6. A Summary of the Market

The explanation of the free economic system constitutes a great architectural edifice. Starting from human action and its implications, proceeding to individual value scales and a money economy, we have demonstrated that the quantity of goods produced, the prices of consumers’ goods, the prices of productive factors, the interest rate, profits and losses, all can be explained by the same deductive apparatus. Given a stock of land and labor factors, given existing capital goods inherited from the past, given individual time preferences (and, more broadly, technological knowledge), the capital goods structure and total production is determined. Individual preferences set prices for the various consumers’ goods, and the alternative combinations of various factors in their production set the marginal value-productivity schedules of these factors. Ultimately, the marginal value product accruing to capital goods is resolved into returns to land, labor, and interest for time. The point at which a land or labor factor will settle on its DMVP schedule will be determined by the stock available. Since each factor will operate in an area of diminishing physical and certainly diminishing value returns, any increased stock of the factor, other things being equal, will enter at a lower DMVP point. The intersecting points on the DMVP schedules will yield the prices of the factors, also known as “rents” and “wage rates” (in the case of labor factors). The pure interest rate will be determined by the time-preference schedules of all individuals in the economy. Its chief expression will be not in the loan market, but in the discounts between prices in the various stages of production. Interest on the loan market will be a reflection of this “natural” interest rate. All the prices of each good, as well as the interest rate, will be uniform throughout the entire market. The capital value of every durable good will equal the discounted value of the sum of future rents to be obtained from the good, the discount being the rate of interest.

All this is a picture of the evenly rotating economy—the equilibrium situation toward which the real economy is always tending. If consumer valuations and the supply of resources remained constant, the relevant ERE would be reached. The forces driving toward the ERE are the profit-seeking entrepreneurs, who take the lead in meeting the uncertainties of the real world. By seeking out discrepancies between existing conditions and the equilibrium situation and remedying them, entrepreneurs make profits; those businessmen who unwittingly add to the maladjustments on the market are penalized with losses. Thus, to the extent that producers wish to make money, they drive toward ever more efficient servicing of the desires of the consumers—allocating resources to the most value-productive areas and away from the least value-productive. The (monetary) value productivity of a course of action depends on the extent to which it serves consumer needs.

But consumer valuations and supplies of resources are always changing, so that the ERE goal always changes as well and is never reached. We have analyzed the implications of changing elements in the economy. An increase in the labor supply may lower the DMVP of labor and hence wage rates, or raise them because of the further advantages of the division of labor and a more extended market. Which will occur depends on the optimum population level. Since labor is relatively more scarce than land, and relatively nonspecific, there will always be idle and zero-rent land, while there will never be involuntarily idle or zero-wage labor. An increase or decrease in the supply of “sub-marginal” land will have no effect on production; an increase in supramarginal land will increase production and render hitherto marginal land submarginal.

Lower time preferences will increase capital investment and thereby lengthen the structure of production. Such lengthening of the production structure, increasing the supply of capital goods, is the only way for man to advance from his bare hands and empty acres of land to more and more civilized standards of living. These capital goods are the necessary way stations on the road to higher total production. But they must be maintained and replaced as well as initially produced if people wish to keep their higher standard over any length of time.

To expand production, the important consideration is not so much technological improvement as greater capital investment. At no time has invested capital exhausted the best technological opportunities available. Many firms still use old, unimproved processes and techniques simply because they do not have the capital to invest in new ones. They would know how to improve their plant if capital were available. Thus, while the state of technology is ultimately a very important consideration, at no given time does it play a direct role, since the narrower limit on production is always the supply of capital.

In a progressing economy, given a constant supply of money, increased investment and a longer capital structure bring about lower money prices for factors and still lower prices for consumers’ goods. “Real” factor prices (corrected for changes in the purchasing power of the monetary unit) increase. In net terms, this means that real land rents and real wage rates will increase in the progressing economy. Interest rates will fall as time-preference rates drop and the proportion of gross investment to consumption increases.

