Old Inflated Inflationary Fallacies (II)

In the first part we saw some fallacies about the “administered price” theory. The task is not over yet, so here is a second part. It is not at all a convincing theory, we will see that it still has numerous theoretical and empirical problems. Rejection is the only alternative I found for this theory; its numerous flaws make it untenable.

-"Wait a moment. Are you saying that there are no “price formers” in the market economy?"

Yes. In the real world free market all firms are “price takers”. There is no firm that can suspend the Law of supply and demand, no company can avoid in having a surplus if the price is too higher or have excessive orders and earn less than the maximum profits by setting a too low price. Sooner or later the firm will tend to set a “market clearing” price, the price that actually clears its supply and give it the maximum profit. In the real world the firm must make a “trial and error” process to “target” this market price[1]. As you read it, in our real world all firms, either big or small, are “price takers”. All are subject to consumer’s desires.

-"Aha! I knew it! You are just relaying on the neoclassical-mainstream theory of perfect competition! And you Austrians call yourselves a heterodox school?"

Of course Austrians do not rely on that. There is a very fundamental difference between real world firms and “perfect competition” firms as Shapiro notes: “Thus real-world firms are "price-takers" no less than firms in pure competition, the only difference being this: PC firms "take" their P from the market right from the start (they have perfect knowledge!), whereas real firms "take" their P only after trial-and-error search in the market. Irony of ironies: real firms are, in an ultimate sense, price-takers, too!

-"So, are you denying any control over price in the real world non-hampered market economy?"

In the real world every firm can set the price they want or not sell at the current market price. The firms can restrict their supply in order to try to obtain a higher price, but all that firms can do is that. Restricting supply is not forcing buyers to pay the higher price; the buyer is free to not pay. All that firms can do is to set the price they want, that’s all, the second half of the action (the purchase of the buyer) is totally out of their control.

-"Ok, can you please give me a summary?"

Shapiro can do it much better than I could do: “Thus we see that so long as the firm: (a) must seek the market-clearing price in order to avoid overpricing or underpricing its product and to maximize its profits, and (b) does not have the power to force buyers to pay its asking price, then so long must the firm—even the ugly "giant" oligopolist—be viewed as a price-taker rather than a price-controller. So long as the market demand can upset any price posted by the firm, we must conclude that it is market demand and not the firm that ultimately determines selling prices. In the absence of perfect knowledge, real-world price-takers have to grope and search for their profit-maximizing price instead of getting it automatically and instantaneously as in the unreal world of pure competition. In the real world, there is no way for the firm to avoid subservience to the market as the ultimate determiner of its selling price. Hence, since all real-world firms are necessarily price-takers, the PC model no longer has a monopoly on price-takers!”

The main problem, the core fallacy, with the “administered” price doctrine is superficiality. Its supporters see someone on some particular market setting a price and people buying the good, and they think that the seller “determined” the price. Consumers don’t feel they are being “administered” when they go to Walmart. Just imagine your daily life if you should bargain the price of every good and service you buy. Imagine yourself haggling every day the gas price of your car every time you need it, haggling a chewing gum price, a movie ticket price, the bread price, the renting price, the pizza price, etc. Just imagine a romantic dinner with your girlfriend and having to bargain the price of meal, the drink price and even bargain with the valet parking guy! It would be an isolated exchange in every exchange! You would end exhausted every day having to negotiate every price, it would be extremely costly. But it is not only a problem of costs. The real world (unhampered) market is, in great majority of cases, a two-sided competition, this guaranties a market price and not having to bargain every price. This process of two-side competition protects the weakest people (those who do not have great bargain abilities). Market process of price formation protects the weak people from others with a much better developed negotiation skills.  

Actually the evolution from the oriental bazar to this “one-price” system is actually a manifestation of consumer’s desires. It evolved to satisfy their demands for a time-saving and easy way to acquire the goods and services they need. The great irony: the system that the “administered” theorists see as a “oligo/monopolist” domain, is actually a manifestation of “consumers sovereignty” and obeys the same fundamental Laws.

-"Yeah yeah, that sounds great “in theory”. But what about the empirics?"

There is no conclusive evidence of the "administered price" thesis at all, all we can say is that there is a lot of conflicting evidence. Its own theoretical problems makes it very difficult to “test” empirically. A good summary is here and you will see the great problems with the empirical test of that. If you come with 100 papers “demonstrating” its existence I could also bring 100 papers denying it. The own inexactitude, arbitrary and superficial nature of the theory allows that.

-"So you are saying that “money matters”?" 

Yes (but not in the monetarist-positivist way). What we call “inflation” today (the sustained rise in price level in a determined period) is consequence of monetary manipulation. As Haberler explains:

“the so-called “administrative inflation" could never develop without an expansion of monetary demand. But all I wish to show here is how, without the assumption of arbitrary administrative discretion in price fixing, the price behavior sketched by Gardiner Means can be explained.”

-"Are you certain of this?"

Prices that are "administered" are not prices of our uncertain world. An entrepreneur produces a good only because he anticipates a margin between today costs and the expected future price, if this is not expected to happen he will not launch the project. Those future prices are not “equilibrium” prices in neoclassical sense, but the prices that the producer expects the consumers of his product will be willing to pay. Notice that the time difference between these two magnitudes (today costs and future selling price to be asked) gives the margin for uncertainty, a lot of things can happen between these moments. It could be the case that a) product price is approximately the same he expected, so he obtains the expected profit or b) it can be that the price is higher so he earns more than he expected or c) the price is lower so he earns nothing but at least he is able to cover some of the costs or d) the price is so low he cannot even cover costs and he lose money. But not even costs are rigidly determined in present; they also are to some extent uncertain. Remember that in Austrian theory not only the ends are subjective, but also the means. Uncertainty is a fundamental element and its impossible for human action to exists without it; the axiom of human action implies uncertainty. Is there any uncertainty when you can “administer” the price of your product? If you have “control over price” then you are certain of that price, you control it! This theory assumes away any trace of uncertainty in this issue. Not only it assumes that your company or industry certainly controls the price, it also assumes you are certain that buyers will pay that prices. You are not anticipating future prices or costs; you are assuming that the entrepreneurs are certain about future price and that that certainty will be fulfilled (does this sounds to you like “perfect knowledge-equilibrium” as much as it sounds to me?). I must say this because the school of thought that uses administered price as a “price theory” claims that uncertainty is very important.

Conclusion

This theory is not even a theory of price determination. All that can do is to describe a particular institution (like one-price markets, mark ups rules of thumb, etc),  but it does not tell us anything about the real ultimate causes of price formation. The problem with it is its superficiality, it is the main problem about methodological nominalism: it cannot reach the essence.

It should not be a mystery that this "heterodox" post keynesian-friendly guy is destroying Argentina's economy.

[1] It is obvious that this price changes as data (valuations, incomes, technologies, other prices, etc) changes in every moment, but the tendency is permanent.