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Can someone summarize the economic calculation problem?

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fegeldolfy posted on Wed, Nov 7 2012 8:23 PM

I'm trying to explain it to a fried on facebook, but I don't understand it that well.

 

Thanks.

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Jargon replied on Tue, Nov 20 2012 11:15 PM

Fool on the Hill:

But the only way to tell if one system is better at producing a result than another system is if there is an independent way of verifying the results of the two systems. So saying that the market is efficient at determining whether a person actually needs something, presupposes an independent, non-systematic, way of determining actual need. To deny any independent means of verification is to accept the market on a "leap of faith." If the market is the only way of knowing whether actual needs are being satisfied, then the most that can be said about alternative systems is that we don't know whether they are satisfying actual needs better or worse. And thus there would be no reason to choose the market over them, since what we really want is not to know needs but to satisfy them.

Market price is the aggregation of all relevant valuations.

But if the "most urgent items" simply means "that which one most wants to spend their money on" then that's a petitio principii.

Who else would the items be urgent to other than the holder of the cash?

Can any such totalizing system be truly rational when the needs in question are the needs of individuals and not of a system?

Yes. Yes it can. There is no 'system' out there.

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But the only way to tell if one system is better at producing a result than another system is if there is an independent way of verifying the results of the two systems. So saying that the market is efficient at determining whether a person actually needs something, presupposes an independent, non-systematic, way of determining actual need. To deny any independent means of verification is to accept the market on a "leap of faith." If the market is the only way of knowing whether actual needs are being satisfied, then the most that can be said about alternative systems is that we don't know whether they are satisfying actual needs better or worse. And thus there would be no reason to choose the market over them, since what we really want is not to know needs but to satisfy them.

They're free to try compete with the market. No libertarian advocates stopping individuals from setting up competing systems, provided they don't preclude the existence of the market. But conversely, neither can advocates of such systems prohibit market systems from arising.

Also, if you have some superior means to determing what an actor's most urgent wants are given their circumstances, by all means try market it to them and explain to them what they "should" spend their money on.

Freedom of markets is positively correlated with the degree of evolution in any society...

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Jon: "They're free to try compete with the market. No libertarian advocates stopping individuals from setting up competing systems, provided they don't preclude the existence of the market. But conversely, neither can advocates of such systems prohibit market systems from arising." And the fact that something else can compete with the market is proof that the market is not the final judge. In other words, it's not needed to do the things Mises seems to say its needed for, which is the basis of his entire argument.
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Ugh, why do capitalists use such shitty forum software? Maybe its because we don't pay to use the site and hence there is no price data to tell the admins how much we hate it.
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And the fact that something else can compete with the market is proof that the market is not the final judge. In other words, it's not needed to do the things Mises seems to say its needed for, which is the basis of his entire argument.

Hardly. Mises's argument is that in a system where ownership of capital goods vests in the single commune/state, that it'd be utterly unable to economise in any real sense. The minute you concede that competition is required for varying forms of capital goods ownership in order to derive which is more efficient, you are not arguing in terms of the original socialist calculation argument, although it will still apply to a degree, much like it does to very large corporations.

Moreover, all the word "can" implies is it can try to. Not that it'll succeed.

 

Freedom of markets is positively correlated with the degree of evolution in any society...

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And the reason it is unable to economize is because it is unable to judge, no?
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It has no external point of reference to judge whether it is making the most efficient usage of its resources as against competing owners of these goods. The situation is absolutely no different to one single corporation owning the world's capital goods. It can try to divide itself up into internal profit centres, but unlike the corporation in a free market, it cannot be acquired or driven into bankruptcy for failure to compete with other firms, so in essence we're talking about salaried managers at best.

Freedom of markets is positively correlated with the degree of evolution in any society...

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And by the same token, the market system as a whole doesn't have any external point of reference to judge whether it is making the most efficient usage of its resources as against competing modes of production (i.e. non-market systems). First of all, prices don't tell producers whether they are using goods more efficiently than their competitors because this evaluation is contingent on the unknowable future. In fact, I believe that Mises says that the price for a factor of production is determined by the expected price of the final goods that it can produce. If the price of a producers good is determined by the entrepreneur and his competitors, then how can this serve as an "external" point of reference? Second, profit only reveals the preference for existing goods and does not tell us what should be produced. When the workers have produced their goods and have received their pieces of paper for them (i.e. money), the only preferences that their economic transactions can reveal is that between one good that has been produced and another good that has been produced, or between a good and a piece of paper. What is important in evaluating a mode of production is whether those goods were worth the labor that went into them, and whether those goods that were produced were preferable to the goods that could've been produced instead. So the prices of consumer goods can't serve as an external point of reference either--they are also determined by the actions of the entrepreneurs.
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Answered (Not Verified) Anenome replied on Sat, Nov 24 2012 10:21 PM
Suggested by Jon Irenicus
 
 

Fool on the Hill:
And by the same token, the market system as a whole doesn't have any external point of reference to judge whether it is making the most efficient usage of its resources as against competing modes of production (i.e. non-market systems). First of all, prices don't tell producers whether they are using goods more efficiently than their competitors because this evaluation is contingent on the unknowable future.

