WEBVTT

NOTE The Determination of Prices

1
00:00:00.000 --> 00:00:04.120
I'm Peter Klein, and it's a pleasure to be with you this morning.

2
00:00:04.120 --> 00:00:09.520
Let me start by saying how delighted I am to be able to participate in this series on

3
00:00:09.520 --> 00:00:13.960
Fundamentals of Economic Analysis, a Causal Realistic Approach.

4
00:00:13.960 --> 00:00:19.980
As you may know, Professor Salerno gave a similar set of lectures last year by himself,

5
00:00:19.980 --> 00:00:24.400
and so it was decided that I should join him this year to add a little rigor to the analysis.

6
00:00:24.400 --> 00:00:25.400
I'm just kidding.

7
00:00:25.400 --> 00:00:29.120
Actually, Joe's not in here, that was for his benefit.

8
00:00:29.120 --> 00:00:58.120
The truth is that Joe and I share a belief that the kind of causal, realistic analysis that we'll be discussing this week is not only fundamental to Austrian economics, the core in a sense of Austrian economic thinking, but also that it has been unduly neglected, shall we say, not only by mainstream economists, but even by many who call themselves Austrian economists.

9
00:00:58.120 --> 00:01:20.120
So really what we hope to achieve with the seminar and ultimately with a written version that will come out in book form in the not too distant future is to help to encourage sort of a revival of this kind of analysis within the Austrian school and hopefully to initiate some changes that may spread beyond the Austrian school as well.

10
00:01:20.120 --> 00:01:30.120
We've already had two introductory lectures yesterday on the basics of value and exchange, demand and so on.

11
00:01:30.120 --> 00:01:35.120
So today we're going to build on that analysis and move on to thinking about the determination of prices.

12
00:01:35.120 --> 00:01:38.120
We think about prices in monetary terms.

13
00:01:38.120 --> 00:01:44.120
So imagine that we have an economy with multiple individuals who are interested in participating in exchange.

14
00:01:44.120 --> 00:01:49.120
There is a common medium of exchange in this economy.

15
00:01:49.120 --> 00:01:59.120
So goods and services can be exchanged in numbers, determined in monetary terms, so there are money prices in this economy.

16
00:01:59.120 --> 00:02:10.120
Let's try to understand, as Carl Menger did, and as Menger's successors did, what determines the prices that are actually paid in market transactions day to day.

17
00:02:10.120 --> 00:02:19.120
Okay. Again, just to remind you of sort of the institutional and informational assumptions of our analysis, right?

18
00:02:19.120 --> 00:02:24.120
So we assume that buyers and sellers are aware of at least some feasible trades.

19
00:02:24.120 --> 00:02:31.120
So they know that there are other agents in the economy who may have goods and services that they wish to buy or to sell.

20
00:02:31.120 --> 00:02:37.120
Market participants understand that participating in the division of labor will bring them benefits.

21
00:02:37.120 --> 00:02:46.120
Okay, so they're not just sort of mindlessly, robotically acting in a pre-programmed fashion or in a manner determined by evolution in any sort of narrow sense.

22
00:02:46.120 --> 00:02:52.120
But they have some cognitive faculty of awareness. They want to be in the division of labor.

23
00:02:52.120 --> 00:02:59.120
We make some very simple assumptions about people's preferences. Sellers prefer higher profits to lower profits.

24
00:02:59.120 --> 00:03:07.120
And we can add a very simple assumption about learning, namely that buyers and sellers have the capacity to learn from their mistakes.

25
00:03:07.120 --> 00:03:10.120
And we'll see what that means in more concrete terms in just a moment.

26
00:03:10.120 --> 00:03:18.120
The point is we do have some assumptions about people's abilities, but they're pretty mild assumptions.

27
00:03:18.120 --> 00:03:27.120
We're not making any kind of strong assumptions about, for example, perfect knowledge, as in the textbook model of perfectly competitive general equilibrium,

28
00:03:27.120 --> 00:03:34.620
where all agents are perfectly informed about the existence of all other agents and all feasible trades and all resource attributes and so on.

29
00:03:34.620 --> 00:03:36.620
We're not making an assumption that strong.

30
00:03:36.620 --> 00:03:48.620
We're not assuming, as in the perfectly competitive model, infinitely large numbers of buyers and sellers where sellers are facing a perfectly elastic demand curve and so on.

31
00:03:48.620 --> 00:03:51.620
Joe talked about this yesterday.

32
00:03:51.620 --> 00:03:57.020
We're not assuming that the goods and services being exchanged are infinitely divisible or perfectly divisible.

33
00:03:57.220 --> 00:04:00.660
So you won't see any partial derivatives in the discussion today.

34
00:04:00.940 --> 00:04:08.540
There's not only no need to apply the calculus notion of infinitely small adjustments, but also no...

35
00:04:09.660 --> 00:04:16.340
Also doing so would be illegitimate in the world of real action because human agents think in discrete terms.

36
00:04:16.340 --> 00:04:20.140
You think about buying a Coke or you think about buying an automobile.

37
00:04:20.140 --> 00:04:26.260
Automobile. You don't think about buying one nth of an automobile as n goes to infinity

38
00:04:26.260 --> 00:04:32.620
and so on. Okay? Here's what we're going to do. We'll walk through a series of different

39
00:04:32.620 --> 00:04:37.620
scenarios from the most simple to the most complicated. So we'll start with a simple

40
00:04:37.620 --> 00:04:44.980
case of two-person exchange. Then we'll go on to a setting where you have many potential

41
00:04:44.980 --> 00:04:52.980
There are multiple buyers of one single commodity, think of an auction, an art market or something like that.

42
00:04:52.980 --> 00:04:56.980
There's one painting and several people who are potentially interested in buying.

43
00:04:56.980 --> 00:05:00.980
Then we'll think about a situation with one buyer and multiple sellers competing for the same buyer,

44
00:05:00.980 --> 00:05:08.980
working our way up to an analysis of bilateral competition or multiple buyers and multiple sellers.

45
00:05:08.980 --> 00:05:11.980
And of course I'm thinking about this with a specific example.

46
00:05:11.980 --> 00:05:17.980
I used to do with my car, the radio on my car, more specifically the CD player on my car.

47
00:05:17.980 --> 00:05:22.980
I drive an old Nissan Maxima. There's a picture of it right there.

48
00:05:22.980 --> 00:05:29.980
That's actually the stock photo. That's not my car, although it does look like the grounds of my estate in the background.

49
00:05:29.980 --> 00:05:36.980
The radio looks like that. Now what happened is a CD jammed in the radio.

50
00:05:36.980 --> 00:05:40.980
So I was listening to a CD and I pressed eject and it wouldn't come out.

51
00:05:40.980 --> 00:05:44.780
It's one of those, you know, it slides in and then it kind of goes down. So you can't reach it.

52
00:05:44.780 --> 00:05:50.580
Of course, there's only a teeny little slot. So this happened while I was out on the road somewhere.

53
00:05:50.580 --> 00:05:54.940
I wasn't home, you know, like with tools. So I'm, I can't remember, I'm in a parking lot or on the side of the road.

54
00:05:54.940 --> 00:05:58.760
And I'm trying to figure out how the heck am I gonna get the CD out of there because I don't want to lose it,

55
00:05:58.760 --> 00:06:01.080
number one, and I still had another hour's drive ahead of me.

56
00:06:01.080 --> 00:06:05.180
I didn't want to be without, you know, without anything to listen to. Tried to stick my fingers in there.

57
00:06:05.180 --> 00:06:10.080
Of course, it didn't work. I think I found, like, I had a pocket knife or a screwdriver or something, tried to stick it in there.

58
00:06:10.080 --> 00:06:11.180
That didn't work.

59
00:06:11.180 --> 00:06:12.240
I had the brilliant idea, I said,

60
00:06:12.240 --> 00:06:16.360
well, the only implement I have that is the right size

61
00:06:16.360 --> 00:06:18.680
to go in there where I can sort of twiddle and wiggle

62
00:06:18.680 --> 00:06:22.460
and maybe hope to pry it loose is another CD, right?

63
00:06:22.460 --> 00:06:24.740
So I took another CD and kind of stuck it in there.

64
00:06:24.740 --> 00:06:27.280
Okay, I'm a professor, I'm not very practical.

65
00:06:27.280 --> 00:06:28.980
And I tried to wiggle and jiggle, and of course,

66
00:06:28.980 --> 00:06:31.480
what happened is the CD player sucked that one in too.

67
00:06:31.480 --> 00:06:33.800
So now there's two CDs jammed in there.

68
00:06:33.800 --> 00:06:36.940
Okay, so being very clever, I said to myself,

69
00:06:36.940 --> 00:06:39.040
yeah, I just need to replace the whole unit,

70
00:06:39.040 --> 00:06:41.440
But when I went to the dealer and said,

71
00:06:41.440 --> 00:06:44.640
how much will it cost to get a new factory radio?

72
00:06:44.640 --> 00:06:48.280
I mean, it's some ridiculous 500 bucks or something.

73
00:06:48.280 --> 00:06:50.480
I thought, well, I'll go to Circuit City or Best Buy

74
00:06:50.480 --> 00:06:51.940
and get an aftermarket radio.

75
00:06:51.940 --> 00:06:54.640
But then I'll look like one of those people who invests a lot

76
00:06:54.640 --> 00:06:56.640
in his car stereo, and I don't want people to think

77
00:06:56.640 --> 00:06:58.440
that I'm putting a lot of time into this.

78
00:06:58.440 --> 00:07:01.760
Of course, I've already put in many, many hours at this point.

79
00:07:01.760 --> 00:07:03.800
I said, I'll just go onto eBay and see

80
00:07:03.800 --> 00:07:08.560
if I can find a replacement for my factory original radio.

81
00:07:08.560 --> 00:07:14.560
And in fact, if you go to eBay, it turns out there's a whole bunch of people selling radios very similar to mine.

82
00:07:14.560 --> 00:07:18.560
Some of these are exactly the right model, some of them are pretty close.

83
00:07:18.560 --> 00:07:23.560
And it turns out, if you're clever, you can even purchase from certain vendors on the web

84
00:07:23.560 --> 00:07:29.560
instructions for how to pull the unit out yourself and replace it and stick it back in.

85
00:07:29.560 --> 00:07:33.560
So I can do all this without having to pay, without participating in the division of labor

86
00:07:33.560 --> 00:07:37.560
and paying somebody to put it in for me, I could do it all myself and wouldn't that be fun?

87
00:07:37.560 --> 00:07:43.560
Then I started to look at these radios and they turned out to be a little bit more expensive than I was anticipating.

88
00:07:43.560 --> 00:07:50.560
You can see some of these have a buy it now price between $100, $150, some of them are up to $200.

89
00:07:50.560 --> 00:07:59.560
I watched some of the auctions to see where the market would clear eventually and they all cleared at a price a little higher than what I had in mind.

90
00:07:59.560 --> 00:08:05.560
So the point is I'm still driving around with busted radio, but I'm determined to figure this out at some point.

91
00:08:05.560 --> 00:08:12.560
Now back to our story, what determines the prices at which these radios will sell, right?

92
00:08:12.560 --> 00:08:14.560
Why are some of them more expensive than others?

93
00:08:14.560 --> 00:08:23.560
How does the design of the sort of selling institution, the market as designed here by eBay, affect the price that will be determined, that will prevail and so on?

94
00:08:23.560 --> 00:08:26.560
Okay, so let's go back to our story for a second.

95
00:08:26.560 --> 00:08:56.560
Okay, start with a simple case in which there's only one radio available for sale, okay, and there's only one potential buyer of that radio, okay, so we can think about each person, right, each buyer and seller has a subjectively determined preference ordering or value scale, as Joe described yesterday, right, where they rank the possession of a radio in relation to the possession of various dollar amounts, okay, so imagine that we can define what we call the reservation prices,

96
00:08:56.560 --> 00:09:02.560
Meaning for the buyer, the highest price that he would willingly pay and still acquire the radio.

97
00:09:02.560 --> 00:09:06.560
Okay, so assume that the buyer's reservation price is $250.

98
00:09:06.560 --> 00:09:11.560
He would not pay more than $250 for a radio, but he would pay up to $250.

99
00:09:11.560 --> 00:09:14.560
Okay, it doesn't mean that he prefers to pay $250.

100
00:09:14.560 --> 00:09:16.560
He'd prefer to pay $10.

101
00:09:16.560 --> 00:09:21.560
Okay, but he'd be willing to pay as much as $250, but he would rank $250 higher than,

102
00:09:21.560 --> 00:09:27.560
$251 would be higher on his preference ordering than possession of a radio.

103
00:09:27.560 --> 00:09:36.560
Likewise, the seller has what we call a reservation price, the lowest price that he would be willing to go and still be willing to sell the radio.

104
00:09:36.560 --> 00:09:42.560
So imagine that the buyer's reservation price is $250, the seller's reservation price is $200.

105
00:09:42.560 --> 00:09:49.560
Well, there's a feasible trade here. There's room for mutual benefit for gains from trade.

106
00:09:49.560 --> 00:10:00.560
They could exchange this one radio at any price between $200 and $250, greater than $200, less than $250, and each would be better off than he was before.

107
00:10:00.560 --> 00:10:13.560
Okay, so what we can say in a case like this is that the equilibrium price could lie anywhere below the buyer's subjective valuation and above the seller's subjective valuation.

108
00:10:13.560 --> 00:10:23.560
So notice that in this case we can't explain exactly what the price will be. Will it be $225? Will it be $201? Will it be $249?

109
00:10:23.560 --> 00:10:33.560
Well it depends on the relative bargaining abilities of the two parties. It might depend on some aspect of institutional design that isn't explicitly addressed here.

110
00:10:33.560 --> 00:10:42.560
So in terms of sort of deriving exact laws of economics, the way Joe described them yesterday, the most we can say is that the price will lie somewhere in this interval.

