WEBVTT NOTE 5.09. Pricing and the Theory of Bargaining 1 00:00:00.000 --> 00:00:05.720 9. Pricing and the Theory of Bargaining 2 00:00:05.720 --> 00:00:12.240 We have seen that for all goods, total receipts to sellers will tend to equal total payments 3 00:00:12.240 --> 00:00:21.080 to factors, and this equality will be established in the evenly rotating economy. In the ERE, 4 00:00:21.080 --> 00:00:26.360 interest income will be earned at the same uniform rate by capitalists throughout the 5 00:00:26.360 --> 00:00:37.360 The Remainder of Income from Production and Sale to Consumers will be earned by the owners of the original factors, land and labor. 6 00:00:37.360 --> 00:00:53.360 Our next task will be to analyze the determination of the prices of factor services and the determination of the interest rate as they tend to be approached in the economy and would be reached in the ERE. 7 00:00:53.360 --> 00:01:03.360 Until now discussion has centered on the capital good structure, treated as if it were in one composite state of production. 8 00:01:03.360 --> 00:01:11.360 Clearly there are numerous stages, but we have seen that earnings in production ultimately resolve themselves, 9 00:01:11.360 --> 00:01:19.360 and certainly do so in the ERE, into the earnings of the original factors, land and labor. 10 00:01:19.360 --> 00:01:25.600 Later on, we shall expand the analysis to include the case of many stages in the production 11 00:01:25.600 --> 00:01:31.940 process, and we shall defend this type of temporal analysis of production against the 12 00:01:31.940 --> 00:01:38.940 very fashionable current view that production is timeless under modern conditions, and that 13 00:01:38.940 --> 00:01:44.780 the original factor analysis might have been useful for the primitive era, but not for 14 00:01:44.780 --> 00:01:46.900 a modern economy. 15 00:01:46.900 --> 00:01:53.500 As a corollary to this, we shall develop further an analysis of the nature of capital and time 16 00:01:53.500 --> 00:01:56.540 in the production process. 17 00:01:56.540 --> 00:02:03.860 What will be the process of pricing productive factors in a world of purely specific factors? 18 00:02:03.860 --> 00:02:10.100 We have been assuming that only services and not whole goods can be acquired. 19 00:02:10.100 --> 00:02:15.020 In the case of labor, this is true because of the nature of the free society. 20 00:02:15.020 --> 00:02:20.980 In the case of land and capital goods, we are assuming that the capitalist product owners 21 00:02:20.980 --> 00:02:27.220 hire or rent rather than own any of the productive factors outright. 22 00:02:27.220 --> 00:02:33.040 In our example, the 95 ounces went to all the factor owners jointly. 23 00:02:33.040 --> 00:02:39.780 By what principles can we determine how the joint income is allocated to the various individual 24 00:02:39.780 --> 00:02:41.900 factor services? 25 00:02:41.900 --> 00:02:48.020 If all the factors are purely specific, we can resort to what is usually called the Theory 26 00:02:48.020 --> 00:02:49.620 of Bargaining. 27 00:02:49.620 --> 00:02:55.980 We are in a very analogous situation to the two-person barter of Chapter 2, for what we 28 00:02:55.980 --> 00:03:03.860 have is not relatively determinate prices or proportions, but exchange ratios with wide 29 00:03:03.860 --> 00:03:08.420 zones between the marginal pairs of prices. 30 00:03:08.420 --> 00:03:14.880 The maximum price of one is widely separated from the minimum price of the other. 31 00:03:14.880 --> 00:03:21.700 In the present case, we have, say, twelve labor and land factors, each of which is indispensable 32 00:03:21.700 --> 00:03:24.180 to the production of the good. 33 00:03:24.180 --> 00:03:31.260 None of the factors, furthermore, can be used anywhere else, in any other line of production. 