Incorrect. It's based on knowing only the now and the past, which can be used as the basis of how likely one is to receive that price in the future, but it doesn't require knowledge of the future. Socialism doesn't even have knowledge of the now for it has no prices!

The producer simply calculates if he can make a profit on those goods today based on known quantities and prices. He knows if the price of a thing rises beyond a certain point his profit margin will be squeezed to nothingness.

But it's probable that if the price of that thing is rising, it's because another producer has found a use for that good for which people are willing to pay much more. Thus, the first producer stops using that good if its price rises too high because the second producer has found a more efficient use of that good, and the means of that communication is price level.

Prices are communication and coordination across an economy. That communication enables business calculation. An economic system attempting to do without a price system is completely blind.

Fool on the Hill:
In fact, I believe that Mises says...

Here, just read Mises directly addressing the calculation problem.

 
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Answered (Not Verified) filc replied on Sat, Nov 24 2012 11:07 PM

Can be summarized as

  1. What? What do we produce?
  2. Quantity? How much of it do we produce?
  3. Who? For whom do we produce it?
  4. How? In what way should we produce it?

Answers to the above question

  1. Price mechanism
  2. omnipotence/omniscience
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Anenome replied on Sat, Nov 24 2012 11:38 PM
 
 

filc:

Answers to the above question

  1. Price mechanism
  2. omnipotence/omniscience

I suggest a 3rd answer ends up being the choice mechanism of socialism: politics / whim.

Without an ability to calculate, the politician is free to pick winners and losers, to be blown about by the demands of constituents, and use all sorts of political considerations to decide who to patronize. The politicians is invested with the economic powers of a god without any of the omniscience needed to wield it, and the result can only be gross inefficiency as one mind tries to wrap its head around demands that were previously solved by the application and independent knowledge of millions of minds.

If the planner forgets a certain field, tons of potatoes may go unpicked. Or, he can simply forget the Ukraine and fail to feed the people living there until they die by the millions.

 
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And by the same token, the market system as a whole doesn't have any external point of reference to judge whether it is making the most efficient usage of its resources as against competing modes of production (i.e. non-market systems).

It isn't a "system". It isn't a single isolated organisation. It is the sum total of all owners of capital goods competing for ownership of said resources, bidding for them. These individuals and organisations are comparing their performance and valuations against each other, and that is what allows them to calculate.  This means it also encompasses any socialist states exchanging resources.

First of all, prices don't tell producers whether they are using goods more efficiently than their competitors because this evaluation is contingent on the unknowable future.

No, this is what profits or losses do. Not prices. As for the "unknowable" future, that is where the risk element of entrepreneurship comes in. I agree with Anenome re his comments on this.

In fact, I believe that Mises says that the price for a factor of production is determined by the expected price of the final goods that it can produce.

Correct.

If the price of a producers good is determined by the entrepreneur and his competitors, then how can this serve as an "external" point of reference?

Your problem is that you think of the market as some special "system". It isn't. It is competition between all institutions, organisations and individuals. You would be correct if you were referring to a single corporation i.e. a single owner of all capital goods, which would indeed have no external point of reference in the form of competition for ownership by other market agents, whatever they may be, but we are not comparing a single corporation as an organisation to a socialist state/commune.

Second, profit only reveals the preference for existing goods and does not tell us what should be produced.

Can you tell me what "should" be produced by peering into people's heads? I asked you to do this already. Can you provide me of a better indication of what "should" be produced absent individuals allocating their spending, within their resource constraints?

When the workers have produced their goods and have received their pieces of paper for them (i.e. money), the only preferences that their economic transactions can reveal is that between one good that has been produced and another good that has been produced, or between a good and a piece of paper.

Or more accurately, between money or a claim to it. Money is by definition the most widely exchangeable of all resources.

What is important in evaluating a mode of production is whether those goods were worth the labor that went into them,

Yeah, hence market socialists concede that markets for final consumer goods are necessary to efficiently allocate these goods. They think that this solves the calculation problem, because then you can just plug in equations and voila, now you know how to allocate capital goods! It doesn't, because the problem concerns the fact that capital goods themselves need to be priced and allocated, and there are always different ways of doing things, determined by the profitability of doing so (which is impossible to determine absent prices and therefore competing ownership of these goods.)