111
00:10:42.560 --> 00:10:43.920
in this interval, okay?

112
00:10:43.920 --> 00:10:45.780
This is pretty straightforward.

113
00:10:46.900 --> 00:10:48.340
Slightly more complicated case.

114
00:10:48.340 --> 00:10:51.600
Suppose there is one radio available for sale

115
00:10:51.600 --> 00:10:55.520
and five potential buyers, okay, B1 through five.

116
00:10:55.520 --> 00:10:59.320
And each one has a different reservation price.

117
00:10:59.320 --> 00:11:01.440
So the first buyer values the radio

118
00:11:01.440 --> 00:11:03.960
as much as $300, but not more.

119
00:11:03.960 --> 00:11:05.680
The second buyer values the radio

120
00:11:05.680 --> 00:11:10.120
as much as 275, but not more, and so on, okay?

121
00:11:10.120 --> 00:11:11.900
What can we say here?

122
00:11:11.900 --> 00:11:41.540
Well, there's, given the numbers in this example, there are opportunities for mutual gain, right, and in this case, we can say the good will go to the most capable buyer, meaning the buyer with the highest reservation price, the greatest willingness to pay, at a price between his reservation price and the reservation price of the next most capable buyer, assuming that those are above the seller's reservation price, okay?

123
00:11:41.540 --> 00:11:57.940
So the point is, if the radio were offered for sale at $270, there are two potential buyers but buyer one is willing to pay more than $275 and buyer two isn't.

124
00:11:57.940 --> 00:12:03.940
So buyer one would offer to outbid buyer two by offering $276.

125
00:12:03.940 --> 00:12:06.940
So the price can be no lower than $275.

126
00:12:06.940 --> 00:12:18.940
Otherwise, we would not have resolved which buyer is going to get the radio, and the price can't be greater than 300, otherwise no one's interested in buying, can't be below 200, otherwise the seller is not interested in selling.

127
00:12:18.940 --> 00:12:35.940
So again, we can establish precisely a range for the equilibrium price, no higher than the most capable, what von Boehm-Bawerk calls the most capable buyer, the buyer with the highest willingness to buy, and no lower than the price of the willingness to pay of the next most capable buyer.

128
00:12:35.940 --> 00:12:50.940
So again, we're establishing a range, not an exact number, and we can say the equilibrium quantity Q star is one, there will be one unit exchanged, and the equilibrium price P star will lie between 275 and 300.

129
00:12:50.940 --> 00:12:52.940
Pretty straightforward stuff.

130
00:12:52.940 --> 00:13:10.940
Here's a slightly different case. Suppose that we have the same competition among buyers, but suppose that the seller's reservation price is greater than the reservation price of the most capable buyer.

131
00:13:10.940 --> 00:13:19.940
Well, here there are no feasible gains from trade. No buyer is willing to pay as much as the seller requires, so the equilibrium quantity here is zero.

132
00:13:19.940 --> 00:13:22.540
Okay, so there will be no exchange in a case like this.

133
00:13:22.540 --> 00:13:24.760
So just to remind you, there's a caveat, right?

134
00:13:24.760 --> 00:13:28.880
No matter what the rank ordering of preferences among buyers,

135
00:13:28.880 --> 00:13:30.060
there has to be at least one buyer

136
00:13:30.060 --> 00:13:32.460
who is willing to pay what the seller asks, okay?

137
00:13:33.540 --> 00:13:38.540
Now, reverse case, one-sided competition among sellers.

138
00:13:38.540 --> 00:13:41.400
So imagine there's a single buyer for this radio, me,

139
00:13:41.400 --> 00:13:43.980
but there's five different sellers on eBay,

140
00:13:43.980 --> 00:13:46.700
each of whom has a radio for sale, right?

141
00:13:46.700 --> 00:13:48.060
Will I end up buying one at all?

142
00:13:48.060 --> 00:13:49.860
And if so, which one will I buy?

143
00:13:49.860 --> 00:14:19.860
Well, if you imagine that the reservation prices are arranged like this, where the most I'm willing to pay is 250, okay, and we can arrange the sellers from what we would call the most capable seller, meaning the seller with the lowest reservation price, down to the least capable seller, the one with the highest reservation price, okay, so S1 would take anything more than 150 for the radio, S2 would require at least 170 and so on, okay. Well, given that I'm willing to pay as much as

144
00:14:19.860 --> 00:14:28.860
Competition Among Sellers assures that the equilibrium price will be no lower than $150 and no greater than $170.

145
00:14:28.860 --> 00:14:35.860
Okay, so one unit of the good, one radio will be purchased at a price somewhere between $150 and $170.

146
00:14:35.860 --> 00:14:38.860
Okay, so far so good.

147
00:14:38.860 --> 00:14:41.860
It's not terribly profound, is it?

148
00:14:41.860 --> 00:14:45.860
Okay, but we'll see, it gets a little bit more interesting and complicated.

149
00:14:45.860 --> 00:14:52.860
Now, suppose we have multiple buyers and multiple sellers, or bilateral competition.

150
00:14:52.860 --> 00:15:01.860
This is where we get into the somewhat misunderstood and frequently blind analysis from Boehm-Bawerk of what he called the marginal pairs.

151
00:15:01.860 --> 00:15:04.860
Boehm-Bawerk's analysis of the marginal pairs.

152
00:15:04.860 --> 00:15:15.860
There's no, as an aside, if you read Human Action, Mises does not go into a lot of detail about the mechanics of price setting.

153
00:15:15.860 --> 00:15:26.860
Rather, he simply mentions, almost in passing, that, of course, prices in markets are determined by the marginal payers, as Boehm-Bawerk has explained.

154
00:15:26.860 --> 00:15:32.100
and then he goes on and does the rest of his analysis and to your contemporary

155
00:15:32.100 --> 00:15:38.060
readers, marginal payers, what's he talking about? What's that? Where are the supply

156
00:15:38.060 --> 00:15:42.100
and demand curves in Mises? Where are the little tables explaining who exchanges

157
00:15:42.100 --> 00:15:45.820
what? Well Mises takes for granted that the educated reader is first completely

158
00:15:45.820 --> 00:15:49.660
familiar with von Boehm-Bawerk's analysis which most modern readers no

159
00:15:49.660 --> 00:15:53.640
matter how well educated they may be are not. Okay so let's spend a little bit of

160
00:15:53.640 --> 00:15:56.640
There's no time going through exactly what Boehm-Bawerk had in mind.

161
00:15:56.640 --> 00:15:59.640
Okay, so here we have two-sided competition, right?

162
00:15:59.640 --> 00:16:03.640
There are five potential buyers with their valuations,

163
00:16:03.640 --> 00:16:07.640
or the highest prices they're willing to pay, arranged as follows.

164
00:16:07.640 --> 00:16:13.640
And there are five possible sellers, okay, with their valuations arranged as follows.

165
00:16:13.640 --> 00:16:25.640
So notice, we're assuming here that, I mean, how many units of the good are available for potential transactions?

166
00:16:25.640 --> 00:16:28.640
How many units are out there in the marketplace that could be exchanged?

167
00:16:28.640 --> 00:16:29.640
Five.

168
00:16:29.640 --> 00:16:30.640
Yeah, five, right?

169
00:16:30.640 --> 00:16:36.640
I mean, the point is there are five sellers, so to be a seller, meaning you currently possess the good, and you might be willing to give it up for money.

170
00:16:36.640 --> 00:16:42.640
There are five people who want it, meaning they don't currently possess the good, but they would be willing to give up some money to get it.

171
00:16:42.640 --> 00:16:48.640
So, key assumption, there are five units that exist, five units that are available at this moment.

172
00:16:48.640 --> 00:16:53.640
The question is, who will end up having them?

173
00:16:53.640 --> 00:16:58.640
So you can imagine a set of circumstances under which there's no trade at all,

174
00:16:58.640 --> 00:17:03.640
and at the end of the day, at the end of the trading period, the five sellers still have the five radios.

175
00:17:03.640 --> 00:17:05.640
There were no transactions.

176
00:17:05.640 --> 00:17:11.640
Or, at the end of the day, none of the sellers has a radio anymore, and all five of the buyers have a radio.

177
00:17:11.640 --> 00:17:21.640
Five transactions. So we can see that the range of equilibrium quantities is from zero to five. It can't be more than five because there's only five radios.

178
00:17:21.640 --> 00:17:32.640
So how do we solve for what the price will be, what's the equilibrium price in this case, and what's the equilibrium quantity, how many units will be exchanged?

179
00:17:32.640 --> 00:17:36.640
Well, there are a couple different ways we can think about it, and let's walk through a few of them.

180
00:17:36.640 --> 00:17:40.640
Okay, one is to imagine that we sort of pair these guys up.

181
00:17:40.640 --> 00:17:46.640
Okay, so imagine that, you know, they're arranged where buyer one meets seller one and buyer two meets seller two,

182
00:17:46.640 --> 00:17:48.640
and they just sort of pair off, right?

183
00:17:48.640 --> 00:17:51.640
And if they happen to be paired off in this order, what do you say?

184
00:17:51.640 --> 00:17:56.640
Well, I mean, there are potential gains from trade between B1 and S1, right?

185
00:17:56.640 --> 00:18:02.640
Because B1 values a lot more than S1 does, so they could arrange a trade somewhere between 300 and 150.

186
00:18:02.640 --> 00:18:10.640
Feasible gains from trade in the second pair, the third pair could make a deal, the fourth pair could make a deal, the fifth pair couldn't.

187
00:18:10.640 --> 00:18:19.640
Okay, so when we get down to B5 and S5, the buyer values it less than the seller, so there's no possible price that would lead to a transaction in that case.

188
00:18:19.640 --> 00:18:25.640
Okay, well that tells us that, makes us think, well maybe there are going to be four transactions, but not five.

189
00:18:25.640 --> 00:18:42.640
Right, but this doesn't tell us what determines which buyer gets paired up with which seller, and if we're imagining a market for a homogeneous good, right, nobody would want to pay more for the good than somebody else in the market is paying for that good.

190
00:18:42.640 --> 00:18:52.640
Right, so if we want to explain the emergence of a uniform price in this market, where everyone is transacting at the same price, simply doing it this way doesn't help us.

191
00:18:52.640 --> 00:19:03.640
Another way we could think about it, is what if we just line up all the buyers' valuations and all the sellers' valuations and mash them into the same column?

192
00:19:03.640 --> 00:19:10.640
In other words, regardless of whether you're a buyer or a seller, what if we just put you all in a list like this?

193
00:19:10.640 --> 00:19:19.640
So we rank everybody based on their valuation of the good in monetary terms.

194
00:19:19.640 --> 00:19:30.640
So notice that it goes B1, B2, B3, S5, then B4, S4, B5, S3, S2, S1. So we've got buyers and sellers mixed up in here.

195
00:19:30.640 --> 00:19:44.640
But think of the market this way. Again, at the beginning of the day, there were five sellers, each of whom had a radio, and five buyers, none of whom had a radio.

196
00:19:44.640 --> 00:19:52.640
If we imagine some process in which radios end up in the hands of those who value them the most,

197
00:19:52.640 --> 00:19:56.640
at the end of the day, who's going to have the five radios?

198
00:19:56.640 --> 00:20:02.640
Well, the five radios will end up in the hands of the five individuals who value them the most.

199
00:20:02.640 --> 00:20:08.640
And notice that that's one, two, three, four buyers and one seller.

200
00:20:08.640 --> 00:20:12.640
So at the end of the day, four of the radios have changed hands,

201
00:20:12.640 --> 00:20:16.640
But one of them remains in the hands of its original possessor.

202
00:20:16.640 --> 00:20:21.640
So again, that tells us that the equilibrium quantity in this market has got to be four.

203
00:20:21.640 --> 00:20:25.640
There will be four trades, but not a fifth.

204
00:20:25.640 --> 00:20:27.640
Now, how does Boehm-Bawerk analyze it?

205
00:20:27.640 --> 00:20:33.640
The more standard way that you may have seen this before is in the analysis of the marginal pairs.

206
00:20:33.640 --> 00:20:38.640
The way it's done in the reading by Percy Greaves,

207
00:20:38.640 --> 00:20:53.640
If you had a chance to look at his, in his book, Understanding the Dollar Crisis, the early chapters on value and exchange and pricing provide the same kind of analysis, but in a slightly more complicated version than my simple one.

208
00:20:53.640 --> 00:20:58.640
Okay, so go back to our original layout of the buyers and sellers, right?

209
00:20:58.640 --> 00:21:12.640
If you just sort of mark in blue the five highest valuations, identify the five participants with the highest valuations, you see the four buyers and that one seller.

210
00:21:12.640 --> 00:21:20.640
So what can we say about the price that will be paid on the market if there is a uniform price for all of these trades?

211
00:21:20.640 --> 00:21:32.640
Well, the price can't be, so the first buyer is willing to pay at least $300, the second buyer is willing to pay at least $275 and so on.

212
00:21:32.640 --> 00:21:41.640
Okay, well notice that B5, think of B5 as the first buyer who says, I'm out.

213
00:21:41.640 --> 00:21:49.640
Okay, so the first four buyers all buy, by the time we get to the fifth buyer he says, sorry that's too rich for my blood, I don't want to participate.

214
00:21:49.640 --> 00:22:05.640
So B5 is the first buyer who doesn't participate, who doesn't exchange, or if you look at the sellers, the first four most capable sellers do exchange, so at the end of the day they don't have a radio anymore.

215
00:22:05.640 --> 00:22:14.640
S5 is the first seller who says, no, wait a minute, I need at least $2.30 to be willing to let go of this good, I'm not going to participate unless I get at least $2.30.

216
00:22:14.640 --> 00:22:28.640
So the equilibrium price must lie somewhere between $200, the valuation of the first buyer who's priced out, and $230, the valuation of the first seller who's priced out.

217
00:22:28.640 --> 00:22:37.640
So again, we can establish a range of possible equilibrium prices somewhere between $200 and $230.

