you are able to turn a profit, it is a signal to you and the rest of the economy that you are utilizing resources in a favored way. (And that you should continue to do that, and in fact others should do what you're doing). If you become no longer profitable, it is a signal to you (and everyone else) that you are not utilizing the economy's resources in a preferred way. You are destroying wealth (meaning, you are combining capital in a way that the finished product is actually less preferred by the market overall than what was consumed/occupied to create it.)
So instead of thinking "prices of finished goods are determined by the prices of what goes into making them", scale back and ask "well...what determines the prices of those inputs?" And the answer is of course, the same thing that determines the prices of anything: supply and demand.
So look at it this way: Suppose gold were fetching a high price. That would mean there is a decent enough demand for it, and a limited enough supply. But what is the nature of the demand? What exactly do the people want the gold for? In what form do they prefer that resource to be placed? Do people want the physical gold itself? Or do they want it to be made into watches? Or do they want rings? Or does everyone just want authentic astronaut helmets with the gold lining in the visor?
Whatever the answer is, it will be shown in the prices for all of those items...because the prices (including the price of gold) are determined by consumer preferences. In other words, the question that prices answer is: "of all the things every single resource in the economy could be used for...what is most preferred? And how does that rank in terms of everything else?" And if you think about it, that's a pretty complex question to answer...considering every single product or service you could purchase (including all the raw materials that go into making all those things). And don't forget, a lot of different items require the same raw materials...so there are an uncountable number of subsets of tradeoffs being made. And this only grows with the size and technological advancement of the economy in question.
See, the astronaut helmet may be really expensive...but at the same time few people would be willing to pay that high price. There isn't a very high demand for the helmet...but all the resources (i.e. time, labor, raw materials, manufacturing work, etc) that went into creating the helmet...there is a high demand for all that. The helmet fetches a high price not because everyone wants a helmet...but because the helmet consumed and occupied a bunch of resources that could have gone to other things a lot of people do want. (This is of course the "opportunity cost" in economics). The only reason the helmet gets sold is because someone finds it more valuable than the price he is paying to get it. But suppose no one (not even NASA) wanted a helmet like the one you made. It may have cost you $10,000 (worth of plastic, gold, machine time, labor, etc.) to make it...but if you can only sell it for $5,000 it means you have sustained a loss...why? Because you combined all that capital in a way that actually destroyed value. All that time and energy and resources was much more valuable before you turned it into a helmet. So the fact that you sustained a loss is the market's way of telling you "don't use our resources like that. That's not what we want."
But if you were able to sell it for $20,000 however, then you have made a profit...you have combined capital in a way that increased wealth...you have taken resources and created something that the market values even more than what you consumed to make it.
Because remember, there is a limited amount of resources, and there is virtually a limitless amount of wants (meaning there is an infinite amount of things every single resource could be used for, and by every single person on the planet.) So what prices do is allow a communication of all the preferences of everyone so that all the resources can be coordinated in a way that maximizes value. There is no way any person or group of people could know the most efficient way to use the limited resources available to best provide for all the subjective wants of so many individuals. This is why the Soviets waited 4 hours a day in lines just to get bread....because when you purport to set prices, what you are really saying is "Not only do I know exactly what people want, I know exactly how badly they want it in relation to everything else they want, as well as exactly the resources that are available and exactly the productive capacity we have to satisfy all those wants and how best to go about executing all that." This is why Hayek called it "The Fatal Conceit."
Now that I think about it, the best read for you at this point might be Peter Schiff's How an Economy Grows and Why it Crashes. It's an update and expansion of his father's book of a similar title. You'll have to check out a library or bookstore to get the former, but the latter is available in pdf here, and our own Nielsio posted a nice reading of it here.
I think a lot of confusion arises from the notion that something other then people mihgt be the cause of price fluctuation. It's easy to forget that when talking about "supply and demand" or "average price" or "cost of production" to be determinants of price.
People act. They set the prices. They might take a lot of things into acount, but those things are not linear causes of his acts.
The problem I have with the Rothbard quote you gave is that he appears to be equivocating on the word 'value'.
If we take valuation to be a subjective and unquantifiable process, i.e. the ordinal arrangement of preferences, then it is indeed true that valuation determines which goods are produced and in which proportions. But 'value' is not the same as 'price', which is objective and quantifiable.