What determines whether the good was "worth" producing was whether it went to satisfying some want, which the consumer is willing to sacrifice resources for in exchange. That is, unless you think you know better than the consumer constrained by scarcity as to what they "should" consume and therefore what "should" be produced.

and whether those goods that were produced were preferable to the goods that could've been produced instead. So the prices of consumer goods can't serve as an external point of reference either--they are also determined by the actions of the entrepreneurs.

No, not really. They are determined by the demand of said goods, which in turn determines whether it is worth incurring costs to supply the good. Entrepreneurs can attempt to close supply/demand gaps and identify new forms of goods to supply for which they anticipate demand. But they do not determine prices. They only control the supply element, and that in turn is only worth bringing to existence if there is demand for it.

Of course, a socialist state/commune that exists with markets external to it can try and price capital goods with reference to them, as the USSR did. This will allow it to calculate to a degree, but it will always be drawing on pricing based on circumstances external to itself and therefore not necessarily fit for purpose.

Freedom of markets is positively correlated with the degree of evolution in any society...

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"So the prices of consumer goods can't serve as an external point of reference either--they are also determined by the actions of the entrepreneurs."

Entrepreneurs do not set prices. This is one of the great economic fallacies prevalent in the general public's mind.

Price is determined by the intersection of supply and demand, and there are many considerations surrounding that assertion. But one thing you could never say is that price is determined by the entrepreneur.

What is determined by the entrepreneur is asking price, but asking a certain price is no guarantee at all that he'll find buyers willing to pay that price.

All market transactions are essentially auctions. Most are streamlined auctions that do away with bid interactions. Instead the producer puts out a set asking price and if a buyer agrees to pay that, they simply pick up the good and purchase it.

A seller can still price himself out of the market and receive no buyers. The resulting loss would quickly end the production of that good, preserving overall efficiency and freeing up that good for other kinds of more efficient production.

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Anenome: "Incorrect. It's based on knowing only the now and the past, which can be used as the basis of how likely one is to receive that price in the future, but it doesn't require knowledge of the future. Socialism doesn't even have knowledge of the now for it has no prices!"

And what exactly in the past tells us how likely something is to occur in the future? If Charlie buys a chair today, does that in itself tell us something about how likely Fred is to buy a chair tomorrow? Doesn't such a position go against Mises's supposed anti-empiricism regarding human action? Mises:

"Praxeological knowledge makes it possible to predict with apodictic certainty the outcome of various modes of action. But, of course, such prediction can never imply anything regarding quantitative matters. Quantitative problems are in the field of human action open [p. 118] to no other elucidation than that by understanding. / We can predict, as will be shown later, that?--other things being equal?--a fall in the demand for a will result in a drop in the price of a. But we cannot predict the extent of this drop. This question can be answered only by understanding."

So according to Mises here, it seems that we can't predict "how likely" something is to occur except by means of the "understanding." And what does Mises mean by understanding? "Understanding, by trying to grasp what is going on in the minds of the men concerned, can approach the problem of forecasting future conditions. We may call its methods unsatisfactory and the positivists may arrogantly scorn it. But such arbitrary judgments must not and cannot obscure the fact that understanding is the only appropriate method of dealing with the uncertainty of future conditions."

Earlier, Clayton made the distinction between what we might call "revealed preferences" and "psychological motivations." Here Mises affirms my earlier claim that it is understanding psychological motivations that allows for future prediction and not the preferences revealed in the price data. However, Mises is clearly wrong in asserting that praxeology--absent "understanding"--allows us to predict with "apodictic certainty" that a fall in demand for A will result in a drop in the price of A. It seems to me that Mises is relying on the "praxeological" mode of prediction when he is making the economic calculation argument.

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Anenome: "The producer simply calculates if he can make a profit on those goods today based on known quantities and prices. He knows if the price of a thing rises beyond a certain point his profit margin will be squeezed to nothingness."

So we have two things: the given price of the inputs and the expected price of the final product. What, according to Mises, determines the price of the inputs? The expected price of the final goods. So both the prices of the inputs and the expected prices of the final goods are reducible to the expected price of the final goods (plus the requisite compensation for time preference of course!). In other words, the entrepreneurs guess that people will prefer x to y, z to x, etc., and this determines the price of the production goods. And somehow when entrepreneurs form these prices through their guesses, that makes them necessarily accurate guesses! Because if they weren't accurate, they couldn't serve as a rational basis for economic calculation. Yet when "central planners" makes such guesses about future consumer preferences, the planners are unable to rationally allocate the productive goods because these goods have no prices!

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