218
00:22:37.640 --> 00:22:45.640
Why those numbers? If the price were below 200, then the fifth buyer would want to buy one.

219
00:22:45.640 --> 00:22:53.640
But at a price below 200, there are no other radios available for him to buy.

220
00:22:53.640 --> 00:22:56.640
They've all been sold already.

221
00:22:56.640 --> 00:23:03.640
Likewise, if the price were above $230, then the fifth seller would say, I want to sell too.

222
00:23:03.640 --> 00:23:10.640
But there are no buyers available for him to sell to, that all the buyers have already purchased at that price who are willing to purchase at that price.

223
00:23:10.640 --> 00:23:20.640
Okay, so to maximize the gains from trade, to maximize the number of transactions, the price must lie between 200 and 230.

224
00:23:20.640 --> 00:23:29.640
In Boehm-Bawerk's language, if you think of pairing off, you know, B1, S1, B2, S2, B3 and S3 and so on, right?

225
00:23:29.640 --> 00:23:59.640
Right, the pair B4 and S4, right, that's the last pair that does end up participating in exchange, right, and the pair B5 and S5, that's the last pair that ends up not participating in exchange, right, and that's what Boehm-Bawerk calls the marginal pairs, okay, so the B4-S4 pair and the B5-S5 pair, those are the marginal pairs, and it's their valuations, or more precisely the valuations

226
00:23:59.640 --> 00:24:07.640
The first set of potential traders who are excluded that establish a feasible range on the equilibrium price.

227
00:24:07.640 --> 00:24:10.640
Okay.

228
00:24:10.640 --> 00:24:15.640
We could look at this graphically if we wanted to.

229
00:24:15.640 --> 00:24:16.640
Okay.

230
00:24:16.640 --> 00:24:17.640
Here's one way to do it.

231
00:24:17.640 --> 00:24:26.640
Suppose we just, we take all of our ten market participants and we arrange them from highest valuation to lowest valuation,

232
00:24:26.640 --> 00:24:56.640
ndependent of whether you're a buyer or a seller, okay, and we just put them all on the same diagram, right, again we've got the guys in blue are the ones who at the end of the day end up with a radio, the five with the highest valuations, and the ones in black are the ones with the end of the day end up without a radio, okay, so notice that all the sellers except for S5 go home with cash instead of radio, all the buyers except for B5 go home with radio instead of cash,

233
00:24:56.640 --> 00:25:07.640
And you can see the range established between 230 and 200, so here's 200 and here's 230, just a little bit above 225.

234
00:25:07.640 --> 00:25:19.640
And so S5 is the valuation of the first seller who's priced out, B5 is the valuation of the first buyer who's priced out.

235
00:25:19.640 --> 00:25:28.640
Equality Price Doubt. So you can see that our range for the equilibrium price will lie somewhere between $230 and $200.

236
00:25:28.640 --> 00:25:38.640
And notice that there only exist five units of the good. So here's one, two, three, four, five, the five units of the good.

237
00:25:38.640 --> 00:25:47.640
If we were to sort of connect the dots, we could represent this as a total demand curve,

238
00:25:47.640 --> 00:25:55.640
Meaning a demand curve that incorporates not only the willingness to pay of potential buyers who want the good,

239
00:25:55.640 --> 00:26:01.640
but also the sort of willingness to sell of the potential sellers who have the good.

240
00:26:01.640 --> 00:26:07.640
Okay, so if we aggregate the buyers and sellers into a single demand curve,

241
00:26:07.640 --> 00:26:09.640
we could connect the dots and have something like this.

242
00:26:09.640 --> 00:26:13.640
This is the analysis of total demand that comes from Wicksteed.

243
00:26:13.640 --> 00:26:43.640
Something that's illuminating about thinking of the total demand curve as including the valuations of both buyers and sellers is that it reminds us that sellers are participating in this market for the same reason as buyers, namely because they seek to substitute more highly valued goods and services for less highly valued goods and services, where we include not only radios but also sums of money as entries

244
00:26:43.640 --> 00:26:46.640
in the Individuals' Value Scales.

245
00:26:46.640 --> 00:26:51.240
Okay, so the point is sellers have a demand for the good too, right?

246
00:26:51.240 --> 00:26:55.440
At a certain price, they would prefer to keep the good rather than sell the good.

247
00:26:55.440 --> 00:27:00.000
Well, that's simply another way of saying the sellers have a demand for money

248
00:27:00.000 --> 00:27:04.640
at which they would exchange the good or reciprocal demand for the good

249
00:27:04.640 --> 00:27:07.440
at which they, for which they would exchange money and so on.

250
00:27:07.440 --> 00:27:10.840
Okay, so buyers and sellers both have demands and they're both determined

251
00:27:10.840 --> 00:27:13.040
by the subjective valuations they attach

252
00:27:13.040 --> 00:27:16.320
to the good and service, good or service in question.

253
00:27:16.320 --> 00:27:17.680
Okay?

254
00:27:17.680 --> 00:27:19.860
So what in the, we'll get to this in a moment,

255
00:27:19.860 --> 00:27:22.400
what in the standard Marshallian analysis

256
00:27:22.400 --> 00:27:24.100
is two completely separate

257
00:27:24.100 --> 00:27:26.820
and independent determinants of price,

258
00:27:26.820 --> 00:27:29.680
the demand side and the supply side

259
00:27:29.680 --> 00:27:31.840
in causal realistic analysis

260
00:27:31.840 --> 00:27:36.160
are two different dimensions of the same side of the market.

261
00:27:36.160 --> 00:27:39.680
Okay, it's all demand driven.

262
00:27:39.680 --> 00:27:52.380
Okay, so notice that we have the demand curve interacting with a fixed stock of the good in question, okay?

263
00:27:52.380 --> 00:27:54.680
There's another way we could represent the same diagram.

264
00:27:54.680 --> 00:28:00.680
Suppose you said, well, let's separate the buyer, sorry, another way to represent the same information.

265
00:28:00.680 --> 00:28:08.080
Suppose we were to separate the buyers and sellers and put them in two separate, you know, two separate sets.

266
00:28:08.080 --> 00:28:18.080
Okay, so we put all the buyers, we plot the valuations of all the buyers and we plot the valuations of all the sellers and look at them separately.

267
00:28:18.080 --> 00:28:31.080
Okay, so again, notice that we have the five most capable buyers and obviously I just made up these numbers and I've made them, so you have straight lines here, no reason why they would have to be straight lines.

268
00:28:31.080 --> 00:28:35.580
And then we have the sellers from most willing to sell to least willing to sell.

269
00:28:35.580 --> 00:28:44.580
Right, and if you think about, again, feasible gains from trade in terms of the marginal pairs, right, here's the first pair where there are potential gains from trade,

270
00:28:44.580 --> 00:28:55.580
second pair, third pair, fourth pair, but the fifth pair, right, would not exchange, right, so the marginal pairs are these, this pair, and this pair, right,

271
00:28:55.580 --> 00:29:02.880
Right? So we know that the equilibrium quantity cannot exceed the valuations of this fourth pair.

272
00:29:02.880 --> 00:29:07.880
Okay? So that's why we know the equilibrium quantity of exchange is four.

273
00:29:07.880 --> 00:29:18.580
Okay? And the, so at five here we have a vertical line representing the number of radios that's available, the fixed stock of radios that's available.

274
00:29:18.580 --> 00:29:22.780
Let me just back up to the previous slide, something I forgot to mention is

275
00:29:22.780 --> 00:29:31.780
One drawback of Wicksteed's total demand analysis is that you can't sort of tell at a glance what the equilibrium quantity will be.

276
00:29:37.780 --> 00:29:45.780
You have to sort of look at the B's and S's and notice that the top five guys include four B's and one S.

277
00:29:45.780 --> 00:29:47.780
So there must have been four trades but not a fifth.

278
00:29:47.780 --> 00:29:59.780
In other words, knowing where the total demand curve intersects the fixed stock of the good doesn't tell you the equilibrium quantity because that includes some sellers as well.

279
00:29:59.780 --> 00:30:07.780
So some of those who are in this part of the total demand curve, the part before you get to the fixed stock, some of these may be sellers.

280
00:30:07.780 --> 00:30:11.780
So you have to actually look at each individual valuation and see who it is, okay, to get the four.

281
00:30:11.780 --> 00:30:26.780
You can't sort of tell at a glance, whereas if we separate the potential buyers, give them one demand curve, and give the potential sellers another demand curve, what Wichita calls the inverse demand curve, or reciprocal demand curve,

282
00:30:26.780 --> 00:30:37.780
then you can look at where they cross, which is what we like to do when we teach economics classes, right? Look where things cross, and see that, oh, well, the equilibrium quantity can't be five.

283
00:30:37.780 --> 00:30:40.780
Okay, it can be no more than four because you can look at where they cross.

284
00:30:40.780 --> 00:30:46.780
You can see the equilibrium price and equilibrium quantity more easily in this version than in the previous version.

285
00:30:46.780 --> 00:30:49.780
Okay, but otherwise they contain the same information.

286
00:30:49.780 --> 00:30:52.780
Okay, excuse me.

287
00:30:52.780 --> 00:30:59.780
Let's do a little further simplification of the diagram.

288
00:30:59.780 --> 00:31:03.780
Well, first let me show you one more case, sorry.

289
00:31:03.780 --> 00:31:17.780
Notice we've assumed here that sellers' valuations are such that there's at least one seller, B5, whose valuation is higher than that of the least capable buyer, B5.

290
00:31:17.780 --> 00:31:26.780
But suppose that isn't the case. I mean, suppose all of these sellers, as is in the case on my eBay auction, a lot of the sellers are junkyard dealers.

291
00:31:26.780 --> 00:31:31.780
Right? I mean, they don't particularly desire to consume the services of the radio.

292
00:31:31.780 --> 00:31:36.780
The only reason they would hold on to it is if they think they can get a higher price at some point in the future.

293
00:31:36.780 --> 00:31:38.780
We'll get to that point in just a moment.

294
00:31:38.780 --> 00:31:42.780
But let's assume that none of the sellers value these radios particularly highly.

295
00:31:42.780 --> 00:31:48.780
So if we change the numbers in my example, suppose we have a picture that looks something like this.

296
00:31:48.780 --> 00:32:00.780
Suppose the least capable seller, S5, still values the good less than the least capable buyer, B5.

297
00:32:00.780 --> 00:32:04.780
In this case, all five radios are going to be exchanged.

298
00:32:04.780 --> 00:32:08.780
No seller is going to go home at the end of the day with a radio.

299
00:32:08.780 --> 00:32:14.780
Actually, I just noticed now when I drew these diagrams, I should have made B5 blue and S4 and S5 black.

300
00:32:14.780 --> 00:32:17.780
I forgot to do that. Joe, make a note to remind me to do that later, please.

301
00:32:17.780 --> 00:32:47.780
please. My assistant is in the back of the room. Anyway, the point is, right, if even the least capable seller values the good at a price less than that of the least capable buyer, then the equilibrium quantity will be where the demand curve intersects the fixed stock of the good. Okay, so then the equilibrium quantity in this case would be five with an equilibrium price of 200. Okay, again,

302
00:32:47.780 --> 00:33:00.780
There's a little subtlety here. I don't want to look like I'm engaging any sleight of hand, but most of the diagrams that you see drawn, for example, in the diagrams in the Shapiro book, assume this kind of a setup.

303
00:33:00.780 --> 00:33:11.780
Okay, though if you don't watch carefully, you might miss how it got there. Right, so now if we take this diagram and simplify it, okay, so I took out all the little dots and just had the lines.

304
00:33:11.780 --> 00:33:22.780
Okay, so we've got, there are five units of the good, okay, and so what I've traced as the sort of supply curve is the fixed stock of the good,

305
00:33:22.780 --> 00:33:31.780
but then remember at a price below, whatever this is, 170 I think, some of the sellers would prefer to hold on to the good rather than offer it for sale.

306
00:33:31.780 --> 00:33:38.780
Okay, so at a price below 170, not all five units are going to be available, are going to be offered on the market.

307
00:33:38.780 --> 00:33:47.780
Okay, but assuming that we can meet the least capable seller's reservation price, all five units will be available for exchange, right?

308
00:33:47.780 --> 00:33:51.780
And then the demand curve represents the valuations of the buyers, right?

309
00:33:51.780 --> 00:34:00.780
And where the demand curve and the supply curve intersect gives us our equilibrium price of $200, our equilibrium quantity of five, namely the entire stock of the good.

310
00:34:00.780 --> 00:34:07.780
Okay, so this is kind of a, so think of this as just basic supply and demand analysis, supply and demand curves.

311
00:34:07.780 --> 00:34:08.780
Yes?

312
00:34:08.780 --> 00:34:22.780
Two graphs back, where you have the marginal buyer and seller at 230 and 200, so that transaction won't occur.

313
00:34:22.780 --> 00:34:31.780
So why would the price not be limited to B4's reservation price of 2.5 or whatever that is, as opposed to 230?

314
00:34:31.780 --> 00:34:37.780
And vice versa, why wouldn't S4 be the bottom limit?

315
00:34:37.780 --> 00:34:43.780
Okay, you're saying why isn't the range from $2.20 or $2.10 or whatever it is to $2.25?

316
00:34:43.780 --> 00:34:48.780
Right, well, I mean, go back to this diagram here, okay?

317
00:34:48.780 --> 00:34:57.780
So the point is, is there a feasible trade at a price above $2.25 but below, say, $2.26?

318
00:34:57.780 --> 00:35:02.780
So, yeah, I mean, I know, I'm sorry, you said...

319
00:35:02.780 --> 00:35:03.780
Yes, so at $2.26.

320
00:35:03.780 --> 00:35:12.780
What would happen at $226? Could we have a fourth transaction at a price of $236?

321
00:35:12.780 --> 00:35:18.780
Not between these two, but between these two. That's a good point.