If rents are earned by a durable factor, they can be and are “capitalized” on the market, i.e., they have a capital value equivalent to the discounted sum of their expected future rents. Since land is a form of investment on the market just as are shares of a firm, its future rents will be capitalized so that land will tend to earn the same uniform interest rate as any other investment. In a progressing economy, the real capital value of land will increase, although the value will fall in money terms. To the extent that future changes in the value of land can be foreseen, they will be immediately incorporated into its present capital value. Therefore, future owners of land will benefit by future increases in its real capital value only to the extent that previous owners failed to anticipate the increase. To the extent that it was anticipated, the future owners will have paid it in their purchase price.

The course of change in a retrogressing economy will be the opposite. In a stationary economy, total production, the capital structure, real wages per capita, real capital values of land, and the rate of interest will remain the same, while the allocation of factors of production and the relative prices of various products will vary.⁷⁰

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¹Net rents equal gross rents earned minus gross rents paid to owners of factors.

²Its capital value will be positive, however, if people expect the land to earn rents in the near future.

³As Frank Fetter stated in “The Passing of the Old Rent Concept,” Quarterly Journal of Economics, May, 1901:

The last unit of product of any finite amount would . . . have to pay its corresponding rent. The only product obtained, in the strict theory of the case, without paying rent, would be one unit infinitesimally small—in plain Anglo-Saxon, would be nothing at all. No finite unit of product can be shown to be a no-rent unit. (p. 489)

⁴The terms “marginal,” “supramarginal,” etc., are rather differently used here from the way they are used above. Instead of dealing with the supply and demand for a homogeneous good or factor, we are here referring to one class of factors, such as lands, and comparing different qualities of the various factors in that class. The near-zero-earning land is “marginal” because it is the one just barely put to use.

⁵Here we shift the definition of progressing economy to mean increasing capital per person, so that we can contrast the effects of changes in the supply of one type of factor to changes in the supply of another.

⁶There is, of course, no reason to assume that maximum real income per head is necessarily the best ethical ideal; for some, the ideal might be maximum real income plus maximum population. In a free society, parents are free to choose their own ethical principles in the matter.

⁷Economics can say little else about population and its size. The inclusion of a corpus of “population theory” under economics instead of biology or psychology is the unfortunate result of the historical accident that the early economists were the first to delve into demographic problems.

⁸The Lausanne way (of Walras and Pareto) of phrasing this distinction would be to say that, in the former case (when we are moving along the curve), we implicitly assumed that “(the supply of) tastes, techniques, and resources remains given in the economy.” In the present case, we are considering a change in a resource (e.g., an increase in the supply of labor). We would amend this to say that only tastes and resources were considered given. As we saw in the previous section, techniques are not immediate determinants of production changes. The techniques must be put to use via saving and investment. In fact, we may deal with tastes and resources alone, provided that we include time preferences among the “tastes.”

⁹When an owner performs, and earns a return for, an essentially labor activity which he could also perform as an employee (e.g., the owner-manager), that return is an implicit wage. On definitions of “labor,” see Spencer Heath, Citadel, Market, and Altar (Baltimore: Science of Society Foundation, 1957), pp. 235–36.

¹⁰When we use the term “quality” here and in other parts of catallac-tic analysis, we are not employing it in some metaphysical sense or from some “higher” ethical point of view. We mean quality as expressed by choice of the market, in the form of a higher MVP and therefore a higher wage.

¹¹For an example of an interesting work on bargaining with unions based squarely on the false labor-management dichotomy, see Lee H. Hill and Charles R. Hook, Jr., Management at the Bargaining Table (New York: McGraw-Hill, 1945). On foremen's unions, see Theodore R. Iserman, Industrial Peace and the Wagner Act (New York: McGraw-Hill, 1947), pp. 49–58.

¹²This “rule” by consumers’ valuations holds in so far as entrepreneurs and owners of factors aim at maximum money income. To the extent that they abstain from higher money income to pursue nonmonetary ends (e.g., looking at one's untilled land or enjoying leisure), the producers’ own valuations will be determining. From the general praxeological point of view, these producers are to that extent acting as consumers. Therefore, the full rule of consumers’ value scales would hold even here. However, for purposes of catallactic market analysis, it may be convenient to separate man as a producer from man as a consumer, even though, considered in his entirety, the same man performs both functions. In that event, we may say that to the extent that nonmonetary goals enter, not consumers’ values are determining, but the values of all individuals in society. For further discussion of this question and of “consumer sovereignty,” see chapter 10 below.

