WEBVTT NOTE Production: Particular Factor Prices and Productive Incomes 1 00:00:00.000 --> 00:00:11.340 Okay, well, we're back to production economics and this is the last chapter in the section on production theory that we started yesterday. 2 00:00:11.340 --> 00:00:15.600 I like this chapter very much. It contains some of my favorite sections of the entire book, 3 00:00:15.600 --> 00:00:22.840 but that's just because of my own idiosyncratic preferences and research interests and so on. 4 00:00:22.840 --> 00:00:30.340 I don't want to say hodgepodge is not the right word, but there's a set of related sort of applied topics that are covered, right? 5 00:00:30.340 --> 00:00:33.840 We've already discussed the general principles of factor pricing. 6 00:00:33.840 --> 00:00:37.840 We've talked about the role of discounting, the place of the entrepreneur and so on. 7 00:00:37.840 --> 00:00:45.840 Now Rothbard delves into more detail on certain aspects of the labor market, certain aspects of the market for land and the services of land, 8 00:00:45.840 --> 00:00:51.720 certain aspects of the market for capital goods, the cost of the firm, some organizational 9 00:00:51.720 --> 00:00:59.320 and managerial issues associated with the firm and so on. 10 00:00:59.320 --> 00:01:05.160 Some of the highlights of the chapter include his extension and development of the theory 11 00:01:05.160 --> 00:01:08.200 of rent that we began discussing yesterday. 12 00:01:08.200 --> 00:01:15.800 And again, the key pioneer in this area, as Rothbard explains, is the early 20th century 13 00:01:15.800 --> 00:01:21.960 American economist Frank Fetter, who Joe mentioned in one of his, in his opening lecture, 14 00:01:21.960 --> 00:01:28.680 as being a very important figure in the causal realist or Mengerian tradition in economics, 15 00:01:28.680 --> 00:01:33.720 which was thriving in parts of Britain and in the United States before World War I. 16 00:01:33.720 --> 00:01:41.720 And it's something that we often forget because we associate the Austrian school with the University of Vienna, with Menger and his followers. 17 00:01:41.720 --> 00:01:51.720 And then we think of the modern, the 20th century important Austrians such as Mises, Hayek, the early Lachmann and so on. 18 00:01:51.720 --> 00:01:59.720 And then we have the modern Austrians associated with the Austrian revival, Rothbard of course, and then the post-74 Austrians. 19 00:01:59.720 --> 00:02:15.720 We tend to forget that, to a large extent, the Mangerian causal realist tradition was becoming widely incorporated into various parts of what we then would call mainstream Anglo-American economics. 20 00:02:15.720 --> 00:02:28.720 Wickstede in the UK and people like Frank Fetter, Herbert Davenport, Frank Taussig, John Bates Clark and others in the US who were major, very important figures in the profession. 21 00:02:28.720 --> 00:02:35.240 I'm not sure about Fetter, but his contemporaries in this area were these causal realist guys 22 00:02:35.240 --> 00:02:37.960 who were president of the American Economic Association and so on. 23 00:02:37.960 --> 00:02:39.280 I don't know if Fetter was. 24 00:02:39.280 --> 00:02:40.680 Davenport was in one year. 25 00:02:40.680 --> 00:02:41.680 Fetter was as well. 26 00:02:41.680 --> 00:02:47.480 So these were very prominent mainstream American economists, Fetter at Princeton, Davenport 27 00:02:47.480 --> 00:02:51.920 at Chicago and at Cornell and so on, Tausig at Harvard. 28 00:02:51.920 --> 00:02:55.200 So these were not sort of backwater fringe guys. 29 00:02:55.200 --> 00:02:56.800 These were the mainstream guys. 30 00:02:56.800 --> 00:03:02.960 and they were doing applications and extensions of the Mengerian causal realist tradition. 31 00:03:02.960 --> 00:03:11.960 However, their work became overshadowed and was largely forgotten by the 1920s and 1930s 32 00:03:11.960 --> 00:03:13.600 in the Anglo-American world. 33 00:03:13.600 --> 00:03:19.280 Anyway, the point is Rothbard takes and rehabilitates Federer's approach to rent, which we talked 34 00:03:19.280 --> 00:03:24.720 about yesterday, and incorporates it into a more general theory of factor pricing. 35 00:03:24.720 --> 00:03:28.720 That's one of the important parts of the chapter. 36 00:03:28.720 --> 00:03:35.720 The section on cost extends and elaborates on some issues that came up yesterday 37 00:03:35.720 --> 00:03:41.720 about differences between Rothbard's approach and the standard cost curve approach, 38 00:03:41.720 --> 00:03:48.720 mostly Marshallian, the approach that you get in standard textbook micro theory, 39 00:03:48.720 --> 00:03:53.720 Rothbard's treatment of vertical integration and the limits to the size of the firm 40 00:03:53.720 --> 00:04:04.720 What does he bring into the discussion of the limits to the firm? 41 00:04:04.720 --> 00:04:07.720 That's a very important topic in Austrian economics, 42 00:04:07.720 --> 00:04:13.720 but one that hadn't previously been incorporated into this particular application. 43 00:04:13.720 --> 00:04:15.720 Yeah, socialist calculation debate. 44 00:04:15.720 --> 00:04:16.720 That's right. 