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KEY LESSONS OF AUSTRIAN ECONOMICS – CONT’D

Key Lesson #4: Value and costs are subjective

Us: We know that in order to conduct a transaction (e.g. money for a gadget), people assign value to that gadget. If they think that the value is higher than the money they are willing to spend, they buy the gadget. If they decide the opposite, they don’t buy it. It is clear that the concept of value is purely subjective.  However, what about the cost that the manufacturer of that gadget pays? Is it subjective or objective? At first glance, it would seem it is objective. The manufacturer has no choice but to spend the manufacturing cost and so be able to produce the gadget. However, what Austrian Economics pointed out, is that  the manufacturer is also making a subjective valuation call. For example, the manufacturer decides to spend the money to make the gadget as opposed to spend the money speculating in the stock market. The manufacturer believes he will make more money selling the gadget than playing the stock market. This is also a subjective decision.

Them: they believe that either the costs are objective or that in a way it is irrelevant since prices are magically decided by the equilibrium between supply and demand. We have already explained why the concept of “objective” costs is ludicrous; because it demands that manufactures be objective people. Not going to happen. But what’s the deal with the “equilibrium”?  Well, if value is subjective (i.e. the amount of money I am willing to pay) and cost is also subjective (i.e. the cost a manufacturer is willing to pay to produce a gadget) how is that the transaction money for gadget is suddenly in an “equilibrium”? Equilibrium means that both plates of a balance have the same weigh. But if buyers and producers are changing the weighs on the balance based on gut feeling, can we call this an equilibrium? Equilibriums are supposed to be stable, economic transactions are not. Consider this.  You go grocery shopping. Today a can of tuna is selling at $1.5. Tomorrow, the same can is on sale for $1.1. What happened? Was there suddenly an explosive overpopulation of tuna that increased the supply dramatically? Or is it more likely that the grocery shop owner decided to attract new people with a juicy offer? Well, according to them, is the tuna.  And there you have it, nonsense in its full glory!

 

Key Lesson #5: Markets provide just the right amount of information

Us: The most important piece of information a market provides is price. With this information, market participants can obtain mutual gains from transactions. This is actually the only information that it is required. For example, going back to our previous example of tuna cans, if the shop owner decides to raise the price of a can to $2 each, we will be eating less tuna. We do not need to know if the increase in price per can is due to a decreased supply of tuna, an increased price in the wages of tuna packers or low tuna fishing yields. All the information we need to benefit from our tuna purchases is its price. Prices change quickly when conditions change, and this allows people to adapt quickly. This issue is actually related to the amount of information available in a market. Austrian Economics simply state that people in markets act based on little and imperfect information. However, the market manages to make the most of this. In other words, markets are efficient; they get the most benefits for all participants with a minimum of information required. This does not mean that markets are absolutely efficient. It is conceivable that in theoretical, ideal conditions, markets could provide the absolute maximum benefits for participants, but, then again, only in theoretical conditions which cannot be achieved in practice.

Them: Originally, they stated that markets were perfect, that all market participants had all the information about a transaction available to them at all times and fully. Yes, that’s right. They assumed that somehow, magically, when I go to buy a tuna can to the supermarket I know everything, from tuna packers’ wages, to fishing statistics, from transportation costs to shop profit margins and their financial obligations! How much more ridiculous can this get? Anyhow, over time (and thanks in no small measure to Austrian Economics), they changed their tune. Now they are saying that yes indeed, markets make good use of however little information is there, but, somehow, markets are not efficient. The idea being that because markets are not absolutely efficient, there is room for improvement (which is reasonable and does not contradict Austrian Economics). But this improvement does not come from market evolution, but from… wait for it… governments!!!  To find out how a government can actually improve the market, we need to take a closer look at what governments may do under various conditions. In other words, the question is no longer if the government can actually improve the market, but what should the government do (theoretically) to improve the market. The question has shifted to: what is the government’s role in the markets? The only problem is, they have not proven that governments can actually, practically improve markets!!! They just jumped to conclusions.  When have you seen that a government, any government, anywhere on the planet has acted consistently and over sufficiently long times to improve a market? Let’s us help you here: never! The reason is simple: lack of motivation. There is no motivation in any government official to “do the right thing”. No motivation means no market improvements.  Yes, it is that simple!

 

Key Lesson #6: Private property is absolutely necessary for economic common sense

Us: common sense in economics simply means to use scarce resources in the most efficient way. Because these resources are privately owned, there is a huge incentive to do it as efficiently as possible. Going back to our tuna example, if the price of a can is now at $2, I will probably choose to spend my money (my resource) on something cheaper, let’s say sardines. This way, I get more stuff for my money. If the money belongs to my billionaire uncle and he just dumps it in my lap, I will probably buy tuna since I don’t really care! It is not my money.  If you want to have efficient markets, you need private property.

Them: For the longest time, socialistic theories infiltrated economic thought. The idea was that if incentive was the issue, socialism can provide other incentives to people to behave in the same efficient manner. The problem was not an issue of incentives, but an issue of resource use. Incentives were only the engine that pushed the decision, but the decision itself depends on prices. Going back to our tuna example, if I go to the supermarket and I am told that the price of tuna just went up, but, no we don’t know by how much, what do you do? Do you buy tuna or sardines? Without being able to compare the prices of one against the other, it is not possible to make a rational decision. Prices are telling us what is scarce and what is not. Through this information, we can make common sense decisions. Without this information, we cannot. Current economic theories are still socialistic to the degree to which they support government actions in markets. The problem is, as soon as a government steps into a market they artificially change prices. Once prices are affected, we can no longer trust prices to tell us what is scarce and what is not. Without this information, we cannot make common sense decisions. Without common sense decisions, resources are wasted and our standards of living decrease.

 

Key Lesson #7: A competitive market is a process

Us: Competitive markets don’t “just happen to be there”. Competition implies activity. There are people competing against each other. These people, the entrepreneurs, are motivated by potential profits to seek opportunities for mutual gain.  They are looking for and discovering inefficient use of resources. When they find them, they earn a profit for making this inefficient use more efficient. Going back to our tuna can example, if my usual supermarket raised tuna prices to $2 a can, perhaps that other supermarket saw an opportunity and lowered their prices to $1.9. By doing so, they lure customers to their store, selling more tuna cans than before and making a profit for it. But they also benefit from more customers accessing their store, which will, in turn, buy more food. They saw a market inefficiency (high tuna prices) and produced and opportunity to re-allocate my resources (my money) in a more efficient way (cheaper tuna prices). In so doing, they earned a profit but I also benefited (mutual gain). Is these entrepreneurs that make free markets efficient. Competitive markets are discovery mechanisms through which people generate mutual gains and use scarce resources efficiently. No entrepreneurs, no free market.

Them: For many classic economic theories, competitive markets are “just there”. They “just happen”. Magically. They can be quantified, measured and analyzed through statistical analysis. Entrepreneurs are participants, yes, but only as a far second thought. Markets need people to buy and sell, and that is all that entrepreneurs are, one half of the transaction. Nothing more. Because of this, markets can be altered (manipulated) since competition is an “equilibrium” process. We can look at the desired mathematical outcome and create a government policy that will force markets into that direction. Never mind entrepreneurs. Does this sound familiar to you? Does this sound like something that will work in real life? Let’s artificially alter market conditions and expect entrepreneurs to behave as predicted by statistical models? Or does it sound like nonsense and wishful thinking?

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Austrian Economics In Theory - Part 6

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