¹³In the free society, as we have indicated above, the site could not originally become the property of anyone until it had been “used” in some way, such as being cleared, cultivated, etc. There need be no subsequent use, however, until rents can be obtained.

¹⁴There will be such a backward supply curve if the marginal utility of money falls rapidly enough and the marginal disutility of leisure forgone rises rapidly enough as units of labor are sold for higher prices in money.

¹⁵It will be noted that we have avoided using the very fashionable term “model” to apply to the analyses in this book. The term “model” is an example of an unfortunate bias in favor of the methodology of physics and engineering, as applied to the sciences of human action. The constructs are imaginary because their various elements never coexist in reality; yet they are necessary in order to draw out, by deductive reasoning and ceteris paribus assumptions, the tendencies and causal relations of the real world. The “model” of engineering, on the other hand, is a mechanical construction in miniature, all parts of which can and must coexist in reality. The engineering model portrays in itself all the elements and the relations among them that will coexist in reality. For this distinction between an imaginary construct and a model, the writer is indebted to Professor Ludwig von Mises.

¹⁶For some philosophical discussions of human variation, see Harper, Liberty, pp. 61–83, 135–41; Roger J. Williams, Free and Unequal (Austin: University of Texas Press, 1953); George Harris, Inequality and Progress (Boston: Houghton Mifflin, 1898); Herbert Spencer, Social Statics (New York: D. Appleton & Co., 1890), pp. 474–82; A.H. Hobbs, The Claims of Sociology (Harrisburg, Pa.: The Stackpole Co., 1951), pp. 23–64; and Hobbs, Social Problems and Scientism (Harrisburg, Pa.: The Stackpole Co., 1953), pp. 254–304.

¹⁷Cf. Van Sickle and Rogge, Introduction to Economics, pp. 178–81.

¹⁸For a treatment of wage rates and geography, see the section below on “The Economics of Location and Spatial Relations.”

¹⁹It should be understood throughout that when we refer to increases in wage rates or ground rents in the expanding economy, we are referring to real, and not necessarily to money, wage rates or ground rents.

²⁰This assumes, of course, that there is no offsetting decline in capital elsewhere. If there is, then there will be no general rise in wages.

²¹For a discussion of these problems, see Mises, Human Action, pp. 598– 600.

²²Capital goods will remain unemployed because of previous entrepreneurial error, i.e., investing in the wrong type of capital goods.

²³See Mises, Human Action, pp. 595–98. As Mises concludes, “Unemployment in the unhampered market is always voluntary.” Particularly recommended is Mises’ critique of the theory of “frictional unemployment.”

²⁴Economics does not “assume mobility of labor.” It simply analyzes the consequences of a laborer's decision to be “mobile” or “immobile,” the latter amounting to a voluntary choice of at least temporary unemployment.

²⁵The “idleness” referred to here is catallactic, and not necessarily total. In other words, it means that a man does not seek to sell his labor services for money and therefore does not enter the societal labor market. He might well be very “busy” working at hobbies, etc.

²⁶Hayek, Prices and Production, pp. 91–93.

²⁷Cf. Fred R. Fairchild and Thomas J. Shelly, Understanding Our Free Economy (New York: D. Van Nostrand, 1952), pp. 478–81.

²⁸Hence, when the economist considers only the single firm (as in recent years), he goes completely astray by ignoring the generality of economic interrelations. To analyze means-ends relations logically, as economics does, requires taking all relations into account. Failure to do so, either by treating the single firm only or by treating unreal holistic aggregates or by taking refuge in the irrelevant mathematics of the Lausanne “general equilibrium” school, is equivalent to abandoning economics.

²⁹Many beginning students come away with the impression that economics consists of an indigestible brew of “cost curves” to be memorized by rote and drawn neatly on the blackboard.

³⁰E.T. Weiler, The Economic System (New York: Macmillan & Co., 1952), pp. 141–61; Stigler, Theory of Price, pp. 126ff.

³¹Stigler, Theory of Price, p. 126.

³²Robbins points out that the length of a period of productive activity depends upon the expectations of entrepreneurs concerning the permanence of a change and the technical obstacles to a change. Robbins, “Remarks upon Certain Aspects of the Theory of Costs,” pp. 17–18.