45 00:04:16.720 --> 00:04:18.720 And we'll get to that a little bit later. 46 00:04:18.720 --> 00:04:29.720 There's some very important lessons in this chapter for our understanding of the socialist calculation debate even though this is not explicitly a chapter on socialism. 47 00:04:29.720 --> 00:04:40.720 Those are some of my favorites. I mean, as you think back over the chapter and maybe look at your notes, if you took notes on your reading or as you're looking through the study guide, 48 00:04:40.720 --> 00:04:54.720 Did anything else stand out in your mind as being particularly interesting or controversial or difficult about this particular chapter? 49 00:04:54.720 --> 00:05:06.720 Any ideas that come to mind? Turn-ons, turn-offs? Nothing specific? Yes? 50 00:05:06.720 --> 00:05:36.200 Sorry, no such thing as involuntary... 51 00:05:36.200 --> 00:05:39.200 Unemployment. 52 00:05:47.200 --> 00:05:53.200 And this is a claim that is by no means generally accepted among economists, even among some Austrian economists. 53 00:05:53.200 --> 00:05:58.200 There was a certain incident, I don't want to go into the gory details, especially since we're on tape, 54 00:05:58.200 --> 00:06:04.200 but a fellow traveler and critic of the Austrian School, 55 00:06:04.200 --> 00:06:34.200 So, particularly if some Austrians who are near and dear to our hearts in this own room claimed that this statement is ridiculous, is preposterous, that it doesn't take Dick into account uncertainty in the market process, and blah, blah, blah, it's sort of too equilibrium bound, anyone who believes this must be completely nuts, to which one of our friends responded, well, this is exactly what Mises believed. Mises makes this argument explicitly in Human Action, about all unemployment being voluntary, 56 00:06:34.200 --> 00:06:38.200 In an appropriate sense, we understand what's meant by this, to which the critic responded, 57 00:06:38.200 --> 00:06:42.200 well, you guys are all cultists because you just bow down to Ludwig, 58 00:06:42.200 --> 00:06:47.200 you know, which of course had nothing to do with the point that was under consideration, 59 00:06:47.200 --> 00:06:51.200 namely that it isn't true that no serious economist could believe this, 60 00:06:51.200 --> 00:06:54.200 because Mises believed it and he was a serious economist, 61 00:06:54.200 --> 00:06:59.200 which doesn't mean that you're using Mises to prove that the statement is true, 62 00:06:59.200 --> 00:07:03.200 only to demonstrate that some serious economist thought it was true. 63 00:07:03.200 --> 00:07:06.700 and Rothbard has a good explanation of why it is in fact true. 64 00:07:06.700 --> 00:07:11.800 I mean do you want to, I mean I think it's right to point out it sounds kind of harsh in one sense. 65 00:07:11.800 --> 00:07:16.300 I mean in a sort of a common sense knee-jerk fashion we say well you know I 66 00:07:16.300 --> 00:07:20.200 I work in a factory and the factory closed and I lost my job. 67 00:07:20.200 --> 00:07:24.500 I didn't choose that. It's not what I wanted. How can you say that I 68 00:07:24.500 --> 00:07:29.800 am voluntarily choosing to be unemployed? What does Rothbard mean in context 69 00:07:29.800 --> 00:07:34.800 When he says there's no such thing as involuntary unemployment on the free market. 70 00:07:34.800 --> 00:07:35.800 You want me to? 71 00:07:35.800 --> 00:07:36.800 Yeah, or anybody. 72 00:07:36.800 --> 00:07:38.800 David, do you want to? 73 00:07:38.800 --> 00:07:43.800 I was just going to say he means that there's no... 74 00:07:43.800 --> 00:07:48.800 If you lose your job because the plant closes, it's not involuntary, but it's... 75 00:07:48.800 --> 00:07:50.800 Not voluntary, but he's talking more about actual unemployment. 76 00:07:50.800 --> 00:07:53.800 It can't be stopped from... 77 00:07:53.800 --> 00:07:56.800 No, it would be unemployed if somebody stops you from being employed. 78 00:07:56.800 --> 00:07:58.800 Somebody forces you to work. 79 00:07:58.800 --> 00:08:04.800 Okay. Excuse me. No, that's right. That's one way to put it. 80 00:08:04.800 --> 00:08:15.800 You could also add that the concept of unemployment, of course, only makes sense relative to a particular wage payment, a wage rate. 81 00:08:15.800 --> 00:08:26.800 When we talk about a piece of land being unused, well, it's unused given the market price of land. 82 00:08:26.800 --> 00:08:42.800 Right, given this land is not currently being used because the value that the entrepreneur would realize from using this land is less than what the entrepreneur would have to pay to get it, it's, you know, sub-marginal land. 83 00:08:42.800 --> 00:08:52.800 You say the same thing about capital goods, they're not currently being used because their DMVP is less than their, is less than the rental price that's currently being charged. 84 00:08:52.800 --> 00:08:58.000 Okay, so unemployment only makes sense relative to a wage rate, right? 