Menno Rol wrote: [As a student, I got entangled in reasonings on what came
first, changes in quantities or in prices. Till I discovered that the
concept of 'price' in the Marshallian picture is ambiguous.]
I had the same problem. It seems to me that the resolution requires a
rejection of Marshall, and an embrace of Walras plus Mises, but with further
twists.
1. Marshall inherited the classical ambiguity between numeraire and
nominal price, and hence did not define price sharply. If we take a
Walrasian individual who produces and consumes n different goods under
subsistence (without any connection to the market), we must adopt one of the
goods or even an imaginary good as the numeraire good. There must be a
numeraire factor to convert every other good into units of the numeraire to
measure value. That is what the classical authors thought of as nominal
price, as distinct from the real or relative price. Confusion can be avoided
if we use the term numeraire instead of nominal price, and reserve the term
price to denote real or relative price, namely, take price always as a
ratio. That ratio of course is the quantity of the second good that pays for
the first good.
2. Marshall aborted the umbilical chord between price and income and
threw out the classical concern as expressed in Says Law. This abortion
occurred because Marshall took the individual away from the market and put
him in splendid isolation. A buyer cannot buy anything without an income,
and that income must be earned by selling something. Price theory must keep
the door open for income theory to see how the change in price affects the
income and is in turn affected by income. Marshalls famous pupil Keynes
struggled with the problem of bringing income back into the picture of
demand and supply. Keynes was correct in seeing that the equality of demand
and supply determined income rather than price. But everybody is afraid of
the great master, and hence even Keynes did not dispute the master.
3. Taking a clue from Walras, and with further incitement from
Mises, we may deal with [what came first, changes in quantities or in
prices]. Split the people into separate identities as optimizers and as
entrepreneurs. Thus we may imagine that in an evenly rotating economy of
Mises, the optimizers (producer, consumers) optimally choose quantities
under predetermined prices of yesterday (but not forbidding them to make
some guesses about possible price changes). Next, they hand over the output
to the entrepreneurs as arbitrageurs to settle the prices. The entrepreneurs
or arbitrageurs are not producers or consumers, and they do not optimize at
all. Their job is that of the Walrasian auctioneer: clear the market of
whatever the quantities are. They find a price that settles both the prices
and the incomes such that the value of demand is equal to the value of
supply, as well as the quantity of income is equal to the quantity of
expenditure. For the next day, rotate the economy again. If the price of
today has changed, tomorrow the optimizers will change the quantities in
response, and then bring those to the merchants, who will once again change
the prices if there is a need to do so for market clearing. The process
keeps on going until the economy becomes even: day after day, the same
prices persist and the same quantities are optimally chosen.
4. Like the proverbial egg first or chicken first problem, the
resolution of the price-quantity sequence is to see that two distinct
processes or pursuits are involved in the essentially inseparable procedure:
prices and quantities are both determined together. Thus suppose that two
neighbors are negotiating over a barter between two goods x and y, and they
have not yet produced any. Suppose John says to Paul: I will give so much of
x to you, how much y will you give? Then Paul gives an answer and John says,
no, you will give more y or I will give less x and so on. At last, they find
a mutually agreed bargain. That at once settles the quantities, and the
price as a ratio between the quantities. Also inseparably, the market
incomes and expenses of the agents are also determined by the same acts. As
analysts, we can break down the affair into price theory and output theory,
and apply optimization and entrepreneurship in isolation. The key is that
optimizers are price takers while entrepreneurs are price makers.
5. The gist of the Misesian market drama is this: let optimizers
produce a certain quantity at a presumed price which equates with marginal
cost (all measured in terms of the other good to be had in exchange). But as
an entrepreneur, the seller tries to get a price higher than marginal cost.
It is simpler to pretend that the seller is a pure seller as arbitrageur,
who acquires goods at marginal cost, (but does not produce or consume them)
and then adds a mark up if possible. The entrepreneurs dictum is to buy
cheap and sell dear. The price is set arbitrarily above the sellers marginal
cost and below the buyers marginal cost (which may be ranked in terms of
utility as well). The arbitrariness of arbitrage remains a debatable issue
among the esoteric followers of Mises and Kirzner against Shackle and
Lachmann, while all of them dismiss the pretense of determinate price as
shown by deterministic algebra. This is a matter of competition, and
Kirzner likes it to be seen as a process rather than as a point. The
Marshallian intersection of the demand and supply curve of one good is too
simplistic to reveal the many complexities. Sadly, lack of formalization
keeps the good work of Mises, Kirzner, Hayek and Lachmann out of reach.
6. I no longer worry whether the egg came first or the chicken did.
I worry about the richness of the egg and the chicken. The Marshallian egg
is not sufficiently nutritious, and it can give birth to a very poor
chicken. I want richer ones.
Mohammad Gani
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