³³For a critique of cost-curve theory, see the articles by Robbins, Thirlby, and Gabor and Pearce cited above, especially Gabor and Pearce, “A New Approach to the Theory of the Firm.” Also see Milton Friedman, “Survey of the Empirical Evidence on Economies of Scale: Comment” in Business Concentration and Price Policy (Princeton, N.J.: National Bureau of Economic Research, 1955), pp. 230–38; Armen Alchian, “Costs and Outputs” in The Allocation of Economic Resources (Stanford: Stanford University Press, 1959), pp. 23–40; F.A. Hayek, “Unions, Inflation, and Prices” in Philip D. Bradley, ed., The Public Stake in Union Power (Charlottesville: University of Virginia Press, 1959), pp. 55 f.; Hayek, Pure Theory of Capital, pp. 14, 20–21; Harrod, “Theory of Imperfect Competition Revised” in Economic Essays, pp. 139–87; G. Warren Nutter, “Competition: Direct and Devious,” American Economic Review, Papers and Proceedings, May, 1954, pp. 69ff.; Scott, Natural Resources: The Economics of Conservation, p. 5.

³⁴This law follows from the natural law that every quantitatively observable cause-effect relation can be duplicated. For example, if x + 2y + 3z are necessary and sufficient to form 1p, another set will form another p, so that 2x + 4y + 6z will yield 2p.

³⁵See chapter 10 for more on the theory of pure competition.

³⁶For example, suppose that 1,000 gold ounces invested in factors yield 100 units of product and that 1,100 ounces yield 101 units. All the points in the gap between 1,000 and 1,100 will yield no more than 100 units. The excess of investment over 1,000 and under 1,100 ounces is clearly sheer waste, and no businessman will invest within the gap. Instead, investments will be made at such trough points for average cost as 1,000 and 1,100.

³⁷Stigler, Theory of Price, pp. 132ff.

³⁸We are not discussing the fact that the railroad could, of course, cut down or increase the mileage of its track by including less or more geographic area in its service. The example assumes a given geographic area in which the railroad operates.

³⁹See Mises, Human Action, pp. 338–40. This is the unrealistic condition implicitly assumed by textbook “cost curves.”

⁴⁰Ibid., p. 340.

⁴¹Stigler, Theory of Price, p. 136.

⁴²It is particularly important not to limit possible efficiencies from large-scale production to narrow technological factors such as the “size of the plant.” There are also efficiencies derived from the organization of a firm owning several plants—e.g., management utilization, specialization, efficiency of large-scale purchasing and selling, research expenditures, etc. Cf. George G. Hagedorn, Studies on Concentration (New York: National Association of Manufacturers, 1951), pp. 14 ff.

⁴³See Friedman, “Survey of the Empirical Evidence on Economies of Scale: Comment,” pp. 230–38.

⁴⁴For a good, largely empirical, study of size of firm, see George G. Hagedorn, Business Size and the Public Interest (New York: National Association of Manufacturers, 1949). Also see idem, Studies on Concentration, and John G. McLean and Robert W. Haigh, “How Business Corporations Grow,” Harvard Business Review, November–December, 1954, pp. 81–93.

⁴⁵Plans are relevant, not only in the ERE, but also to all decisions on maintenance or replacement, as well as additions to capital goods when they wear out or fall into disrepair.

⁴⁶It is costless only if no rise in the price of the good is foreseen for the near future. If it is, then there will arise the opportunity cost of forgoing a higher price. Hence, if there is no hope of a higher price, the businessman will sell, however low the price (adjusting for the costs of selling minus the costs of continued storage).

⁴⁷Conventional “cost-curve” analysis depicts average cost and demand curves as tangential in the ERE—i.e., that price = average cost. But (aside from the unreality of assuming smooth curves rather than discontinuous angles), interest return—as well as return to the owner's decision-making ability—will accrue to the entrepreneurs even in the ERE. Hence, no such tangency can arise. See chapter 10 below for the implications of this revision for “monopolistic competition” theory.