85 00:08:58.000 --> 00:09:03.000 So, I mean, at some price, all of us would be unemployed, okay? 86 00:09:03.000 --> 00:09:10.500 So if I go to Lew Rockwell and I say, well, I'd be glad to give some lectures at Rothbard Graduate Seminar, 87 00:09:10.500 --> 00:09:15.500 you know, my price is $50,000 a day. 88 00:09:15.500 --> 00:09:18.400 It's not likely that I would get the job. 89 00:09:18.400 --> 00:09:20.700 I mean, very few of us, and that's what David Gordon gets, 90 00:09:20.700 --> 00:09:22.700 but the rest of us don't get anything close to that. 91 00:09:24.100 --> 00:09:26.720 You know, would you say that, well, 92 00:09:26.720 --> 00:09:29.420 Rockwell is being unfair somehow? 93 00:09:29.420 --> 00:09:32.620 You know, I'm being coerced into idleness this week 94 00:09:32.620 --> 00:09:35.340 because Rothbard won't pay me my 50 large. 95 00:09:35.340 --> 00:09:37.280 Rockwell won't pay me my 50 large. 96 00:09:38.780 --> 00:09:40.580 I mean, obviously we'd say, well, 97 00:09:40.580 --> 00:09:42.780 if I really want to do this thing, 98 00:09:42.780 --> 00:09:45.860 I can lower my bid just a little bit. 99 00:09:45.860 --> 00:09:48.180 I'll go to it for 40, you know, or whatever. 100 00:09:49.380 --> 00:09:50.220 Yeah? 101 00:09:50.220 --> 00:10:04.220 I have to comment, one will be that, according to this idea, we have also to say probably that labor is not a specific factor of production, isn't it? 102 00:10:04.220 --> 00:10:10.220 Because yesterday you were opening this possibility that labor could be a specific factor. 103 00:10:10.220 --> 00:10:19.220 Yes, now that's right, now he's talking about labor that is at least partly non-specific, that can be allocated to multiple production processes, 104 00:10:19.220 --> 00:10:23.920 Production Processes, which is true to all of us, it's true to some extent of all kinds 105 00:10:23.920 --> 00:10:28.480 of labor, but you're right, some labor is relatively more specific to particular production 106 00:10:28.480 --> 00:10:29.480 processes. 107 00:10:29.480 --> 00:10:30.480 But none of them is specific. 108 00:10:30.480 --> 00:10:35.980 Yeah, but the one is even in that case, right, even if I can do nothing other than lecture 109 00:10:35.980 --> 00:10:37.460 at Rothbard Graduate Seminar. 110 00:10:37.460 --> 00:10:40.660 This will be the second comment. 111 00:10:40.660 --> 00:10:52.660 This is based on the definition of voluntary as liberty, isn't it, as two kinds of way to say what's free. 112 00:10:52.660 --> 00:10:59.660 Sure. That's right. He is not making some sort of ontological claim about the nature of liberty or what... 113 00:10:59.660 --> 00:11:05.660 He's using voluntary and involuntary in a particular praxeological sense, right? 114 00:11:05.660 --> 00:11:35.660 meaning that it isn't the case that someone who is willing on the free market if someone who is willing to offer his labor services at a rate below that which the buyer of labor services is willing to pay then there's an opportunity for that for those labor services to be hired there's not there's not a deeper philosophical meaning to voluntary and involuntary in this sense David do you want to comment on that 115 00:12:05.660 --> 00:12:19.660 I mean, what he has in mind here is, you know, catallactic unemployment, right? So there are other senses in which we could use that term unemployment and give it a different sort of metaphysical context, and that isn't what he means here. 116 00:12:19.660 --> 00:12:45.660 The defenders, the other people that are speaking about the involuntary unemployment, they confuse two ways of saying involuntary as being impede by someone else, which is the proper way to say it, because it's the only way that allows you to make a distinction between two categories of action, 117 00:12:45.660 --> 00:12:59.660 and the physical impossibility to find a job, and this definition is not workable, because it means nothing. I am not free neither to fly, I am not free to... 118 00:12:59.660 --> 00:13:05.660 That's exactly right. The claim is not that there are no constraints imposed on job seekers, right? 119 00:13:05.660 --> 00:13:19.160 Right, but rather that the source of persistent unemployment is wage rates that are for whatever reason fixed above their, you know, their equilibrium, their plain state of rest equilibrium values is the point. 120 00:13:19.160 --> 00:13:30.720 There's some other interesting things about wages. Rothbard talks about what he calls overt versus total wages or wage rates. 121 00:13:30.720 --> 00:13:35.800 Anybody remember what that refers to? 122 00:13:35.800 --> 00:13:37.520 Can you see this? 123 00:13:37.520 --> 00:13:43.560 Markers not very good. 124 00:13:43.560 --> 00:13:47.280 Chad, I want this pen removed. 125 00:13:47.280 --> 00:13:51.000 Does anybody remember what he means by this? 126 00:13:51.000 --> 00:13:55.760 Actually, his discussion of wages is pretty sophisticated. 127 00:13:55.760 --> 00:14:04.760 He brings a lot of issues in modern labor personnel economics that were not at all in the mainstream of the profession at this time. 128 00:14:04.760 --> 00:14:14.760 Here he's talking about the distinction between the actual dollar wage rate, what he calls the overt wage rate, and the total compensation package, 129 00:14:14.760 --> 00:14:26.760 which could include other forms of compensation, benefits, non-monetary compensation, the quality of the work environment and so on. 130 00:14:26.760 --> 00:14:29.760 He also uses the term psychic income. 