So when Rothbard says "The cigar machines, which had been rendered valueless, now recoup their great loss in value", all he is saying is that they are once again in demand to produce a wanted good - nothing about the price is inferred.
I absolutely agree that the two ideas are not mutually exclusive, however, I fail to see the connection between relative preferences between different commodities and the objective price. I just do not see the logical connection.
The subjective theory of value says that things have differenet values to different people.
Correct
If a merchant sets a price on what he is selling, he puts the price that he thinks is the best.
I agree
In the first instance, yes this is true.
At the same time, the same thing might have lower value to other people - they will not buy it willingly. Some people, on the other hand, might think it is a bargain and will buy
Yep
Until a competing producer comes along and makes the same product cheaper. At this point this first producer has to set the price at what the market dictates. His own 'preferences' for what he would like to sell the commodity for, must now be aligned with the 'invisible hand', if they aren't he will soon go bust.
There is no such thing as objective price. There is perhaps average price sellers set if a product in a market. Because of sellers' goals to avoid loosing money, they will change acording to the law of suplly and demand. The prices don't behave according to the law, the sellers do.
Consumariat: Imagine that a generic drug becomes available for the treatment of a condition, no substitute good is available (inslulin might be a good example), and the elasticity of demand is low .Say that there are multiple companies producing this drug and competing with each other for customers. Assuming no real differences in quality, competition should surely bring the price down to the level at which profits are around zero. So why do Austrians talk of prices being purely about preferences? Obviously a commodity won't sell if it isn't wanted, but that is just stating the obvious. What insight does this statement provide?
You take for granted(just assume) that there is a demand. Why is there a demand? Where did the demand come from? Demand from whom?
What if no one wanted the drug? Would it matter how many units you produced or how much competition there was if no one wanted the drug? Under those conditions what do you think would happen to the price to influence demand?
You're still missing it.
This is possibly true. I can't rule it out.
Lemme put it another way...What is "demand" but a representation of market valuation? Individuals each have a level of demand for various things, and the prices are simply a result of the relative demand for those things...relative to the supply.
True (although I think a firmer definition of 'valuation' might be needed to check if we are on the same page)
Prices are a metric by which the preferences of all individuals participating in the economy (i.e. "the market") are communicated.
This doen't logically follow from the previous statement. It is an assertion which you have not yet proven to me.
In other words, prices are a mechanism that allows the coordination of all available resources to be utilized in the most efficient and effective ways...based on the preferences of all the individuals in the market.
OK, this is the claim.
This is an extention of the same claim
So look at it this way: Suppose gold were fetching a high price. That would mean there is a decent enough demand for it, and a limited enough supply.
True
But what is the nature of the demand? What exactly do the people want the gold for? In what form do they prefer that resource to be placed? Do people want the physical gold itself? Or do they want it to be made into watches? Or do they want rings? Or does everyone just want authentic astronaut helmets with the gold lining in the visor?
I would suspect it's the helmets, but I'm not very entrepreneurial so in reality I don't know.
Whatever the answer is, it will be shown in the prices for all of those items...because the prices (including the price of gold) are determined by consumer preferences. In other words, the question that prices answer is: "of all the things every single resource in the economy could be used for...what is most preferred?
And the claim is made again
And how does that rank in terms of everything else?
I don't see how the ordinal scales of an individual persons preferences can be applied on aggregate to the whole economy.
The helmet fetches a high price not because everyone wants a helmet...but because the helmet consumed and occupied a bunch of resources that could have gone to other things a lot of people do want.
I agree with this I think
But suppose no one (not even NASA) wanted a helmet like the one you made. It may have cost you $10,000 (worth of plastic, gold, machine time, labor, etc.) to make it...but if you can only sell it for $5,000 it means you have sustained a loss...why?
Because a bad judgment was made regarding what people wanted at the price I was trying to sell at. So, valuations on behalf of my customers certainly set an upper limit to what price I can charge, but not neccesarily the average price that will be charged. This would be set by competition between producers.
there is a limited amount of resources, and there is virtually a limitless amount of wants (meaning there is an infinite amount of things every single resource could be used for, and by every single person on the planet.)
true
So what prices do is allow a communication of all the preferences of everyone so that all the resources can be coordinated in a way that maximizes value.