⁴⁸For further readings on cost, see G.F. Thirlby, “The Marginal Cost Controversy: A Note on Mr. Coase's Model,” Economica, February, 1947, pp. 48–53; F.A. Fetter's classic “The Passing of the Old Rent Concept,” p. 439; R.H. Coase, “Business Organization and the Accountant,” The Accountant, October l–November 26, 1938; and idem, “Full Costs, Cost Changes, and Prices” in Business Concentration and Price Policy, pp. 392–94; John E. Hodges, “Some Economic Implications of Cost-Plus Pricing,” Southwestern Social Science Quarterly, December, 1954, pp. 225–34; I.F. Pearce, “A Study in Price Policy,” Economica, May, 1956, pp. 114–27; I.F. Pearce and Lloyd R. Amey, “Price Policy with a Branded Product,” Review of Economic Studies, Vol. XXIV (1956–57), No. 1, pp. 49–60; James S. Ear-ley, “Recent Developments in Cost Accounting and the ‘Marginal Analysis’ ,” Journal of Political Economy, June, 1955, pp. 227–42; and David Green, Jr., “A Moral to the Direct-Costing Controversy,” Journal of Business, July, 1960, pp. 218–26.

⁴⁹This implicit wage will equal the DMVP of the owner's managerial services, which will tend to equal the “opportunity wage forgone” that he could be earning as a manager elsewhere.

⁵⁰In one of those extremely fertile but neglected hints of his, Böhm-Bawerk wrote:

But even where he [the businessman] does not personally take part in the carrying out of the production, he yet contributes a certain amount of personal trouble in the shape of intellectual superintendence—say, in planning the business, or, at the least, in the act of will by which he devotes his means of production to a definite undertaking. (Böhm-Bawerk, Capital and Interest, p. 8)

⁵¹For an interesting contribution to the theory of business income, though not coinciding with the one presented here, see Harrod, “Theory of Profit” in Economic Essays, pp. 190–95. Also see Friedman, “Survey of the Empirical Evidence on Economies of Scale: Comment.”

⁵²Since the scope of their business property and decisions is relatively negligible compared to their labor services, we may neglect their decision rents here.

⁵³It is a managerial wage, even though the only employee may be the owner himself. It may seem strange to classify a domestic servant as “self-employed,” but actually he is no different from a doctor or a lawyer to the extent that the latter sells his services to consumers rather than to capitalists.

⁵⁴Another reason why an economy of producers’ co-operatives could not calculate is that every original factor would be tied indissolubly to a specific line of production. There can be no calculation where all factors are purely specific.

⁵⁵Vertical integration, we might note, tends to reduce the demand for money (to “turn over” at various stages) and thereby to lower the purchasing power of the monetary unit. For the effect of vertical integration on the analysis of investment and the production structure, see Hayek, Prices and Production, pp. 62–68.

⁵⁶The implicit price, or opportunity cost of selling to oneself, might be less than the existing market price, since the entry of the Jones Company on the market might have lowered the price of the good, say to 102 ounces. There would be no way at all, however, to estimate the implicit price if there were no external market and external price.

⁵⁷On the size of a firm, see the challenging article by R.H. Coase, “The Nature of the Firm” in George J. Stigler and Kenneth E. Boulding, eds., Readings in Price Theory (Chicago: Richard D. Irwin, 1952), pp. 331–51. In an illuminating passage Coase pointed out that State “planning is imposed on industry, while firms arise voluntarily because they represent a more efficient method of organizing production. In a competitive system there is an ‘optimum’ amount of planning.” Ibid., p. 335 n.

⁵⁸Capital goods are stressed here because they are the product for which the calculability problem becomes important. Consumers’ goods per se are no problem, since there are always many consumers buying goods, and therefore consumers’ goods will always have a market.

⁵⁹See the classic presentation of the position in Ludwig von Mises, “Economic Calculation in the Socialist Commonwealth,” reprinted in F.A. Hayek, ed., Collectivist Economic Planning (London: George Routledge & Sons, 1935), pp. 87–130. Also see in the Hayek volume the other essays by Hayek, Pierson, and Halm. Mises continued his argument in Socialism (2nd ed.; New Haven: Yale University Press, 1951), pp. 135–63, and refutes more recent criticisms in his Human Action, pp. 694–711. Aside from these works, the best book on the subject of economic calculation under socialism is Trygve J.B. Hoff, Economic Calculation in the Socialist Society (London: William Hodge, 1949). Also see F.A. Hayek, “Socialist Calculation III, the Competitive ‘Solution’” in Individualism and the Economic Order, pp. 181–208, and Henry Hazlitt's remarkable essay in fictional form, The Great Idea (New York: Appleton-Century-Crofts, 1951).