131 00:14:29.760 --> 00:14:37.760 Did I spell psychic correctly? 132 00:14:37.760 --> 00:14:45.760 Yeah, how'd you know that, you must be psyched. 133 00:14:45.760 --> 00:14:51.760 Right, referring to non-pecuniary benefits from employment. 134 00:14:51.760 --> 00:14:57.760 Right, I mean, most of the professors in the room... 135 00:14:57.760 --> 00:15:01.760 What's he doing? Oh, okay, thank you. 136 00:15:01.760 --> 00:15:05.760 Right, most of the professors in the room believe that 137 00:15:05.760 --> 00:15:14.160 that they could make a much higher salary if they weren't professors, but instead, you know, were CEOs or worked on Wall Street or whatever. 138 00:15:14.160 --> 00:15:17.360 We all believe that we have sacrificed lots of income. 139 00:15:17.360 --> 00:15:20.360 That may not be true, but that's what we believe anyway. 140 00:15:20.360 --> 00:15:26.460 We choose to go into teaching, into the education field because we enjoy it, right? 141 00:15:26.460 --> 00:15:29.760 For the love of the game, we want to make the world better. 142 00:15:29.760 --> 00:15:33.960 We want to educate the next generation and so on. 143 00:15:33.960 --> 00:15:40.260 We put up with these paltry, you know, salaries as a form of sort of voluntary self-sacrifice. 144 00:15:40.260 --> 00:15:43.260 But it doesn't mean that we're underpaid, right? 145 00:15:43.260 --> 00:15:48.660 Because in that sense our compensation, appropriately defined, includes not only cash, 146 00:15:48.660 --> 00:15:53.960 but also the satisfaction and enjoyment of being around wonderful people like you. 147 00:15:53.960 --> 00:15:58.960 Minus having to be around some of the other... 148 00:15:58.960 --> 00:16:06.160 So, I mean, again, that's something that really wasn't in the typical textbook around this time, in the early 1960s. 149 00:16:06.160 --> 00:16:09.860 It's a pretty advanced discussion for its time. 150 00:16:09.860 --> 00:16:17.560 Why don't we talk about a few of these issues in a little bit more detail, and then we'll kind of see where you guys want to go. 151 00:16:17.560 --> 00:16:22.760 I want to talk a little bit about this Rothbard's analysis of costs. 152 00:16:22.760 --> 00:16:30.920 Right, the standard Marshallian analysis differs from Rothbard's analysis in certain critical ways. 153 00:16:30.920 --> 00:16:37.520 Right, one is, the standard analysis describes sort of two planning horizons, 154 00:16:37.520 --> 00:16:41.200 the so-called short run and the long run. 155 00:16:41.200 --> 00:16:44.720 What's meant by the short run, and somebody mentioned this yesterday, I think it was Joe, 156 00:16:44.720 --> 00:16:49.560 what's meant by the short run in the standard analysis, it's not quite, 157 00:16:49.560 --> 00:16:56.840 It's something between Rothbard's plain state of rest or Mises's plain state of rest and the final state of rest. 158 00:16:56.840 --> 00:17:05.120 It means more than simply the period at the conclusion of every voluntary transaction. 159 00:17:05.120 --> 00:17:10.760 It's an equilibrium concept that's kind of a hybrid of the PSR and the FSR. 160 00:17:10.760 --> 00:17:15.360 And you know, there's the standard definition that there's at least one factor of production 161 00:17:15.360 --> 00:17:19.960 that cannot, the use of which cannot be varied for that planning period. 162 00:17:19.960 --> 00:17:24.960 Okay, and then the long run period in which all factors of production are varied, are variable. 163 00:17:24.960 --> 00:17:28.760 Rothbard doesn't like the fixed cost, variable cost distinction. 164 00:17:28.760 --> 00:17:32.060 And he actually, there's some very important literature that's referred to in a footnote. 165 00:17:32.060 --> 00:17:33.660 I didn't write down the page. 166 00:17:33.660 --> 00:17:40.160 There's a long footnote where he refers to a work that was done by some English economists. 167 00:17:40.160 --> 00:17:53.160 There's a volume edited by Buchanan and Thirlby called LSE Essays on Cost, which they may have the footnote in front of them. 168 00:17:53.160 --> 00:17:58.160 Yeah, here it's this one, on page 592. 169 00:17:58.160 --> 00:18:09.160 Yeah, so the footnote at the bottom of page 592 refers to the very important literature from which he derives a lot of his critique of sort of modern cost curve analysis, and that's definitely worth looking at. 170 00:18:09.160 --> 00:18:15.160 One critical point that we referred to yesterday is this assumption, 171 00:18:15.160 --> 00:18:20.160 the role that the assumption of perfect competition plays in the standard analysis, 172 00:18:20.160 --> 00:18:24.160 and the fact that the standard analysis is not causal, right, 173 00:18:24.160 --> 00:18:28.160 but relies on the principle of mutual determination or simultaneous determination. 174 00:18:28.160 --> 00:18:34.160 Right, that it begins with the assumption that firms are price takers in factor markets, 175 00:18:34.160 --> 00:18:38.160 that the markets for factors of production are perfectly competitive. 