322
00:35:18.780 --> 00:35:24.780
Remember, we're pairing these guys up in order.

323
00:35:24.780 --> 00:35:35.780
Exactly. So at a price lower than $2.30 but greater than $2.25, you wouldn't get an additional transaction, it'd just be a different transactor.

324
00:35:35.780 --> 00:35:44.780
You'd have switching places among the sellers. That's a good question. Does everybody get that? That's a good question.

325
00:35:44.780 --> 00:35:51.780
Okay, so now here we have this, again, our supply and demand curves in the case of bilateral competition.

326
00:35:51.780 --> 00:36:00.780
Case two, in other words, one where the seller's evaluations are less than that of the least capable buyer.

327
00:36:00.780 --> 00:36:07.780
Let's just sort of step back from the diagrams for a moment and think about sort of the big picture. What does it mean?

328
00:36:07.780 --> 00:36:19.780
And key points to remember that the equilibrium price in this analysis is determined exclusively by individual subjective valuations.

329
00:36:19.780 --> 00:36:32.780
Note that we have said nothing about the cost of production. We haven't said anything about sort of objective labor cost or objective cost of materials.

330
00:36:32.780 --> 00:36:43.780
In the sort of more standard Marshallian analysis, you might have heard the expression, the two blades of the scissors, meaning the supply and demand curves.

331
00:36:43.780 --> 00:36:55.780
There's a subjectively determined demand side, or one blade of the scissors, but you also need the objectively determined cost side to provide the other blade so that you can cut.

332
00:36:55.780 --> 00:37:00.780
Notice in our analysis we haven't made any reference to objective cost whatsoever.

333
00:37:00.780 --> 00:37:05.780
And I'll come back to this point in a little bit more detail in a few more slides.

334
00:37:05.780 --> 00:37:12.780
But notice that we've assumed that a Marshallian might object and say, but wait a minute,

335
00:37:12.780 --> 00:37:18.780
but you've assumed that there are only five radios in existence.

336
00:37:18.780 --> 00:37:33.780
So, yeah, this analysis might apply to a case of a pure exchange economy where there's a fixed stock of goods or services available for exchange, but can't we produce more?

337
00:37:33.780 --> 00:37:39.780
Well, sure we can, but not instantaneously.

338
00:37:39.780 --> 00:37:48.780
So, it may very well be the case, and we haven't yet explained how there came to be only five radios in existence in the first place, okay?

339
00:37:48.780 --> 00:37:58.780
But, if our objective is to explain the price that obtains in this market transaction for Peter Klein replacement radio, okay?

340
00:37:58.780 --> 00:38:05.780
How the five radios came to be there is irrelevant. It's a moot point at this moment.

341
00:38:05.780 --> 00:38:10.780
We're interested in explaining the moment-to-moment prices that do obtain on the market.

342
00:38:10.780 --> 00:38:18.780
Obviously, there had to be some prior mechanism causing the fact that there are only five radios in existence.

343
00:38:18.780 --> 00:38:23.780
Some radio producers and people in the wholesale market and people who operate junkyards and so on

344
00:38:23.780 --> 00:38:28.780
made some decisions in the past that got us to this point today.

345
00:38:28.780 --> 00:38:31.780
But right now, bygones are bygones.

346
00:38:31.780 --> 00:38:39.780
Right? The fact is, however it happened, there are only five radios existence right now and we can't just magically produce a sixth if we wanted to.

347
00:38:39.780 --> 00:38:52.780
Okay? So there's a temporal dimension to the supply analysis in the standard diagram that is not relevant for explaining the determination of the price today with a couple of caveats that I'll get to in just a moment.

348
00:38:52.780 --> 00:39:06.780
Okay. This is sort of another common misperception. It's the belief that, well, sure, valuations are important, but it's really only the sellers who decide what the price is.

349
00:39:06.780 --> 00:39:20.780
Sellers set the price. Well, I mean, it's easy to have this misconception because when you go down to the grocery store, if I go down to the Super Walmart to purchase what was it that Salerno bought yesterday?

350
00:39:20.780 --> 00:39:26.780
Toothpaste, and I saw there was a Def Leppard album in there. You can really see his age there.

351
00:39:26.780 --> 00:39:37.780
You know, I don't go to the, I don't get the Def Leppard album and take it down to the sales clerk and start bargaining, right?

352
00:39:37.780 --> 00:39:41.780
I mean, there's a posted price and they scan it and I either pay that price or I don't.

353
00:39:41.780 --> 00:39:48.780
So what role do I have in determining the price? Isn't it just given to me by the sellers?

354
00:39:48.780 --> 00:40:18.780
Okay, well we certainly see in the analysis that we've shown here, in our analysis here, that right, it isn't the case that sellers can just ask any price they want, right, because obviously people wouldn't be willing to buy, okay, you know, if I had to pay a thousand bucks to get the original equipment replacement radio, you can be sure I would just break down and have a gaping hole in my dashboard, right, or just go to Best Buy and get some replacement radio or whatever, okay.

355
00:40:18.780 --> 00:40:29.780
Well, it's the same thing with Walmart. Again, if you think about it, if Walmart could simply set the price, well, I mean, why are they charging $249 for a tube of toothpaste?

356
00:40:29.780 --> 00:40:41.780
Why not $24.99 or $249 or a gazillion dollars? Okay, so obviously there must be some limits on sellers' ability to set price unilaterally.

357
00:40:41.780 --> 00:40:57.780
People understand that Walmart can't set the price at a gazillion dollars for a tube of toothpaste, but they think, well, within a range, can't they just set $2.50, $3, $4, who cares?

358
00:40:57.780 --> 00:41:08.780
But the point is, the price that they set, even for small adjustments of a penny here or a penny there, affect the amount of revenue they receive.

359
00:41:08.780 --> 00:41:18.780
It may not be the case that every buyer drops out if the tube of toothpaste is $2.50 instead of $2.49, but some buyers will.

360
00:41:18.780 --> 00:41:25.780
So the total quantity transacted at a price of $2.50 is going to be different.

361
00:41:25.780 --> 00:41:30.780
It's going to be lower than the total quantity transacted at a price of $2.49.

362
00:41:30.780 --> 00:41:35.780
Does that mean they shouldn't raise the price from $2.49 to $2.50?

363
00:41:35.780 --> 00:41:37.980
to see if you're on your toes yesterday.

364
00:41:37.980 --> 00:41:40.340
The answer is it depends, and it depends on what?

365
00:41:40.340 --> 00:41:41.940
That Professor Salerno talked about.

366
00:41:41.940 --> 00:41:42.780
Elasticity.

367
00:41:42.780 --> 00:41:45.180
Yeah, this concept of elasticity, right?

368
00:41:45.180 --> 00:41:48.740
So whether increasing the price leads to an increase

369
00:41:48.740 --> 00:41:50.900
in total revenue or a decrease in total revenue

370
00:41:50.900 --> 00:41:54.260
depends on the characteristics of the market demand curve.

371
00:41:54.260 --> 00:41:59.180
But the point is, buyers affect the elasticity

372
00:41:59.180 --> 00:42:00.500
of the market demand curve.

373
00:42:00.500 --> 00:42:05.500
Indeed, it is nothing other than a construct

374
00:42:05.500 --> 00:42:11.500
The point is that sellers don't unilaterally set the price, even really big sellers.

375
00:42:11.500 --> 00:42:17.500
Another thing to notice about our analysis is that what we're trying to explain,

376
00:42:17.500 --> 00:42:26.500
and what Menger was trying to explain in his 1871 book was the prices that are actually paid in real transactions on the market.

377
00:42:26.500 --> 00:42:32.500
In other words, we're not trying to explain some sort of hypothetical artificial price,

378
00:42:32.500 --> 00:42:34.740
Such as the Perfectly Competitive Price

379
00:42:37.820 --> 00:42:46.120
Okay, if you learn price theory in a typical microeconomics course, the instructor will explain, well, we'll start with the perfectly competitive market

380
00:42:46.540 --> 00:42:52.380
Which of course is unrealistic. No market is really perfectly competitive because perfect competition assumes an

381
00:42:52.940 --> 00:42:58.300
infinite numbers of infinite numbers of buyers and sellers, perfectly divisible good, perfect knowledge,

382
00:42:58.300 --> 00:43:02.140
Barriers to Entry, and so on.

383
00:43:02.140 --> 00:43:07.520
So we set up all these artificial, deliberately artificial assumptions, solve for the price

384
00:43:07.520 --> 00:43:13.820
that would emerge in that hypothetical construct, and say, okay, well now we've done price theory.

385
00:43:13.820 --> 00:43:19.080
Well Menger's objective was not to explain some imaginary price, but the actual price,

386
00:43:19.080 --> 00:43:23.300
the real price.

387
00:43:23.300 --> 00:43:28.500
It isn't to say that Austrian economists, or that causal realist economists, do not

388
00:43:28.500 --> 00:43:31.500
employ hypothetical constructs.

389
00:43:31.500 --> 00:43:36.860
Okay, we'll talk a little bit today and some more later about Mises' concept of the final

390
00:43:36.860 --> 00:43:42.060
price, or the price that emerges in the final, what he calls the final state of rest.

391
00:43:42.060 --> 00:43:44.660
Think of that as kind of a long run equilibrium price.

392
00:43:44.660 --> 00:43:50.180
Well, we might employ a hypothetical construct like that in our reasoning, say, well, let's

393
00:43:50.180 --> 00:43:54.660
Let's imagine a situation where the following things happen, what price would emerge in

394
00:43:54.660 --> 00:43:55.660
that situation?

395
00:43:55.660 --> 00:44:01.740
We may get some insight from that analysis, but that analysis isn't explaining any actual

396
00:44:01.740 --> 00:44:04.620
prices.

397
00:44:04.620 --> 00:44:10.180
The problem for the causal realist economist, the problem with the analysis of perfect competition,

398
00:44:10.180 --> 00:44:17.140
is that it doesn't provide any useful information about the real process of price formation.

399
00:44:17.140 --> 00:44:23.140
It's purely artificial and doesn't serve any instrumental function in our analysis of the market.

400
00:44:23.140 --> 00:44:29.140
Again, that's the realist part of the causal realist definition.

401
00:44:29.140 --> 00:44:32.140
Now, here's a slightly more subtle point.

402
00:44:32.140 --> 00:44:37.140
What about the assumption of perfect information?

403
00:44:37.140 --> 00:44:45.140
Aren't we making some rather strong assumptions about the ability of buyers and sellers

404
00:44:45.140 --> 00:44:51.140
and Sellers to sort of think through this process in advance

405
00:44:51.140 --> 00:44:54.140
and realize that, okay, well, the equilibrium quantity is going to be four,

406
00:44:54.140 --> 00:44:57.140
the equilibrium price is going to be between 200 and 230,

407
00:44:57.140 --> 00:45:02.140
so if somebody offers me less than 200, I should say no.

408
00:45:02.140 --> 00:45:05.140
Well, in fact, we can change our story slightly

409
00:45:05.140 --> 00:45:11.140
and include expectations of future prices that will emerge.

410
00:45:11.140 --> 00:45:16.540
We can include what we would call speculative demands in our analysis.

411
00:45:16.540 --> 00:45:21.740
Go back to our original story, okay, here's the numbers that we used before, right?

412
00:45:21.740 --> 00:45:25.840
And we said the equilibrium price will be something between 200 and 230.

413
00:45:25.840 --> 00:45:33.040
Well, suppose that S1, the first seller, believes, erroneously,

414
00:45:33.040 --> 00:45:37.540
say he believes somehow the equilibrium price is going to be 250.

415
00:45:37.540 --> 00:45:45.240
Or maybe he believes that tomorrow, in tomorrow's market, the equilibrium price will be $250, okay?

416
00:45:45.240 --> 00:45:50.740
So, you know, in the absence of that belief, he would be willing to part with his radio for $150,

417
00:45:50.740 --> 00:45:54.640
but he believes there's somebody out there who'd be willing to pay $250, right?

418
00:45:54.640 --> 00:45:59.840
Well, don't we have to rule that case out to be able to do this sort of analysis?

419
00:45:59.840 --> 00:46:03.340
The answer is no, we can handle it in a very simple way, right?

420
00:46:03.340 --> 00:46:11.040
If it's the case that S1 thinks that at some point in the future he can get $250 for a radio,

421
00:46:11.040 --> 00:46:16.440
well, what is his reservation price in the market today? $250.

422
00:46:16.440 --> 00:46:21.040
Right? We just say, well, in that case, his reservation price isn't $150, but it's $250.

423
00:46:21.040 --> 00:46:23.840
He belongs down here as S5.

424
00:46:23.840 --> 00:46:26.840
And we sort of change the numbers and do the analysis again.

425
00:46:26.840 --> 00:46:30.540
In other words, the point is, the numbers that we write down,

426
00:46:30.540 --> 00:46:35.500
or the valuations that buyers and sellers have, their reservation prices,

427
00:46:35.500 --> 00:46:42.180
include their beliefs about what future market conditions might be.

428
00:46:42.180 --> 00:46:44.940
Are those beliefs necessarily correct or incorrect?

429
00:46:44.940 --> 00:46:46.740
Well, we can't say.

430
00:46:46.740 --> 00:46:52.820
All we can say is that if the price that emerges in the market today is, say, $215,

431
00:46:52.820 --> 00:46:56.540
we can explain it using this analysis.

432
00:46:56.540 --> 00:46:59.100
Now, where did these numbers come from?

433
00:46:59.100 --> 00:47:02.140
Where did the 150 and the 170 and the 190 come from?

434
00:47:02.140 --> 00:47:04.220
Well, I mean, we don't know.

435
00:47:04.220 --> 00:47:06.900
We simply, all we can do from the point of view

436
00:47:06.900 --> 00:47:10.900
of deriving exact laws is take that as given, okay?