⁶⁰It is remarkable that so many antisocialist writers have never become aware of this critical point.

⁶¹Far from being refuted, Mises had already disposed of this argument in his original article. See Hayek, Collectivist Economic Planning, p. 109. Further, Barone's article was written in 1908, 12 years before Mises’. A careful perusal of Mises’ original article, in fact, reveals that he there disposed of almost all the alleged “solutions” which decades later were brought forth as “new” attempts to refute his argument.

⁶²Part of the confusion stems from an unfortunate position taken by two followers of Mises in this debate—Hayek and Robbins. They argued that a socialist government could not calculate because it simply could not compute the millions of equations that would be necessary. This left them open to the obvious retort that now, with high-speed computers available to the government, this practical objection is no longer relevant. In reality, the job of rational calculation has nothing to do with computing equations. Nobody has to worry about “equations” in real life except mathematical economists. Cf. Lionel Robbins, The Great Depression (New York: Macmillan & Co., 1934), p. 151, and Hayek in Col-lectivist Economic Planning, pp. 212f.

⁶³See Gottfried von Haberler, The Theory of International Trade (London: William Hodge, 1936), pp. 3–8.

⁶⁴See Mises, Human Action:

The fact that the production of raw materials and foodstuffs cannot be centralized and forces people to disperse over the various parts of the earth's surface enjoins also upon the processing industries a certain degree of decentralization. It makes it necessary to consider the problems of transportation as a particular factor of production costs. The costs of transportation must be weighed against the economies to be expected from more thoroughgoing specialization. (pp. 341–42)

⁶⁵See Mises, Human Action, pp. 622–24.

⁶⁶For the weighty implications of this “Misesian” analysis for the theory of “international trade,” cf. not only Mises’ Theory of Money and Credit, but also the excellent, though neglected, Chi-Yuen Wu, An Outline of International Price Theories (London: George Routledge & Sons, 1939), pp. 115, 233–35, and passim.

⁶⁷This error lies at the root of attacks on the “basing-point system” of pricing in some industries. The critics assume that uniform pricing of a good means uniform pricing at the various mills, whereas it really implies uniform “delivered prices” of the various firms at any given consumer center. On the basing-point question, see also the analysis in United States Steel Corporation T.N.E.C. Papers (New York: United States Steel Corporation, 1940), II, pp. 102–35.

⁶⁸For purposes of simplification, we have omitted the consumers in Rochester, Detroit, and elsewhere, but the same law applies to them. For consumers in Rochester and Detroit, in equilibrium:

P(Cr) in Rochester	= P(Cd) in Rochester, and
P(Cr) in Detroit	= P(Cd) in Detroit, etc.

⁶⁹For a critique of some aspects of this separation in the “new welfare economics,” see B.R. Rairikar, “Welfare Economics and Welfare Criteria,” Indian Journal of Economics, July, 1953, pp. 1–15.

⁷⁰The last few years have seen signs of a revival of “Austrian” production theory—the tradition in which these chapters have been written. In addition to works cited above, see Ludwig M. Lachmann, Capital and Its Structure (London: London School of Economics, 1956) and idem, “Mrs. Robinson on the Accumulation of Capital,” South African Journal of Economics, June, 1958, pp. 87–100. Robert Dorfman's “Waiting and the Period of Production,” Quarterly Journal of Economics, August, 1959, pp. 351–72, and his “A Graphical Exposition of Böhm-Bawerk's Interest Theory,” Review of Economic Studies, February, 1959, pp. 153–58, are interesting chiefly as a groping attempt by a leading mathematical economist to return to the Austrian road. For an incisive critique of Dorfman, see Egon Neuberger, “Waiting and the Period of Production: Comment,” Quarterly Journal of Economics, February, 1960, pp. 150–53.