176 00:18:38.160 --> 00:18:44.000 So any given entrepreneur, any given firm simply looks at the price of capital and the price of labor, 177 00:18:44.000 --> 00:18:49.360 takes those prices as given, decides how much capital to use, how much labor to use, and so on. 178 00:18:49.360 --> 00:18:57.240 Right? And of course, the market for the product produced by the entrepreneur is also assumed, 179 00:18:57.240 --> 00:19:03.320 those prices are also in the standard model, a competitive model, exogenous and fixed. 180 00:19:03.320 --> 00:19:07.280 Right? So all the entrepreneur does really is solve a math problem. 181 00:19:07.280 --> 00:19:15.780 Right? There's no appraisement, there's no forecasting, there's no entrepreneurship in the sense that we described it yesterday. 182 00:19:15.780 --> 00:19:20.780 You have given input prices, given output prices, a production function with different characteristics. 183 00:19:20.780 --> 00:19:25.680 You just have to maximize profits, you know, using calculus. That's pretty much all there is to it. 184 00:19:25.680 --> 00:19:30.880 I said, you know, you get something like this, that here's a production process with two inputs. 185 00:19:30.880 --> 00:19:36.480 I think it's an example I used in class. I think it was aluminum and steel, A and S. 186 00:19:36.480 --> 00:19:43.180 And you have these green lines corresponding to different levels of output 187 00:19:43.180 --> 00:19:47.480 that particular combinations of aluminum and steel can produce, right? 188 00:19:47.480 --> 00:19:52.980 So you can, so there's some, there's some partial substitutability among the inputs here, okay? 189 00:19:52.980 --> 00:19:59.480 So we don't have the, we don't have fixed proportions, we have variable proportions. 190 00:19:59.480 --> 00:20:05.480 So you can use all the different combinations of A and S that lie along that first green line, 191 00:20:05.480 --> 00:20:35.480 give you a hundred units of output, Q, okay, and all the combinations of aluminum and steel on this second green line give you 200 units of steel, right, so that's all given to the entrepreneur, these green lines are given by the technology of production, by the characteristics of the production process, which of course is also assumed to be exogenously given, it sort of drops down from heaven, here's your production technology, and so there are, you know, there's a price of aluminum and there's a price of steel that's given exogenously in the market, 192 00:20:35.480 --> 00:20:41.080 gives you these purple lines, right, the ratio of relative prices between aluminum and steel. 193 00:20:41.080 --> 00:20:45.000 And so if I want to produce a hundred widgets, I want to produce a hundred automobiles, whatever, 194 00:20:45.000 --> 00:20:51.920 a hundred units of output, the least costly way to do that is by using this many units 195 00:20:51.920 --> 00:20:55.560 of aluminum and this many units of steel, okay. 196 00:20:55.560 --> 00:20:59.500 If I want to produce two hundred units of output, the least costly way to do it, given 197 00:20:59.500 --> 00:21:04.720 these prices, is point B, to use this many units of aluminum and this many units of steel, 198 00:21:04.720 --> 00:21:14.920 Right, and so, the manager, the plant manager, the decision maker, sort of computes, well, for every possible Q, 199 00:21:14.920 --> 00:21:19.820 what's the least costly way to produce that much Q, and how much does that cost? 200 00:21:19.820 --> 00:21:25.520 Well, then I plot that on a curve with costs on the vertical axis and output on the horizontal axis. 201 00:21:25.520 --> 00:21:29.820 I do that for every possible Q and I get some kind of a total cost curve, right, 202 00:21:29.820 --> 00:21:33.820 that might have that kind of curvature or might not, depending on the production function. 203 00:21:33.820 --> 00:21:43.320 Okay, so I get my total cost curve by calculating the least costly way to produce any given level of output, given factor prices. 204 00:21:43.320 --> 00:21:52.920 Okay, and we say, oh, well, what happens if prices change, you know, if one of the inputs becomes more expensive, again, for reasons that are not explained. 205 00:21:52.920 --> 00:21:58.620 There's some exogenous change, in this case, in the aluminum market. 206 00:21:58.620 --> 00:22:04.620 Okay, so the price of aluminum goes up, it was P.A., now it's P.A. prime, that's a higher price. 