437
00:47:10.900 --> 00:47:13.740
Now, there might be other scientific disciplines

438
00:47:13.740 --> 00:47:18.140
like psychology that might seek to explain

439
00:47:18.140 --> 00:47:20.740
where do these different preferences come from?

440
00:47:20.740 --> 00:47:23.820
Why does one person value a radio at $300

441
00:47:23.820 --> 00:47:26.260
and another person values it at only $275?

442
00:47:26.260 --> 00:47:28.420
Does it have something to do with his childhood?

443
00:47:28.420 --> 00:47:58.420
and you know my father had a radio of a certain type or you know I was dropped on my head who knows I mean there might be some information that we can provide but that's beyond the domain of economic analysis right the analysis of human action says given the preferences that people have how will they then behave okay now let's go back to our diagram this is the last sort of simplified diagram that we had right now all I've done here is I've extended the

444
00:47:58.420 --> 00:48:02.420
the demand curve beyond the fixed stock of the good.

445
00:48:02.420 --> 00:48:05.420
It was Q equals five in our last diagram.

446
00:48:05.420 --> 00:48:09.420
This is just the same as the last diagram that we drew,

447
00:48:09.420 --> 00:48:12.420
except I extended the demand curve a little bit farther on down.

448
00:48:12.420 --> 00:48:16.420
Okay, so again, remember the vertical part of the supply curve

449
00:48:16.420 --> 00:48:19.420
represents the fixed stock of the good that is in existence

450
00:48:19.420 --> 00:48:21.420
at the moment of exchange.

451
00:48:21.420 --> 00:48:24.420
And there's this little diagonal part at the bottom,

452
00:48:24.420 --> 00:48:27.420
which represents the prices below which sellers

453
00:48:27.420 --> 00:48:29.220
draw some of their supply.

454
00:48:29.220 --> 00:48:32.540
Now, if you looked at the diagrams in the Shapiro book,

455
00:48:32.540 --> 00:48:36.220
his are essentially like this, but with one slight twist.

456
00:48:36.220 --> 00:48:39.140
He makes the further simplifying assumption

457
00:48:39.140 --> 00:48:44.140
that below the least capable seller's reservation price,

458
00:48:44.820 --> 00:48:46.940
everybody, all sellers drop out.

459
00:48:46.940 --> 00:48:48.580
Okay, so he draws something like this.

460
00:48:48.580 --> 00:48:51.860
So there's some point below which

461
00:48:51.860 --> 00:48:54.180
there are no units available for sale.

462
00:48:54.180 --> 00:48:55.740
So you could just leave this blank.

463
00:48:55.740 --> 00:48:58.380
He draws a dashed line, right?

464
00:48:58.380 --> 00:49:01.100
So again, we're assuming that below,

465
00:49:01.100 --> 00:49:03.540
I think it was 170 in our last example,

466
00:49:03.540 --> 00:49:05.940
assume that no seller would be willing to sell

467
00:49:05.940 --> 00:49:08.140
at a price that low, okay?

468
00:49:08.140 --> 00:49:11.100
If we just, again, for the sake of simplicity

469
00:49:11.100 --> 00:49:13.660
in drawing our diagrams, if we just said,

470
00:49:13.660 --> 00:49:15.020
well, let's just forget about that,

471
00:49:15.020 --> 00:49:17.420
assume that every seller is willing to get rid

472
00:49:17.420 --> 00:49:20.380
of his good at some price, sorry.

473
00:49:20.380 --> 00:49:24.860
We could just, we can really ignore what happens below P1.

474
00:49:24.860 --> 00:49:27.900
Okay, so assume that the equilibrium price

475
00:49:27.900 --> 00:49:32.900
that obtains here exceeds the highest valued seller

476
00:49:33.500 --> 00:49:37.080
or the least capable seller's reservation price, okay?

477
00:49:38.540 --> 00:49:43.540
So how can we explain changes in prices, price changes?

478
00:49:43.600 --> 00:49:47.280
Okay, so imagine that we're in a situation like this

479
00:49:47.280 --> 00:49:51.580
and the price that has emerged is this price P1.

480
00:49:51.580 --> 00:49:59.580
Suppose that there's a change in demand. Say there's an increase in the demand for the good.

481
00:49:59.580 --> 00:50:10.580
Well, Joe explained yesterday what it means to talk about an increase in demand as opposed to an increase in the quantity demanded.

482
00:50:10.580 --> 00:50:14.580
In other words, there's a change in people's value scales.

483
00:50:14.580 --> 00:50:23.580
Okay, so at every possible price, the total quantity demanded on the market is higher than it was before.

484
00:50:23.580 --> 00:50:30.580
Right, how would we represent that in our diagram? Well, simply by shifting the demand curve out and to the right.

485
00:50:30.580 --> 00:50:41.580
Okay, change in preferences, the change in the relative rankings of goods and services on individuals' preference orderings.

486
00:50:41.580 --> 00:50:51.580
Okay, so they value some things relative to money more highly than they did before, okay?

487
00:50:51.580 --> 00:50:54.380
Again, remember just the terminology.

488
00:50:54.380 --> 00:50:59.780
When we talk about a change in demand or an increase in demand, we mean an entire shift,

489
00:50:59.780 --> 00:51:05.980
a change in the entire demand schedule or shifting out of the demand curve,

490
00:51:05.980 --> 00:51:09.080
as opposed to a change in the quantity demanded,

491
00:51:09.080 --> 00:51:11.340
which would refer to moving along a particular,

492
00:51:11.340 --> 00:51:13.760
moving up or down a given demand schedule

493
00:51:13.760 --> 00:51:17.180
or moving along a demand curve, okay?

494
00:51:17.180 --> 00:51:18.600
So what happens?

495
00:51:18.600 --> 00:51:23.600
Well, we started out at an equilibrium price of P1, right?

496
00:51:24.080 --> 00:51:27.080
But with this new high, greater demand,

497
00:51:27.080 --> 00:51:30.180
the demand curve D prime rather than D, right?

498
00:51:30.180 --> 00:51:32.040
At a price of P1, what happens?

499
00:51:32.040 --> 00:51:35.640
Well, the quantity demanded at a price of P1,

500
00:51:35.640 --> 00:51:40.640
It now exceeds the quantity, the available stock.

501
00:51:41.640 --> 00:51:43.760
Okay, so the supply curve represents

502
00:51:43.760 --> 00:51:46.000
the available stock of radios.

503
00:51:46.000 --> 00:51:48.720
At a price of P1, now there are more buyers

504
00:51:48.720 --> 00:51:52.240
wanting to buy radios than radios are available.

505
00:51:52.240 --> 00:51:55.700
Okay, what that implies is that the equilibrium price

506
00:51:55.700 --> 00:51:58.320
can no longer be P1, right?

507
00:51:58.320 --> 00:52:01.200
Buyers and sellers must adjust their behavior

508
00:52:01.200 --> 00:52:05.440
up to a point where the price is something like P2.

509
00:52:05.440 --> 00:52:10.360
Okay, so at a price of P2, once again, the market clears,

510
00:52:10.360 --> 00:52:14.400
meaning that at that price, all buyers who value the good

511
00:52:14.400 --> 00:52:17.200
more highly than that price are able to obtain one

512
00:52:17.200 --> 00:52:19.600
in exchange for that price, okay?

513
00:52:20.800 --> 00:52:23.180
And some of you have seen this kind of analysis before.

514
00:52:23.180 --> 00:52:25.960
Note that if the price were to remain at P1,

515
00:52:25.960 --> 00:52:29.280
we would have a shortage of the good in question, right?

516
00:52:29.280 --> 00:52:31.880
Meaning at that price, the total quantity demanded

517
00:52:31.880 --> 00:52:36.880
Exceeds the Available Stock Given by the Vertical Part of the Supply Curve

518
00:52:38.880 --> 00:52:41.880
Again, just sort of terminology here.

519
00:52:41.880 --> 00:52:48.880
The word shortage sort of sounds similar to, but is not the same as the more general concept of scarcity.

520
00:52:50.880 --> 00:52:56.880
Remember we talked about scarcity as a general condition of human action, right?

521
00:52:56.880 --> 00:53:10.520
Namely, that for a given good or service, the available supply of this good or service is less than that that would satisfy all actual human demands for that good or service, okay?

522
00:53:10.520 --> 00:53:23.840
It's a little bit unfortunate, you know, in English we use sometimes sort of an everyday language, you talk about something being more or less scarce, okay, you know, because of some oil fields were destroyed in the Middle East,

523
00:53:53.840 --> 00:54:04.840
What we mean is, at the price of P1, the quantity demanded exceeds the quantity supplied.

524
00:54:04.840 --> 00:54:08.840
So by shortage, we don't mean there isn't enough that everybody in the universe could have one.

525
00:54:08.840 --> 00:54:16.840
That's scarcity. What we mean is, at this given price, the quantity demanded exceeds the available supply.

526
00:54:16.840 --> 00:54:24.840
This is a good place to think, to stop for a moment and think about some kinds of artificial restriction on the market, right?

527
00:54:24.840 --> 00:54:30.840
Like, oh, sorry, okay, before we do that, one more thing.

528
00:54:30.840 --> 00:54:32.840
Okay, again, why would the demand curve shift?

529
00:54:32.840 --> 00:54:36.840
Well, one, some of these textbooks typically ignore us.

530
00:54:36.840 --> 00:54:39.840
You could have a change in the money supply.

531
00:54:39.840 --> 00:54:45.840
So an increase in the supply of money which lowers the purchasing power of the monetary unit

532
00:54:45.840 --> 00:54:55.840
causes a change in people's value scales where, you know, the money is denominated in nominal terms, right?

533
00:54:55.840 --> 00:55:05.840
So my willingness to pay in dollar terms for, you know, a car radio would go down if there's an increase in the quantity of money, okay?

534
00:55:05.840 --> 00:55:09.840
Because the purchasing power of the dollar is less than it was before, okay?

535
00:55:09.840 --> 00:55:14.840
So we could imagine an increase in the money supply leading to a leftward shift in the demand curve.

536
00:55:14.840 --> 00:55:22.840
We could have a change, more generally, a change in the relative rankings of goods and services on the market.

537
00:55:22.840 --> 00:55:31.840
Again, it could be the preferences people have for this good relative to money, or it could be relative to some other good.

538
00:55:31.840 --> 00:55:36.520
You know, I was thinking, as we all do, I've been thinking a lot lately about Paris Hilton.

539
00:55:39.800 --> 00:55:45.460
You know, I remember reading something that recently that her stint in prison,

540
00:55:45.460 --> 00:55:47.460
I guess she got out and they made her go back and

541
00:55:48.560 --> 00:55:50.560
totally paid attention, but I mean,

542
00:55:51.040 --> 00:55:54.920
for someone in her position, someone in her industry,

543
00:55:56.240 --> 00:55:59.340
a sort of celebrity for being a celebrity,

544
00:55:59.340 --> 00:56:04.040
In my day, the quintessential example is George Plimpton,

545
00:56:04.040 --> 00:56:06.440
a guy who was sort of famous for being famous,

546
00:56:06.440 --> 00:56:08.640
but nobody could tell you exactly what he was famous for.

547
00:56:08.640 --> 00:56:10.640
Paris is sort of like that.

548
00:56:10.640 --> 00:56:13.040
And for somebody like that, you know, the additional publicity

549
00:56:13.040 --> 00:56:15.640
that comes with being sentenced to jail,

550
00:56:15.640 --> 00:56:17.940
I mean, this could be the greatest thing for her career.

551
00:56:17.940 --> 00:56:20.140
This happened in a long time.

552
00:56:20.140 --> 00:56:26.040
So, you know, Paris Hilton is in, she's an actress in some movies.

553
00:56:26.040 --> 00:56:27.940
I don't think she has a CD out, does she?

554
00:56:27.940 --> 00:56:35.940
I don't know if she sings like Jessica Simpson or someone like that, but, you know, suppose that she's an actress in movies, right?

555
00:56:35.940 --> 00:56:43.940
It may be that more people want to go see a movie that Paris Hilton is in. They're more interested in her now because they saw her on jail or crying in the car or whatever it was, okay?

556
00:56:43.940 --> 00:56:53.940
So it could be that there's a change in people's tastes and preferences where they value Paris Hilton more highly than they did before, okay?

557
00:56:53.940 --> 00:56:58.940
for a reason that we as economists would simply take as given.

558
00:56:58.940 --> 00:57:02.940
So there could be some reason why change in musical preferences,

559
00:57:02.940 --> 00:57:07.940
where having a particular type of car radio gives people more satisfaction than they did before,

560
00:57:07.940 --> 00:57:11.940
that would change the demand for car radios of that particular type.

561
00:57:11.940 --> 00:57:16.940
Again, a purely subjective phenomenon.

562
00:57:16.940 --> 00:57:20.940
The price went up from P1 to P2.

563
00:57:20.940 --> 00:57:25.140
Isn't there a sense in which higher prices are bad?

564
00:57:25.140 --> 00:57:28.860
I mean, well, not for sellers, that's right.

565
00:57:28.860 --> 00:57:32.900
But aren't sellers rich, kind of greedy, rapacious capitalists,

566
00:57:32.900 --> 00:57:36.020
and buyers are ordinary good people like you and me,

567
00:57:36.020 --> 00:57:37.980
and don't we want the price to be lower?

568
00:57:37.980 --> 00:57:39.740
That's obviously silly, right?

569
00:57:39.740 --> 00:57:43.460
But I mean, again, if you have the view that we previously

570
00:57:43.460 --> 00:57:46.140
discussed, that sellers kind of unilaterally set the price,

571
00:57:46.140 --> 00:57:49.260
you might think that raising the price isn't fair.

572
00:57:49.260 --> 00:57:51.940
It places a disproportionate burden

573
00:57:51.940 --> 00:57:54.420
on the less well advantaged in society.

574
00:57:54.420 --> 00:57:56.260
Isn't it taking advantage of people

575
00:57:56.260 --> 00:57:58.140
who otherwise couldn't fend for themselves?