There's that claim again
There is no way any person or group of people could know the most efficient way to use the limited resources available to best provide for all the subjective wants of so many individuals.
This is why the Soviets waited 4 hours a day in lines just to get bread....because when you purport to set prices, what you are really saying is "Not only do I know exactly what people want, I know exactly how badly they want it in relation to everything else they want, as well as exactly the resources that are available and exactly the productive capacity we have to satisfy all those wants."
OK, the cogs in my brain are beginning to turn slightly. Here is what I think you might be trying to say;
The amount of people that value a product to be worthy of purchase will determine the amount of demanders. Supply and demand, intermediated by price, will equilebrate production on the amount of goods produced. So it isn't so much that valuation sets prices, its that changing prices (due to supply and demand interaction) enable the amount of output to be scaled to the correct size for satisfaction of wants on the scales demanded. Am I making sense?
There is perhaps average price sellers set if a product in a market. Because of sellers' goals to avoid loosing money, they will change acording to the law of suplly and demand. The prices don't behave according to the law, the sellers do.
This is what I meant by objective price. Sorry to be ambiguous
I already have stated that I agree a product will only sell if it is desired by consumers. This does not imply that those same desires set what the specific price of a good will be. Who on earth would claim that an unwanted commodity was worth anything? The issue here is about the price level.
Consumariat:OK, the cogs in my brain are beginning to turn slightly. Here is what I think you might be trying to say; The amount of people that value a product to be worthy of purchase will determine the amount of demanders. Supply and demand, intermediated by price, will equilebrate production on the amount of goods produced. So it isn't so much that valuation sets prices, its that changing prices (due to supply and demand interaction) enable the amount of output to be scaled to the correct size for satisfaction of wants on the scales demanded. Am I making sense?
You're more or less getting it there. But that last statement is a bit misleading...those two parts aren't mutually exclusive. Depending on what you mean by "valuation sets prices" they are both true...because it is supply and demand that sets prices...but the preferences of the individuals in the market (i.e. market valuations) are acted upon and (therefore) made known every second of every day...through the prices that are set by the supply and demand of all available resources in the economy.
You mentioned not seeing how individual preferences could be "applied on aggregate" to the whole economy...but that's the whole point...there is no "economy"...there are only people. What is an "economy" but the various collections of resources and human actors? Individuals are what makes up the economy. It is the wants, needs, and actions of every individual in the market that make up everything about the economy. Prices are the result of every one of those individuals expressing their wants and needs in the open market (through transactions). No single person could know what every other person wants or needs. All they know is what they personally want or need, and what they are willing to give up to get it. And by transacting with others in a free market, all available resources are utilized in their most efficient, effective fashion based on what every individual who makes up the market has shown he or she wants and needs...through his open market transactions (and the prices that manifest as a result).
So what is it that makes you doubt the at least somewhat a priori assessment that the price mechanism is a communication about the subjective wants of the individuals in the market?
If I have a widget that gets bid up to a $1 million price, (based on the supply available and the relative demand shown through what people are offering to pay me for it), how is that not a communication about market preferences? The individuals offering making me the offers are showing that they value my widget more than all that money (i.e. everything else they could buy with it at that point in time)...they prefer my widget to whatever they are going to give up to get it. Every time you complete a transaction (or even refuse one) you are communicating your personal preferences. Now realize that every single actor in the market is doing that all the time. Prices are the result of all that communication.
(And again, this is why things get so messed up when government interferes and starts setting price controls or printing money out of thin air or setting up barriers that obstruct production or transaction...it sends false signals throughout the market. Think about the billions of transactions that take place every day. That's a very intricate, delicate network of communication. When you print up a Trillion dollars and flush it out into that economy, that throws a serious wrench in the whole order of everything. This is what ABCT is all about.)
(Thomas Sowell talks about prices and central planning)
Again, the concept of what all the individuals (who make up the market) want, how badly they want it in relation to everything else they want, and what resources are available to provide it has been written on extensively, especially within the Austrian School. Mises called it the "economic calculation problem" and Hayek expanded on his work in the writings I listed for you earlier.