207 00:22:04.620 --> 00:22:10.620 Okay, so now if you want to produce a hundred units of steel, a hundred units of output, 208 00:22:10.620 --> 00:22:15.620 a hundred automobiles or whatever, the least costly way to do it is not point A anymore, 209 00:22:15.620 --> 00:22:23.120 now it's point C, right, because you can produce, you can use less, you can spend less on A and S 210 00:22:23.120 --> 00:22:28.420 if you use the combination represented by point C rather than the old one at point A. 211 00:22:28.420 --> 00:22:33.780 okay so a couple things have happened number one the entrepreneurs costs have 212 00:22:33.780 --> 00:22:38.820 gone up total costs have increased and number two the proportions of aluminum 213 00:22:38.820 --> 00:22:44.700 and steel that are cost minimizing have changed right so you're from a 214 00:22:44.700 --> 00:22:49.140 substitute using more steel and less aluminum than it was before but also its 215 00:22:49.140 --> 00:22:52.820 total cost of producing a hundred units and every level of output has gone up so 216 00:22:52.820 --> 00:22:57.900 the total cost per ships ships up okay what does Rothbard say about this well 217 00:22:57.900 --> 00:23:06.900 First of all, he says, you know, these, the Marshalian short run is not interesting. 218 00:23:06.900 --> 00:23:12.900 Okay, it's not the relevant, that's not a relevant planning period for the entrepreneur. 219 00:23:12.900 --> 00:23:13.900 A couple of reasons, right? 220 00:23:13.900 --> 00:23:16.900 Well, the entrepreneur, the prices that the entrepreneur cares about, 221 00:23:16.900 --> 00:23:21.900 and Joe made this point in one of his talks yesterday, I think, or the day before, 222 00:23:21.900 --> 00:23:26.900 is the prices the entrepreneurs care about are the prices they actually pay for things. 223 00:23:26.900 --> 00:23:31.900 Right? When I go out into the aluminum market and the steel market, what do I actually pay? 224 00:23:31.900 --> 00:23:34.900 And what do I think I can actually sell my automobiles for? 225 00:23:34.900 --> 00:23:37.900 The actual real prices that are paid in everyday markets. 226 00:23:37.900 --> 00:23:40.900 They're not equilibrium prices in the Marshallian sense. 227 00:23:40.900 --> 00:23:46.900 They're simply real everyday market clearing prices or plain state of rest PSR prices. 228 00:23:46.900 --> 00:23:49.900 Okay? So that's what the entrepreneur looks at. 229 00:23:49.900 --> 00:23:55.900 And the economist in trying to either to calculate, you know, to reason through 230 00:23:55.900 --> 00:24:04.340 Tracing through, what would be the long-term effects of an increase in the amount of aluminum 231 00:24:04.340 --> 00:24:10.600 that is discovered that's available, an increase in stocks of steel, what impact would that 232 00:24:10.600 --> 00:24:15.380 have on the production process and on prices if we hold everything else constant, right? 233 00:24:15.380 --> 00:24:20.180 That's a mental exercise, so I think if we trace this process through in analytical time, 234 00:24:20.180 --> 00:24:23.380 on the vertical axis of Joe's diagram, 235 00:24:23.380 --> 00:24:25.380 what effect would that have on prices 236 00:24:25.380 --> 00:24:27.460 and allocation of resources and so on? 237 00:24:27.460 --> 00:24:29.300 That doesn't happen in the real world, 238 00:24:29.300 --> 00:24:30.620 but it's useful to the economist 239 00:24:30.620 --> 00:24:33.100 in thinking these things through, right? 240 00:24:33.100 --> 00:24:36.140 And then there's these ERE prices, 241 00:24:36.140 --> 00:24:37.660 which again is a mental construct 242 00:24:37.660 --> 00:24:41.860 that's used by the economist to try to understand what's, 243 00:24:41.860 --> 00:24:44.220 to try to distinguish between interest and profit, 244 00:24:44.220 --> 00:24:46.220 for example, as we discussed yesterday. 245 00:24:47.140 --> 00:24:48.940 I think to keep in mind is that costs 246 00:24:48.940 --> 00:24:56.940 in Rothbardian Analysis, like costs are simply factor prices, or if we mean costs as total 247 00:24:56.940 --> 00:25:01.300 dollar amounts, right, the price of a factor times the number of units of the factor that 248 00:25:01.300 --> 00:25:07.180 I use, right, so the determinant cost is not sort of exogenously given in some kind of 249 00:25:07.180 --> 00:25:12.220 perfectly competitive input market, but rather I as an entrepreneur, I participate in the 250 00:25:12.220 --> 00:25:17.900 determination of my costs, right, in my decisions to go out and purchase or to abstain from 251 00:25:17.900 --> 00:25:21.040 from Purchasing Factors of Production. 252 00:25:21.040 --> 00:25:26.500 Factor prices are set in factor markets through a rivalrous process of competitive bidding 253 00:25:26.500 --> 00:25:30.420 among potential factor users and factor owners. 254 00:25:30.420 --> 00:25:36.300 There's no role for so-called perfect competition in Rothbard's analysis. 255 00:25:36.300 --> 00:25:41.400 We'll see when we look at shapes of cost curves, we'll look at the concept of average cost, 256 00:25:41.400 --> 00:25:44.680 how that comes into the picture. 257 00:25:44.680 --> 00:25:53.680 So he concludes that the sort of standard cost curve analysis, you know, at best it doesn't do any harm, okay? 258 00:25:53.680 --> 00:26:01.680 It's just a different way of looking at the same phenomena that can be described perhaps more precisely using verbal, primarily verbal reasoning. 259 00:26:01.680 --> 00:26:04.680 But at worst it leads to all kinds of misconceptions. 260 00:26:04.680 --> 00:26:09.680 It underlies the whole model of perfect competition, leads us into other kinds of error. 261 00:26:09.680 --> 00:26:23.180 You know, there is some, there's some technical matter in this chapter, you know, about returns to scale, divisible versus indivisible factor. 