576
00:57:58.140 --> 00:58:00.020
Well, I mean, we've obviously seen

577
00:58:00.020 --> 00:58:04.000
that we couldn't support that in our analysis at all.

578
00:58:04.000 --> 00:58:06.140
But more fundamentally, our analysis so far

579
00:58:06.140 --> 00:58:08.640
has been completely value free.

580
00:58:08.640 --> 00:58:11.080
We haven't said what's just and fair,

581
00:58:11.080 --> 00:58:13.460
because concepts like justice and fairness

582
00:58:13.460 --> 00:58:17.500
are fundamentally extra economic concepts.

583
00:58:17.500 --> 00:58:19.460
Okay, we're explaining what the price is.

584
00:58:19.460 --> 00:58:23.260
We're not explaining whether that price is just or fair.

585
00:58:23.260 --> 00:58:27.840
You know, there's a sort of medieval scholastic tradition

586
00:58:27.840 --> 00:58:30.260
of writing about the just price.

587
00:58:30.260 --> 00:58:33.080
Although it turns out, if you look in that literature,

588
00:58:33.080 --> 00:58:35.100
it's not quite the way it's been portrayed.

589
00:58:35.100 --> 00:58:38.840
Many scholastics use the term just price

590
00:58:38.840 --> 00:58:40.880
to refer somebody to the market price.

591
00:58:40.880 --> 00:58:44.040
But more generally, one might have a sort of a normative

592
00:58:44.040 --> 00:58:46.340
theory of what the price ought to be.

593
00:58:47.500 --> 00:58:56.500
Not necessarily a correct theory, but if so, that's something that economic analysis per se does not address, okay, what prices are fair or just.

594
00:58:56.500 --> 00:59:04.500
Now, we can say something about social welfare under conditions of market prices versus some other kind of prices.

595
00:59:04.500 --> 00:59:10.500
We can make some very limited statements about that, which we'll come to in a moment, but we're really not interested in things about the just price.

596
00:59:10.500 --> 00:59:23.500
Related is the issue of price gouging, all these gasoline stations across the U.S., mom and pop gas station owners are being fined and threatened with jail sentences for gouging their consumers.

597
00:59:23.500 --> 00:59:34.500
Again, what does price gouging mean? Well, it means that sellers, it means that there are markets in which the equilibrium price has gone up.

598
00:59:34.500 --> 00:59:36.940
What does this mean to gouge, right?

599
00:59:36.940 --> 00:59:41.060
I mean, obviously gouging is not a scientific value neutral term.

600
00:59:41.060 --> 00:59:44.200
It's a smear, you know, like you gouge somebody's eyes out.

601
00:59:44.200 --> 00:59:47.180
It's a real aggressive, mean and nasty thing to do.

602
00:59:47.180 --> 00:59:49.980
And the idea is that sellers who raise their prices,

603
00:59:49.980 --> 00:59:52.800
for example, under conditions of increased demand,

604
00:59:52.800 --> 00:59:56.040
are taking advantage of hapless buyers.

605
00:59:56.040 --> 00:59:58.020
Again, there's always an increase in the demand

606
00:59:58.020 --> 01:00:00.320
for gasoline in the summertime,

607
01:00:00.320 --> 01:00:02.120
when more people go on vacation.

608
01:00:02.120 --> 01:00:06.880
You know, we could analyze it this way, right?

609
01:00:06.880 --> 01:00:10.520
I mean, suppose the demand for gasoline goes up in this fashion.

610
01:00:10.520 --> 01:00:14.800
Well, the market price will rise from P1 to B2.

611
01:00:14.800 --> 01:00:15.640
Is this bad?

612
01:00:15.640 --> 01:00:16.460
Is this unfair?

613
01:00:16.460 --> 01:00:18.080
Is this evil on the part of sellers?

614
01:00:18.080 --> 01:00:19.840
Well, I mean, there's nothing in our analysis here

615
01:00:19.840 --> 01:00:21.800
that could support that whatsoever.

616
01:00:21.800 --> 01:00:23.920
I mean, this whole concept of price gouging

617
01:00:23.920 --> 01:00:26.080
is sort of a non-scientific,

618
01:00:26.080 --> 01:00:27.640
it's kind of an aesthetic preference

619
01:00:27.640 --> 01:00:28.920
that certain people have to say,

620
01:00:28.920 --> 01:00:31.520
well, I don't like this price, I do like this price.

621
01:00:32.120 --> 01:00:38.120
There's no scientific support for that kind of a statement, that kind of analysis whatsoever.

622
01:00:38.120 --> 01:00:45.120
Now we get to some government interference in the price mechanism.

623
01:00:45.120 --> 01:00:55.120
Imagine that the government, perhaps responding to concerns about price gouging, sets a legally binding maximum price.

624
01:00:55.120 --> 01:01:01.120
So in the case like the one we just looked at, the government says the price cannot be higher than P2.

625
01:01:01.120 --> 01:01:09.120
I mean, I always think of this, you know, the first example that comes to my mind is rent control, government-controlled prices of housing.

626
01:01:09.120 --> 01:01:22.120
Having lived formerly in Berkeley, California, a city with very aggressive rent control policies, there's some first-hand knowledge of the effects of rent control, which we'll talk about in just a moment.

627
01:01:22.120 --> 01:01:32.120
Right, so, I mean, again, imagine that, you know, we're looking at the market for rental housing in a particular community in Auburn, Alabama or Berkeley, California,

628
01:01:32.120 --> 01:01:44.120
and say that the market price, the market clearing price, the equilibrium price is P1, you know, $500 a month for an apartment, three-bedroom apartment, apartment of a particular type.

629
01:01:44.120 --> 01:01:51.120
Okay, again, we're assuming that we're dealing with homogeneous units of the good, so units of the good that are equally serviceable, right?

630
01:01:51.120 --> 01:01:56.120
That's a precondition for the notion of a supply, the supply of a good, right?

631
01:01:56.120 --> 01:02:06.120
But the government, some do-gooders on the city council say, well, $500 a month is too high. No one should be able to charge more than 350.

632
01:02:06.120 --> 01:02:16.120
and we'll get those nasty, greedy, rapacious landlords and we'll make the citizens better off by forcing the price to be lower than it otherwise would be.

633
01:02:16.120 --> 01:02:20.120
We'll notice what happens at a price of P2.

634
01:02:20.120 --> 01:02:31.120
The immediate effect of a legal restriction on the price, a price ceiling below the equilibrium price, is to create a shortage, just as we saw a couple slides back.

635
01:02:31.120 --> 01:02:39.120
So at a price of P2, the number of people wanting to rent an apartment exceeds the number of apartments available.

636
01:02:39.120 --> 01:02:48.120
So there's a shortage of housing at a price below the equilibrium price.

637
01:02:48.120 --> 01:02:53.120
Is that bad? Well, I mean, look, think of it this way.

638
01:02:53.120 --> 01:03:00.120
At the rent control price, there aren't enough apartments to go around.

639
01:03:00.120 --> 01:03:02.120
Who's gonna get them?

640
01:03:02.760 --> 01:03:04.680
Okay

641
01:03:04.680 --> 01:03:10.120
In our previous analysis of the marginal payers, you know who ends up with the five radios at the end of the day?

642
01:03:10.560 --> 01:03:13.880
Well, it's the five market participants who have what?

643
01:03:16.600 --> 01:03:18.600
Yeah, well we say who have the highest

644
01:03:18.960 --> 01:03:21.920
Valuations because we haven't said how much money they have like in their bank account

645
01:03:22.240 --> 01:03:27.400
But those who have the greatest willingness to pay for the good people who value the good the most highly

646
01:03:27.400 --> 01:03:29.400
I meant the most money, four of the three.

647
01:03:57.400 --> 01:04:06.400
If the available supply of apartments get allocated among this larger set of buyers who are willing to pay at the rent-controlled price, well, it's mostly political.

648
01:04:06.400 --> 01:04:15.400
It's who you know. When I was in Berkeley, all the good rent-controlled apartments around campus were sort of legacy apartments,

649
01:04:15.400 --> 01:04:26.400
meaning you had an older sibling who had that apartment and they passed it on to you, or you have a personal connection with the landlord, or you're in a fraternity, or you have to have some personal connection.

650
01:04:26.400 --> 01:04:36.400
In many cases, under conditions of a shortage, the available stock is allocated according to some other allocation rule like willingness to wait online.

651
01:04:36.400 --> 01:05:06.400
Okay, so, you know, when the Xbox 360 first went on sale, and at the price that they charged, I don't have one, so I don't know what the price was, $3.99 or something, right, I mean, partly to create a buzz, right, sometimes the sellers will set a price below the equilibrium or market clearing price on that initial day, right, because they want the

652
01:05:06.400 --> 01:05:16.400
I want pictures on TV of people camping out, these really nerdy people who spend 48 hours in line to be the first one to get an Xbox or whatever.

653
01:05:16.400 --> 01:05:31.400
So if I wanted an Xbox 360 on the first day and was willing to pay a thousand bucks to get one, I might have a hard time getting one if I'm not willing to spend 48 hours camping out in a line of people who haven't taken a shower in a long time.

654
01:05:31.400 --> 01:05:39.400
So, I mean, the point is that rent control doesn't magically increase the stock of apartments, you know, to this level here.

655
01:05:39.400 --> 01:05:43.400
There's still only this many apartments, and they've got to be allocated somehow.

656
01:05:43.400 --> 01:05:47.400
And if it can't be by willingness to pay, it must be by some other mechanism.

657
01:05:47.400 --> 01:05:52.400
It's hard to think of a reason why allocation by that other mechanism would be preferable.

658
01:05:52.400 --> 01:05:56.400
You see, we can think of this as a misallocation of the stocks of the good.

659
01:05:56.400 --> 01:06:04.120
I mean, units of the good are not going to the highest valued users, but rather being allocated by some other criterion, right?

660
01:06:04.120 --> 01:06:12.160
And if we were to extend our analysis to some kind of long run situation, right, we can imagine the long run, well, I mean,

661
01:06:12.160 --> 01:06:19.920
building owners are getting less money for their units than they could get in an unregulated market.

662
01:06:19.920 --> 01:06:33.400
Their incomes go down, their willingness to maintain the stock, maintain the quality of apartments, to invest in upkeep and maintenance and so on, those incentives are attenuated.

663
01:06:33.400 --> 01:06:40.080
So there's a long run deterioration of the housing stock. And of course you can see this if you go to any rent controlled community in America.

664
01:06:40.080 --> 01:06:47.080
You'll see a stock of dilapidated apartments, dilapidated units, because there's little incentive for sellers to maintain them.

665
01:06:47.080 --> 01:06:57.080
One of the interesting sort of political economy aspects of this, I get a critical point that there's a different allocation mechanism being used under rent control.

666
01:06:57.080 --> 01:07:10.080
It creates these sort of weird coalitions. And one of the things that used to frustrate me greatly when I was in this situation is that I had moved out to Berkeley to start graduate school,

667
01:07:10.080 --> 01:07:40.080
School, and I didn't know other people in the community. I didn't have access to sort of a legacy apartment. But I would have been willing to pay more than what some of the current residents were paying in their rent controlled units. Now who were the current residents? Well, some of them were students who had a personal connection and were able to get their hands on one of the desirable units close to campus. But a lot of them were 40 and 50 year old guys who hadn't been students for a long time. You know, the guys you see down on telegraph

668
01:07:40.080 --> 01:07:50.080
of Avenue, selling incense, and ex-hippie types who had been students there 20 or 30 years back and had never moved out.

669
01:07:50.080 --> 01:07:55.080
I mean, they had a sweet meal on a very inexpensive apartment. Why would they ever move?

670
01:07:55.080 --> 01:08:00.080
So the point is I couldn't dislodge these people even if I wanted to.

671
01:08:00.080 --> 01:08:08.080
So what frustrated me is in the newspaper coverage of rent control issues or in the policy debate,

672
01:08:08.080 --> 01:08:15.080
Analyst would always describe the two factions as landlords and tenants, right?

673
01:08:15.080 --> 01:08:21.080
So the pro-tenant faction is the group that wants to keep rent control in place,

674
01:08:21.080 --> 01:08:28.080
and the pro-landlord faction is the group that wants to eliminate rent control or raise the rent control prices.

675
01:08:28.080 --> 01:08:32.080
Say, well, wait a minute. Tenants are not a homogeneous group.

676
01:08:32.080 --> 01:08:37.080
I was a tenant, and I wanted them to abolish the stupid restrictions.

677
01:08:37.080 --> 01:08:47.080
Okay, so it's a fallacy to think that a price ceiling benefits buyers and hurts sellers simply isn't the case.

678
01:08:47.080 --> 01:08:54.080
It benefits some buyers, those who are still able to obtain the good at the lower price, at the expense of other buyers.

679
01:08:54.080 --> 01:09:00.080
Buyers who are unable to obtain a unit even though they would have been willing to pay a higher price.

680
01:09:00.080 --> 01:09:06.080
Okay, so you get all kinds of weird political dynamics to another reason to be very suspicious of this type of policy.

681
01:09:06.080 --> 01:09:36.080
Policy. Okay. We've looked at changes in demand. How about changes in supply? Suppose that there is an increase in the available stock of the good. Now, notice that this can't happen instantaneously, right? But suppose that, you know, on this eBay auction, right? I mean, suppose that, you know, today there are a certain number of radios available because junkyard dealers have found them and put them on eBay, and then

682
01:09:36.080 --> 01:09:41.080
The sellers decide that well maybe there's more demand out there than we thought

683
01:09:41.080 --> 01:09:45.080
and some dealers who previously hadn't made their radios available on eBay

684
01:09:45.080 --> 01:09:50.080
or people go out into the junkyard and they pull radios out of trashed cars

685
01:09:50.080 --> 01:09:52.080
and they make them available for sale.