34 00:03:31.260 --> 00:03:37.020 The question for these factor owners to solve is the proportionate share of each in the 35 00:03:37.020 --> 00:03:39.060 The Total Joint Income 36 00:03:39.060 --> 00:03:46.500 Each factor owner's maximum goal is something slightly less than 100% of the income from 37 00:03:46.500 --> 00:03:48.180 the consumers. 38 00:03:48.180 --> 00:03:53.580 What the final decision will be cannot be indicated by praxeology. 39 00:03:53.580 --> 00:03:58.580 There is, for all practical purposes, no theory of bargaining. 40 00:03:58.580 --> 00:04:04.740 All that can be said is that since the owner of each factor wants to participate and earn 41 00:04:04.740 --> 00:04:12.140 and some income, all will most likely arrive at some sort of voluntary contractual arrangement. 42 00:04:12.140 --> 00:04:18.620 This will be a formal type of partnership agreement if the factors jointly own the product, 43 00:04:18.620 --> 00:04:26.820 or it will be the implicit result if a pure capitalist purchases the services of the factors. 44 00:04:26.820 --> 00:04:32.180 Economists have always been very unhappy about bargaining situations of this kind, since 45 00:04:32.180 --> 00:04:37.500 Economic Analysis is stopped from saying anything more of note. 46 00:04:37.500 --> 00:04:43.660 We must not pursue the temptation, however, to condemn such situations as in some way 47 00:04:43.660 --> 00:04:52.040 exploitative or bad, and thereby convert barrenness for economic analysis into tragedy for the 48 00:04:52.040 --> 00:04:53.040 economy. 49 00:04:53.040 --> 00:04:59.000 Whatever agreement is arrived at by the various individuals will be beneficial to every one 50 00:04:59.000 --> 00:05:00.000 of them. 51 00:05:00.000 --> 00:05:03.200 Otherwise, he would not have so agreed. 52 00:05:03.200 --> 00:05:09.400 It is generally assumed that in the jockeying for proportionate shares, labor factors have 53 00:05:09.400 --> 00:05:13.240 less bargaining power than land factors. 54 00:05:13.240 --> 00:05:19.200 The only meaning that can be seen in the term bargaining power here is that some factor 55 00:05:19.200 --> 00:05:25.160 owners might have minimum reservation prices for their factors, below which they would 56 00:05:25.160 --> 00:05:27.480 not be entered in production. 57 00:05:27.480 --> 00:05:33.560 In that case, these factors would at least have to receive the minimum, while factors 58 00:05:33.560 --> 00:05:39.880 with no minimum, with no reservation price, would work even at an income of only slightly 59 00:05:39.880 --> 00:05:41.600 more than zero. 60 00:05:41.600 --> 00:05:48.280 Now it should be evident that the owner of every labor factor has some minimum selling 61 00:05:48.280 --> 00:05:51.840 price, a price below which he will not work. 62 00:05:51.840 --> 00:05:57.780 In our case, where we are assuming, as we shall see quite unrealistically, that every 63 00:05:57.780 --> 00:06:04.820 factor is specific, it is true that no laborer would be able to earn a return in any other 64 00:06:04.820 --> 00:06:06.520 type of work. 65 00:06:06.520 --> 00:06:13.860 But he could always enjoy leisure, and this sets a minimum supply price for labor service. 66 00:06:13.860 --> 00:06:19.960 On the other hand, the use of land sacrifices no leisure, except in rare cases where the 67 00:06:19.960 --> 00:06:26.080 The owner enjoys a valuable aesthetic pleasure from contemplating a stretch of his own land 68 00:06:26.080 --> 00:06:27.600 not in use. 69 00:06:27.600 --> 00:06:34.680 There is no revenue that the land can bring him except a monetary return in production. 70 00:06:34.680 --> 00:06:40.860 Therefore, land has no reservation price, and the land owner would have to accept a 71 00:06:40.860 --> 00:06:46.240 return of almost zero, rather than allow his land to be idle. 72 00:06:46.240 --> 00:06:52.120 The bargaining power of the owner of labor, therefore, is almost always superior to that 73 00:06:52.120 --> 00:06:54.440 of the owner of land. 74 00:06:54.440 --> 00:07:01.640 In the real world, labor, as will be seen, is uniquely the non-specific factor, so that 75 00:07:01.640 --> 00:07:07.600 the theory of bargaining could never apply to labor incomes. 