262 00:26:23.180 --> 00:26:32.180 Some of my, how shall I put this delicately, some of my more philosophically inclined friends, their eyes glaze over at a lot of the parts of this chapter. 263 00:26:32.180 --> 00:26:36.980 Returns to Scale and, you know, increasing average costs and the, you know, 264 00:26:36.980 --> 00:26:45.380 get me epistemology or methodology or radical libertarian political economy or whatever. 265 00:26:45.380 --> 00:26:48.980 Okay, there is some of that in here, but there's a lot of this kind of stuff too. 266 00:26:48.980 --> 00:26:52.180 But just, if you're in that category, suck it up. 267 00:26:52.180 --> 00:27:01.980 He does talk a little bit about, you know, kind of the technical or technological aspects of production. 268 00:27:01.980 --> 00:27:06.980 Ways in which factors of production, if they have different characteristics, can be combined. 269 00:27:06.980 --> 00:27:09.980 Walter, you all right there? 270 00:27:09.980 --> 00:27:13.980 Yeah, there's no water in here. 271 00:27:13.980 --> 00:27:18.980 I thought you were getting ready to come up to the board and correct me on something. 272 00:27:18.980 --> 00:27:23.980 He points out that, for example, if all factors of production are perfectly divisible, 273 00:27:23.980 --> 00:27:26.980 then you have constant returns to scale. 274 00:27:26.980 --> 00:27:32.480 The beginning of business is kind of a logical derivation, right? 275 00:27:32.480 --> 00:27:37.980 That if particular means can be combined to achieve one particular end, 276 00:27:37.980 --> 00:27:42.980 then twice as many of the same means can produce twice as many of the same ends. 277 00:27:42.980 --> 00:27:48.980 You can simply reproduce, here's one process, we just set up another process right next to it. 278 00:27:48.980 --> 00:27:54.480 There should be no difference in terms of the productivity of those two processes, 279 00:27:54.480 --> 00:28:09.480 But that's only the case if both the factors that you use and the product that's being produced are perfectly divisible into infinitesimally small units. 280 00:28:09.480 --> 00:28:18.480 When you have indivisibilities either of factors and or of the output, then you don't necessarily get constant returns to scale. 281 00:28:18.480 --> 00:28:21.980 Right? Other things can happen depending on the circumstances. 282 00:28:21.980 --> 00:28:25.480 He has an interesting discussion of the refrigerators. 283 00:28:25.480 --> 00:28:29.480 So, you know, make a note by that. 284 00:28:29.480 --> 00:28:32.980 Go back and look at that example, if you don't remember it. 285 00:28:32.980 --> 00:28:41.980 He says, you know, for example, that you're, you know, it takes a certain amount of capital and labor, let's say, 286 00:28:41.980 --> 00:28:45.480 a certain combination of factors to produce one refrigerator. 287 00:28:45.480 --> 00:28:56.480 Well, if you add just a little bit more of each factor of production, you get, you know, 1.2 refrigerators, but nobody wants to buy 0.2 of a refrigerator, okay? 288 00:28:56.480 --> 00:29:11.480 So as you, you know, when you start out producing refrigerators, right, you're spending money on factors, but you don't have any output that you can sell until you get a refrigerator, right? 289 00:29:11.480 --> 00:29:19.480 Right, so your average cost, your per unit cost as you begin to use factors before you get to a full refrigerator is going up. 290 00:29:19.480 --> 00:29:26.480 Okay, because you're having, you know, you're increasing your use of factors, you're spending more money on factors. 291 00:29:26.480 --> 00:29:31.480 You're using more factors but you're not getting any more saleable output. 292 00:29:31.480 --> 00:29:36.480 Right, until you hit that first refrigerator and now I have something I can sell so my average cost goes down. 293 00:29:36.480 --> 00:29:43.480 And then I start working on the second refrigerator and my average cost rises until I get the second refrigerator made and so on. 294 00:29:43.480 --> 00:29:48.480 So you have this kind of bumpy, discontinuous sort of average cost curve. 295 00:29:48.480 --> 00:29:56.480 Again, talking only here about quantities of factors used, we'll get in just a second to the prices that you pay for those factors. 296 00:29:56.480 --> 00:30:04.480 It says, well, suppose that not only the output but the factors of production themselves are indivisible, right? 297 00:30:04.480 --> 00:30:10.080 Right, so I can hire, you know, one hour of Walter Block's time, but let's say I can't hire a minute of his, 298 00:30:10.080 --> 00:30:12.680 I can't rent him for a minute, for whatever reason. 299 00:30:12.680 --> 00:30:16.880 He's unwilling to supply his services for less than a full hour, okay? 300 00:30:16.880 --> 00:30:23.080 Or I can rent the services of an automobile for a certain period of time, but not for less than that, whatever, right? 