686
01:09:52.080 --> 01:09:56.080
So imagine that the next day or in the next sales period

687
01:09:56.080 --> 01:09:59.080
the stock of available radios is greater than it was.

688
01:09:59.080 --> 01:10:05.080
We could represent this with a movement in the supply schedule or the supply curve.

689
01:10:05.080 --> 01:10:14.080
So imagine that the stock of good has increased from one period to the next, from the original vertical supply curve S to a new one S prime.

690
01:10:14.080 --> 01:10:20.080
Again, distinction between change in supply and change in quantity supplied.

691
01:10:20.080 --> 01:10:29.080
In the textbook treatment, you had sort of the same thing of moving along a supply curve versus shifting a supply curve.

692
01:10:29.080 --> 01:10:36.080
Remember here what we're calling the supply curve represents the stock of the good that's available.

693
01:10:36.080 --> 01:10:41.080
So it really doesn't make sense to talk about moving up and down a given supply curve,

694
01:10:41.080 --> 01:10:47.080
because it's not really a supply schedule in the same sense that the demand curve represents a demand schedule.

695
01:10:47.080 --> 01:10:51.080
All we're saying here is there's an increase in the stock of the good.

696
01:10:51.080 --> 01:11:02.080
If the price were to remain at P1, what would happen? Well, at a price of P1, the available stock exceeds the quantity demanded at a price of P1.

697
01:11:02.080 --> 01:11:11.080
So buyers and sellers have an incentive to lower the price to the new market clearing or equilibrium price P2.

698
01:11:11.080 --> 01:11:19.080
At a price of P1, the quantity available exceeds the quantity demanded, which we call a surplus.

699
01:11:19.080 --> 01:11:37.780
Okay. Some radios end up unsold at the end of the day. Okay. We could do another analysis of intervention here with what we call a price floor, meaning a legally mandated minimum price.

700
01:11:37.780 --> 01:11:47.280
Good example would be the labor market. Okay. So imagine that there is a stock of available labor and there's some demand for that labor.

701
01:11:47.280 --> 01:11:55.280
Now we'll talk tomorrow in a little bit more detail about where the demand for labor comes from, but remember the demanders of labor are employers.

702
01:11:55.280 --> 01:12:01.280
So just take it as given for the moment that there exists some demand for labor represented by this demand curve.

703
01:12:01.280 --> 01:12:09.280
If the market wage is P1, but the government says it's illegal to pay anyone less than P2, what will happen?

704
01:12:09.280 --> 01:12:15.280
Well, at a price of P2, only this much labor will be hired by employers.

705
01:12:15.280 --> 01:12:21.280
And so these additional units of labor, if you think of them as workers, will be unemployed.

706
01:12:21.280 --> 01:12:24.280
So there's unemployed labor, a surplus of labor.

707
01:12:24.280 --> 01:12:31.280
That's what unemployment is by definition, is at the given wage rates, the quantity supplied,

708
01:12:31.280 --> 01:12:34.280
quantity available of labor exceeds the quantity demanded.

709
01:12:34.280 --> 01:12:41.280
So notice that it doesn't even make sense to talk about unemployment without reference to a wage rate.

710
01:12:41.280 --> 01:12:46.280
Unemployment at a particular wage rate is a meaningful concept.

711
01:12:46.280 --> 01:12:51.280
Without talking about the wage rate, we don't know whether labor is unemployed or not.

712
01:12:51.280 --> 01:12:56.280
We have the same sort of thing here. We have a misallocation of labor.

713
01:12:56.280 --> 01:13:03.280
So people who get jobs are not those who have the highest valuations of money relative to their labor time.

714
01:13:03.280 --> 01:13:09.280
People who are the most willing to work, but rather the people who know somebody or have a connection or whatever.

715
01:13:09.280 --> 01:13:12.280
You may be willing to work at a price less than P2.

716
01:13:12.280 --> 01:13:17.280
Maybe you're a teenager who's just entering the labor force for the first time,

717
01:13:17.280 --> 01:13:22.280
and you value the experience for your resume more than you value the cash in hand.

718
01:13:22.280 --> 01:13:28.280
You're unable to underbid somebody and take a job away from someone who's employed at the minimum wage.

719
01:13:28.280 --> 01:13:31.280
So there's a misallocation of labor.

720
01:13:31.280 --> 01:13:36.280
Labor is not being used and it's not being put to its most highly valued use.

721
01:13:36.280 --> 01:13:39.640
and we can imagine long run consequences as well.

722
01:13:39.640 --> 01:13:41.760
We think of people who can choose

723
01:13:41.760 --> 01:13:43.880
to enter the labor force or not.

724
01:13:43.880 --> 01:13:48.400
Students, people whose spouses work full time,

725
01:13:48.400 --> 01:13:50.280
people who enter the labor force,

726
01:13:50.280 --> 01:13:52.740
attracted by the higher government minimum wage,

727
01:13:52.740 --> 01:13:55.160
who otherwise would not be in the labor force.

728
01:13:55.160 --> 01:13:58.180
We have sort of additional long run misallocations.

729
01:13:58.180 --> 01:13:59.440
People drop out of school,

730
01:13:59.440 --> 01:14:01.800
who otherwise would be in school and so on.

731
01:14:01.800 --> 01:14:04.960
And we can talk about this in some more detail later.

732
01:14:04.960 --> 01:14:12.000
Okay, so I want to go ahead and summarize so that we can have time for some more questions.

733
01:14:12.000 --> 01:14:17.520
You know, what then is it that prices do in a market economy?

734
01:14:17.520 --> 01:14:22.800
Will prices allocate resources to their highest valued users?

735
01:14:22.800 --> 01:14:26.440
Right, that's a kind of rationing mechanism, right?

736
01:14:26.440 --> 01:14:33.480
Price controls lead to misallocations of resources, meaning rationing by some mechanism other than willingness,

737
01:14:33.480 --> 01:14:36.040
other than subjective valuations of the good,

738
01:14:36.040 --> 01:14:39.320
willingness to buy, willingness to sell, okay?

739
01:14:40.400 --> 01:14:44.480
Market prices provide feedback to entrepreneurs

740
01:14:44.480 --> 01:14:48.040
about the quality or reliability of the decisions

741
01:14:48.040 --> 01:14:52.260
that they have made in the past, right?

742
01:14:52.260 --> 01:14:55.100
So the stock of available radios today

743
01:14:55.100 --> 01:14:58.400
depends on decisions made by entrepreneurs in the past

744
01:14:59.500 --> 01:15:03.240
and by seeing at what price people are willing to buy

745
01:15:03.240 --> 01:15:08.240
Radios. By seeing what the equilibrium prices and quantities are, entrepreneurs can get

746
01:15:08.240 --> 01:15:14.360
some feedback on the quality of those forecasts that they made in the past. Otherwise, they

747
01:15:14.360 --> 01:15:19.300
would, under price controls or government interference with the price system, there's

748
01:15:19.300 --> 01:15:25.160
no way for entrepreneurs to know whether their price forecasts have been validated by consumer

749
01:15:25.160 --> 01:15:26.480
or Preferences or not.

750
01:15:28.880 --> 01:15:30.480
It's a somewhat subtle point is,

751
01:15:30.480 --> 01:15:35.120
you know, there's a whole field in contemporary economics

752
01:15:35.120 --> 01:15:36.720
devoted to the analysis of welfare,

753
01:15:36.720 --> 01:15:38.880
so-called welfare economics.

754
01:15:38.880 --> 01:15:43.280
And under causal realistic, causal realist analysis,

755
01:15:43.280 --> 01:15:47.360
much of that would be regarded as incoherent

756
01:15:47.360 --> 01:15:49.360
or not nonsensical.

757
01:15:49.360 --> 01:15:53.800
Right, but there is at least one powerful sense

758
01:15:53.800 --> 01:15:57.440
of Welfare Maximization that does make sense, right?

759
01:15:57.440 --> 01:16:00.200
And that's this idea that the allocation of resources

760
01:16:00.200 --> 01:16:03.520
that does obtain under market competition,

761
01:16:03.520 --> 01:16:06.740
in other words, these sort of very mundane, everyday,

762
01:16:06.740 --> 01:16:09.680
what Mises would call plain state of rest prices,

763
01:16:09.680 --> 01:16:11.700
the ones that obtained from the analysis

764
01:16:11.700 --> 01:16:14.080
that we've just described, right?

765
01:16:14.080 --> 01:16:16.980
You know, leads to an allocation of resources

766
01:16:16.980 --> 01:16:18.840
that is welfare maximizing

767
01:16:18.840 --> 01:16:22.820
in really the only meaningful sense of that term,

768
01:16:22.820 --> 01:16:32.820
Meaning that goods and services are allocated to individuals, those individuals with the highest subjective valuations for the good.

769
01:16:32.820 --> 01:16:43.820
It's a very simple notion of welfare maximization, which is really the only one that is scientifically meaningful under causal realist analysis.

770
01:16:43.820 --> 01:16:51.820
I want to make two more points before we quit. One has to do with sort of the standard textbook upward sloping supply curve.

771
01:16:51.820 --> 01:16:57.840
Those of you who have had economics courses before will notice that one of the seeming peculiarities,

772
01:16:57.840 --> 01:17:03.840
picadillos, if you will, of this style of presentation is this insistence on drawing these vertical supply curves.

773
01:17:03.840 --> 01:17:10.840
But aren't supply curves upward sloping? At a higher price, won't more units of the good or service be brought to market?

774
01:17:10.840 --> 01:17:16.840
Well, the problem with the standard Marshallian analysis of quantity supplied increasing with the price

775
01:17:16.840 --> 01:17:20.640
is that the diagram combines two different components

776
01:17:20.640 --> 01:17:25.160
that exist in a different time dimension, okay?

777
01:17:25.160 --> 01:17:28.520
In other words, demands, right,

778
01:17:28.520 --> 01:17:32.500
reflect subjective preferences that exist instantaneously,

779
01:17:32.500 --> 01:17:34.560
right, you can instantaneously decide

780
01:17:34.560 --> 01:17:38.360
that you like Paris Hilton more or less than you did before,

781
01:17:38.360 --> 01:17:41.040
okay, whereas stocks of goods and services,

782
01:17:41.040 --> 01:17:44.160
physical units that are available for consumption,

783
01:17:44.160 --> 01:17:48.000
cannot be instantaneously increased, okay?

784
01:17:48.000 --> 01:17:49.600
They can only be increased over time.

785
01:17:49.600 --> 01:17:51.040
There's some production period.

786
01:17:51.040 --> 01:17:53.880
There's some investment and so on that must be made.

787
01:17:53.880 --> 01:17:58.880
Okay, Shapiro calls this the next time around dimension.

788
01:17:59.120 --> 01:18:01.880
Okay, he refers to the vertical supply curves

789
01:18:01.880 --> 01:18:05.840
that we've been drawing as the ex-post supply curves

790
01:18:05.840 --> 01:18:07.800
and the upward sloping curves you see

791
01:18:07.800 --> 01:18:11.200
in the standard textbooks as ex-ante curves.

792
01:18:11.200 --> 01:18:13.640
We're presenting producers sort of ex-ante

793
01:18:13.640 --> 01:18:15.240
are ahead of time decisions.

794
01:18:15.240 --> 01:18:18.160
Yeah, if I thought I could get this price,

795
01:18:18.160 --> 01:18:21.440
I would want to produce this many units.

796
01:18:21.440 --> 01:18:24.200
But again, that's a forward looking decision, fine.

797
01:18:24.200 --> 01:18:26.360
But when it comes to the moment of exchange,

798
01:18:26.360 --> 01:18:28.480
those decisions have already been made

799
01:18:28.480 --> 01:18:30.920
and can instantaneously be adjusted.

800
01:18:30.920 --> 01:18:33.800
Right, now there is one sense in which we can talk about

801
01:18:33.800 --> 01:18:35.960
an upward sloping supply curve.

802
01:18:35.960 --> 01:18:40.960
But it is not an analysis that describes actual prices paid,

803
01:18:40.960 --> 01:18:55.960
but rather an imaginary construct in Mises language, or a hypothetical construct, describing prices that would exist in a kind of, sort of a long run dimension, what Mises calls the final state of rest.

804
01:18:55.960 --> 01:18:59.960
And we can illustrate that with a simple diagram here.

805
01:18:59.960 --> 01:19:11.960
So imagine we have the story we had before where the market is in equilibrium at a price of P1 and there's an increase in demand and a new equilibrium price of P2.

806
01:19:11.960 --> 01:19:18.960
That's day one. In biblical terms, there was morning and evening and the first day.

807
01:19:18.960 --> 01:19:23.960
Now it's the second day. Sorry, I don't know why I said that.

808
01:19:23.960 --> 01:19:28.960
Suppliers say, well, wait a minute, gosh, the price is higher than we thought it was going to be.

809
01:19:28.960 --> 01:19:33.560
At a price of P2, we would be willing to bring additional units to market.

810
01:19:33.560 --> 01:19:40.760
So during the next sales period, so after this, at the end of this day, they go off and produce some more units.

811
01:19:40.760 --> 01:19:43.760
And then the next day, they have some additional units available, right?

812
01:19:43.760 --> 01:19:47.360
So the next day, they have S prime units available.

813
01:19:47.360 --> 01:19:49.860
Can you see the light gray?

814
01:19:49.860 --> 01:19:55.560
It's hard to tell on my screen what's going to show up on the projector here.

815
01:19:55.560 --> 01:20:01.460
Right, so in day two, there's a greater stock of the good available.

816
01:20:01.460 --> 01:20:06.860
And so there's a price P3 that's not as high as P2, but greater than P1.

817
01:20:06.860 --> 01:20:11.860
Okay, so here we are at the start of the second day, and then the buyers think,

818
01:20:11.860 --> 01:20:22.460
wow, we, you know, we, you know, yesterday when the price was P2, the price now is P3.