76 00:07:07.600 --> 00:07:12.920 Contrast the discussion in most textbooks, where bargaining occupies an important place 77 00:07:12.920 --> 00:07:19.560 This is an explanation of market pricing only in the discussion of labor incomes. 78 00:07:19.560 --> 00:07:26.760 Thus, when two or more factors are specific to a given line of production, there is nothing 79 00:07:26.760 --> 00:07:33.320 that economic analysis can say further about the allocation of the joint income from their 80 00:07:33.320 --> 00:07:34.320 product. 81 00:07:34.320 --> 00:07:38.200 It is a matter of voluntary bargaining between them. 82 00:07:38.200 --> 00:07:44.620 Pricing and indeterminate pricing also take place even between two or more nonspecific 83 00:07:44.620 --> 00:07:52.320 factors in the rare case where the proportions in which these factors must be used are identical 84 00:07:52.320 --> 00:07:54.680 in each employment. 85 00:07:54.680 --> 00:08:01.080 In such cases also there is no determinate pricing for any of the factors separately 86 00:08:01.080 --> 00:08:05.360 and the result must be settled by mutual bargaining. 87 00:08:05.360 --> 00:08:11.520 Suppose for example that a certain machine containing two necessary parts can be used 88 00:08:11.520 --> 00:08:14.380 in several fields of production. 89 00:08:14.380 --> 00:08:21.640 The two parts, however, must always be combined in use in a certain fixed proportion. 90 00:08:21.640 --> 00:08:26.680 Suppose that two or more individuals owned these two parts. 91 00:08:26.680 --> 00:08:33.580 That is, two different individuals produce the different parts by their labor and land. 92 00:08:33.580 --> 00:08:40.580 The combined machine will be sold to or used in that line of production where it will yield 93 00:08:40.580 --> 00:08:46.580 the highest monetary income, but the price that will be established for that machine 94 00:08:46.580 --> 00:08:53.700 will necessarily be a cumulative price, so far as the two factors, the two parts, are 95 00:08:53.700 --> 00:08:54.880 concerned. 96 00:08:54.880 --> 00:09:01.600 The price of each part and the allocation of the income to the two owners must be decided 97 00:09:01.600 --> 00:09:05.040 by a Process of Bargaining. 98 00:09:05.040 --> 00:09:08.560 Economics cannot here determine separate prices. 99 00:09:08.560 --> 00:09:14.720 This is true because the proportions between the two are always the same, even though the 100 00:09:14.720 --> 00:09:20.360 combined product can be used in several different ways. 101 00:09:20.360 --> 00:09:27.160 Not only is bargaining theory rarely applicable in the real world, but zones of indeterminacy 102 00:09:27.160 --> 00:09:55.160 The greater the number and variety of goods available, and the greater the number of people with differing valuations, the more negligible will zones of indeterminacy become. 103 00:09:55.160 --> 00:10:02.580 At this point we may introduce another rare explicitly empirical element into our discussion, 104 00:10:02.580 --> 00:10:08.800 that on this earth, labor has been a far scarcer factor than land. 105 00:10:08.800 --> 00:10:14.580 As in the case of Crusoe, so in the case of a modern economy, men have been able to choose 106 00:10:14.580 --> 00:10:21.440 which land to use in various occupations and which to leave idle, and have found themselves 107 00:10:21.440 --> 00:10:28.960 As with idle, no-rent land, that is, land yielding no income, of course, as an economy 108 00:10:28.960 --> 00:10:35.600 advances and population and utilization of resources grow, there is a tendency for this 109 00:10:35.600 --> 00:10:41.600 Superfluity of Land to Diminish, Barring Discoveries of New Fertile Lands.