819
01:20:22.460 --> 01:20:25.500
And let's say that there's another increase in demand.

820
01:20:25.500 --> 01:20:29.340
Now we like Paris Hilton even more than we did before, right?

821
01:20:29.340 --> 01:20:31.500
So there's another outward shift of demand,

822
01:20:31.500 --> 01:20:33.700
price rising all the way to P4.

823
01:20:33.700 --> 01:20:34.620
And so that's the second day.

824
01:20:34.620 --> 01:20:36.000
So then what happens in the third day?

825
01:20:36.000 --> 01:20:38.980
Well, sellers bring even more units to market.

826
01:20:38.980 --> 01:20:41.540
And so now there's a price of P5 and so on.

827
01:20:41.540 --> 01:20:44.060
Right, so if we think of a supply curve

828
01:20:44.060 --> 01:20:47.260
that shifts out over time in response

829
01:20:47.260 --> 01:20:50.340
to increases in demands, right?

830
01:20:50.340 --> 01:20:55.740
And then if we were to sort of plot all of those prices that obtain after the new, after

831
01:20:55.740 --> 01:21:00.860
the supply curve has shifted out, P1, P3 and P5, we could sort of, we could connect the

832
01:21:00.860 --> 01:21:05.500
dots and call that a long-run supply curve, okay?

833
01:21:05.500 --> 01:21:13.000
And say yes, in response to a set of increases in demand, sellers might subsequently response

834
01:21:13.000 --> 01:21:18.140
by increasing their stocks over time, leading to this sort of upward supply curve over time,

835
01:21:18.140 --> 01:21:19.140
okay?

836
01:21:19.140 --> 01:21:23.880
There's no guarantee, starting from the beginning of our diagram, that this particular set of

837
01:21:23.880 --> 01:21:29.500
prices P1, P3 and P5 would obtain in reality.

838
01:21:29.500 --> 01:21:36.060
We're simply saying, if there is a steady increase in demand over time, no other changes

839
01:21:36.060 --> 01:21:41.260
in market conditions and sellers are able to increase their stocks of goods over time

840
01:21:41.260 --> 01:21:47.100
in response to these changes in demand, then we would see equilibrium prices and quantities

841
01:21:47.100 --> 01:21:52.500
that rise over time, okay. But again, this is, we'll get to this in more detail later

842
01:21:52.500 --> 01:21:58.300
in the week, but this is what Mises calls an imaginary construct. It's an aid to reasoning

843
01:21:58.300 --> 01:22:03.540
what would happen under the following circumstances, but we aren't saying that this describes the

844
01:22:03.540 --> 01:22:14.060
prices that are actually paid, okay. Final thoughts before we stop. There's a tradition

845
01:22:14.060 --> 01:22:20.100
in the Austrian economics literature, associated primarily with Hayek and his very influential

846
01:22:20.100 --> 01:22:26.980
1945 article, The Use of Knowledge in Society, of thinking about the role of prices primarily

847
01:22:26.980 --> 01:22:34.060
as signals or transmitters of knowledge or information.

848
01:22:34.060 --> 01:22:38.160
And this is even filtered down into many of the standard textbooks where there's a discussion

849
01:22:38.160 --> 01:22:43.500
of the role of prices in disseminating knowledge or information throughout the economy, prices

850
01:22:43.500 --> 01:22:45.940
is providing signals to market participants.

851
01:22:45.940 --> 01:22:49.500
Well, I mean, there is a sense in which that is true.

852
01:22:49.500 --> 01:22:53.620
Gate prices do embody knowledge about present

853
01:22:53.620 --> 01:22:58.500
or more technically immediate past market conditions, right?

854
01:22:58.500 --> 01:23:01.180
So the fact that Joe was willing to pay 10.49

855
01:23:01.180 --> 01:23:02.980
for the Def Leppard CD or whatever

856
01:23:02.980 --> 01:23:06.180
does provide some useful feedback to Walmart

857
01:23:06.180 --> 01:23:09.220
about consumer demands for goods and services.

858
01:23:09.220 --> 01:23:19.220
But that isn't sufficient for explaining the broader process of production and exchange.

859
01:23:19.220 --> 01:23:29.220
In other words, the fact that buyers are willing to pay a certain price for CDs today is not sufficient to explain entrepreneurs' production decisions,

860
01:23:29.220 --> 01:23:37.220
because those production decisions are guided not only by their experience of the present or the immediate past, prices that have just now been paid,

861
01:23:37.220 --> 01:23:42.220
but also their expectations about the prices that will obtain in the future.

862
01:23:42.220 --> 01:23:50.220
Okay, so prices provide some information but not sufficient information for entrepreneurs to make decisions about the allocation of resources.

863
01:23:50.220 --> 01:23:54.220
So, you know, there's some truth in this but we want to be careful not to overstate it.

864
01:23:54.220 --> 01:24:02.220
Another way to think about it, prices are the product of, but not, are not the antecedent to human action.

865
01:24:02.220 --> 01:24:18.220
and Action. It isn't the case that agents sort of mindlessly or blindly follow price signals leading to an efficient allocation of resources, which is a view that is sort of a misreading of this Hayekian point, I think, that has that implication.

866
01:24:18.220 --> 01:24:27.220
We also might make a notion about the notion of price that you hear sometimes in contemporary economic discourse.

867
01:24:27.220 --> 01:24:33.220
There's kind of a broader notion of price, meaning not specifically prices paid on the market like this,

868
01:24:33.220 --> 01:24:43.220
but what I call pseudo prices, meaning sort of any sort of constraint that market participants face.

869
01:24:43.220 --> 01:24:49.220
For example, in the literature on the economics of crime, some economists will say,

870
01:24:49.220 --> 01:24:53.220
well, you know, if you're caught speeding, you have to pay a $300 fine.

871
01:24:53.220 --> 01:25:00.220
And then in this other city, in Auburn it's $300, in Opelika it's $500.

872
01:25:00.220 --> 01:25:04.220
So the price of speeding is higher in Opelika than it is in Auburn.

873
01:25:04.220 --> 01:25:07.220
And so we expect there to be less speeding in Opelika than in Auburn.

874
01:25:07.220 --> 01:25:10.220
And if the court decides to impose a higher price,

875
01:25:10.220 --> 01:25:15.220
If there's a price, then that's going to affect the, then the amount of speeding will be reduced.

876
01:25:15.220 --> 01:25:27.220
Well, I mean, okay, there's a sense in which the anticipated fine from speeding affects the decision makers, the driver's decision about how fast to drive.

877
01:25:27.220 --> 01:25:31.220
But again, those aren't prices in the sense that we've been talking about today.

878
01:25:31.220 --> 01:25:39.220
Many of those aren't prices that emerge from the voluntary interactions of buyers and sellers reflecting their subjective valuations and so on.

879
01:25:39.220 --> 01:25:46.220
It's just an artificial price made up by the court, you know, which people then, of course, do take into account in making their decisions.

880
01:25:46.220 --> 01:25:53.220
Same thing within a firm, right? I mean, a firm might have an incentive plan where, you know, we have workers who are on an assembly line,

881
01:25:53.220 --> 01:26:01.220
and they're producing unit, they're producing widgets or whatever, and if we pay them a piece rate, you know, they get so many dollars per unit produced,

882
01:26:01.220 --> 01:26:31.220
In a metaphorical sense, that may be okay, but we have to remember, those aren't real prices in the sense that we're talking about, you think of them as sort of pseudo-prices, meaning that we cannot make these sort of overall statements that, oh, well, the prices paid for speeding tickets lead to a maximum price increase, and then we increase the piece rate, we would expect workers to respond by producing more, and sometimes economists will say, well, it's like we increased the price that they receive for selling their output.

883
01:26:31.220 --> 01:26:43.220
and Maximization of Consumer Welfare can't make any sort of statement like that because the process by which these prices emerge is sort of purely arbitrary relative to the process that we've described here.

884
01:26:43.220 --> 01:26:45.220
Okay, well, I've already talked longer than I wanted to.

885
01:26:45.220 --> 01:26:51.220
Are there any questions that have not come up yet?

886
01:26:51.220 --> 01:26:55.220
Okay, I'm sorry, let me go with Fred, and then Dan, and then...

887
01:26:55.220 --> 01:27:02.220
Peter, if you just review the impact on prices of inflation, or increase in the money supply...

888
01:27:02.220 --> 01:27:10.220
Sure. I'll just comment very briefly about it now, because we have some lectures on Thursday, I think, devoted specifically to inflation.

889
01:27:10.220 --> 01:27:17.220
But in the context that we're talking about here, if we think of inflation, meaning increasing the stock of money,

890
01:27:17.220 --> 01:27:22.020
as reducing the buying power of each dollar, right?

891
01:27:22.020 --> 01:27:25.580
Then people will adjust their valuations, right?

892
01:27:25.580 --> 01:27:29.180
Remember the guy who was willing to pay $200 for the radio.

893
01:27:29.180 --> 01:27:32.260
If we were to write out his value scale, right?

894
01:27:32.260 --> 01:27:35.980
We would put $200 and then radio above it.

895
01:27:35.980 --> 01:27:39.160
He values the radio more than the $200, right?

896
01:27:39.160 --> 01:27:42.220
If there's an increase in the monetary unit, right?

897
01:27:42.220 --> 01:27:44.940
And now I know that each dollar purchases

898
01:27:44.940 --> 01:27:48.120
Fewer goods and services than it did before, right?

899
01:27:48.120 --> 01:27:51.820
Then I would, in the new, you know,

900
01:27:51.820 --> 01:27:53.380
after the change in the money supply,

901
01:27:53.380 --> 01:27:57.900
maybe $200 would rank higher than the radio, okay?

902
01:27:59.020 --> 01:28:01.300
But excuse me, lower than the radio, right?

903
01:28:01.300 --> 01:28:06.220
Meaning that now I value a radio more than 250

904
01:28:06.220 --> 01:28:09.980
of the newer dollars relative to 200 of the older dollars.

905
01:28:09.980 --> 01:28:12.280
Right, so it changes people's value scales

906
01:28:12.280 --> 01:28:14.620
where the value scale includes the units

907
01:28:14.620 --> 01:28:17.220
of the Good or Service, and dollar amounts

908
01:28:17.220 --> 01:28:20.260
as in the ones that Joe showed us yesterday.

909
01:28:20.260 --> 01:28:21.100
Dan?

910
01:28:24.340 --> 01:28:27.140
I was just curious about the last 100 that you made

911
01:28:27.140 --> 01:28:29.860
in regard to the speed of buying

912
01:28:29.860 --> 01:28:31.660
and not necessarily being too expensive

913
01:28:31.660 --> 01:28:34.500
because they don't have any, like, emerging quality

914
01:28:36.020 --> 01:28:39.340
as a result of bargaining or expressing significant value.

915
01:28:39.340 --> 01:28:43.460
But earlier you said that we get kind of deluded

916
01:28:43.460 --> 01:29:06.460
I think that sellers set prices because we don't bargain necessarily when we go to a store, so I'm a little confused as to why we're okay in saying that pointing out a cost difference between speed fines in different cities is a component of a price that we're not necessarily certain about.

917
01:29:06.460 --> 01:29:26.460
Let me see if I understand the question. I'm sorry, I should have repeated Fred's question for people who are listening at home.

918
01:29:26.460 --> 01:29:29.460
The first question was about inflation. You probably figured that out.

919
01:29:29.460 --> 01:29:40.460
The question here is, I said earlier that sellers don't unilaterally set the price, but that buyers can impact the prices that are set through their willingness to buy or not to buy.

920
01:29:40.460 --> 01:29:50.460
How can I then say that because the court simply decides that a speeding ticket is going to be $300 to $500, that how is that any less?

921
01:29:50.460 --> 01:29:53.460
How is the process essentially different in that case?

922
01:29:53.460 --> 01:30:04.460
Well, I mean, I think, look, if what you have in mind is, you could say that, well, I mean, the city of Auburn sets the speeding ticket, the price of speeding tickets at $500, and they discover, well, gosh, nobody's speeding.

923
01:30:04.460 --> 01:30:15.460
Right? That fine is so high that everybody's totally scared off, and we're not earning any revenues in speeding fines, so maybe the price is too high, we need to lower the price.

924
01:30:15.460 --> 01:30:27.460
There's a sense in which the actions of drivers can provide some feedback to the government in that case and can induce them to change the price, sure.

925
01:30:27.460 --> 01:30:32.460
But that's still very different from the kind of price setting process that we've been describing here.

926
01:30:32.460 --> 01:30:35.460
First of all, we don't know what the objectives of the city are.

927
01:30:35.460 --> 01:30:42.460
Are they to maximize revenue? Are they to eliminate speeding? Is it to get good PR?

928
01:30:42.460 --> 01:30:52.460
The point is that the city official would be free to say, well, I don't care how people drive, I'm going to set the price whenever I want.

929
01:30:52.460 --> 01:31:05.460
Now, drivers could adjust their behavior so that no actual speeding fines are collected, but the price of the ticket is still $500.

930
01:31:05.460 --> 01:31:11.740
$500. There's nothing that buyers can do to make that price change, sorry, that drivers

931
01:31:11.740 --> 01:31:13.740
can do to make them lower the price.

932
01:31:13.740 --> 01:31:20.740
Right, but I don't think it's fair to say that $500 is the price of speeding. $500 is

933
01:31:20.740 --> 01:31:25.740
the price of a ticket. It's just one small cost component of driving.

934
01:31:25.740 --> 01:31:29.340
Well, I want to move on, but that's why I call it a pseudo-price. I mean, it has some

935
01:31:29.340 --> 01:31:34.300
characteristics that are analogous to a price, but it's different from a market price. That's

936
01:31:34.300 --> 01:31:36.700
That's all I'm saying.

937
01:31:36.700 --> 01:31:40.380
I guess we should stop for our lunch break because we're already a few minutes over.

938
01:31:40.380 --> 01:31:42.380
So thank you very much.