301 00:30:23.080 --> 00:30:30.680 Well, then the shape of the cost curve depends, it depends on how those indivisible factors are utilized, okay? 302 00:30:30.680 --> 00:30:39.280 So, you know, the point is, if I only want Walter Block for a minute, but I'm stuck with him for an hour, right, 303 00:30:39.280 --> 00:30:43.980 then for 59 minutes his services are underutilized, okay? 304 00:30:43.980 --> 00:30:49.480 I only need him for one, I want him to make one little point and then sit down and not say anything else, okay? 305 00:30:49.480 --> 00:30:51.580 But I can't do that. 306 00:30:51.580 --> 00:30:58.280 So the point is, if I have to pay him for a whole hour, then for 59 minutes his services are being wasted. 307 00:30:58.280 --> 00:30:59.880 He's sitting here but not being used. 308 00:30:59.880 --> 00:31:06.580 So he's underutilized, hypothetically, for that 59 minutes, okay? 309 00:31:06.580 --> 00:31:11.880 So, you know, as I'm able to use more and more of his services, okay, 310 00:31:11.880 --> 00:31:17.880 as these physical, as indivisible factors become less underutilized, 311 00:31:17.880 --> 00:31:20.880 then I get increasing returns to scale, okay, 312 00:31:20.880 --> 00:31:25.080 meaning more output per unit of input, okay? 313 00:31:25.080 --> 00:31:30.360 And likewise, as he becomes more overutilized, I get decreasing returns to scale. 314 00:31:30.360 --> 00:31:35.160 You know, the net effect cannot be determined ex ante, praxeologically. 315 00:31:35.160 --> 00:31:39.720 Right, it depends on the particular characteristics of these resources. 316 00:31:39.720 --> 00:31:42.680 It depends on how Walter is being combined with the other factors, 317 00:31:42.680 --> 00:31:48.520 and how useful he is during these periods when he's remaining idle and so on. 318 00:31:48.520 --> 00:31:49.640 Did you ever hand up? 319 00:31:49.640 --> 00:31:55.840 I guess, only a technical and small remark on the average cost per unit, 320 00:31:55.840 --> 00:31:59.640 that it should be infinite until we are first in it. 321 00:31:59.640 --> 00:32:02.040 Yeah, sure, okay. 322 00:32:02.040 --> 00:32:02.840 Yeah, that's right. 323 00:32:02.840 --> 00:32:05.040 If you're producing zero and you're hiring, 324 00:32:05.040 --> 00:32:08.740 if I'm hiring no factors at all, then it should be zero, okay? 325 00:32:08.740 --> 00:32:13.640 If I have to hire, right, at the first moment when I hire him, 326 00:32:13.640 --> 00:32:19.540 if my output is zero, then I, right, then I can't really have a, 327 00:32:19.540 --> 00:32:23.540 As I say, it's undefined, right? Cost per unit is undefined at zero. 328 00:32:23.540 --> 00:32:27.340 You're right. Really, all I'm trying to illustrate is the bumpiness and gappiness, 329 00:32:27.340 --> 00:32:31.340 not the origin of the curve. Don't say that again. 330 00:32:31.340 --> 00:32:34.740 You're right, but don't say that. 331 00:32:34.740 --> 00:32:37.140 But see, there's something else going on too here. 332 00:32:37.140 --> 00:32:42.740 It's not only that the quantities of factors increase as I expand output, 333 00:32:42.740 --> 00:32:45.140 but Rothbard is quite explicit about this. 334 00:32:45.140 --> 00:32:47.740 We're not in the world of perfect competition. 335 00:32:47.740 --> 00:32:55.740 Okay, so as one particular entrepreneur expands output, he must bid factors of production away from other entrepreneurs who are also seeking them. 336 00:32:55.740 --> 00:33:00.740 Okay, so we're in a world of scarce factors of production, they're economic goods. 337 00:33:00.740 --> 00:33:08.740 Okay, so factor prices begin to rise as firms expand output, they try to bid factors of production away from other users. 338 00:33:08.740 --> 00:33:12.740 Right, so in addition to these physical aspects of production, 339 00:33:12.740 --> 00:33:21.220 And we also have to take into account that factor prices will be rising, okay? 340 00:33:21.220 --> 00:33:24.860 So this, you know, I've got my sort of bumpy curve, if you forget about the origin for 341 00:33:24.860 --> 00:33:30.180 a minute, my bumpy curve, you know, it doesn't have, it's sort of detrended, right? 342 00:33:30.180 --> 00:33:36.860 But if we add the increase in factor prices, we want it bumpy and upward sloping, okay? 343 00:33:36.860 --> 00:33:41.360 Because not only do we have this indivisibility issue going on, but also factor prices are 344 00:33:41.360 --> 00:33:42.360 going up. 345 00:33:42.360 --> 00:33:50.880 And he says, if you combine the technological features with the factor pricing features, 346 00:33:50.880 --> 00:33:59.660 we could say that average cost tends to rise as firms expand output due to the increase 347 00:33:59.660 --> 00:34:01.560 in factor prices. 348 00:34:01.560 --> 00:34:06.440 But this may be offset from the gains from more efficient utilization of fixed factors 349 00:34:06.440 --> 00:34:07.440 of production. 350 00:34:07.440 --> 00:34:21.440 Okay, so as I expand my output of lectures, I have to pay more to bid away the water and the electricity and the books and the other factors of production that I need, which makes my average cost rise. 351 00:34:21.440 --> 00:34:27.440 On the other hand, I may be able to make more efficient use of Walter Block, which pulls my average cost back down. 352 00:34:27.440 --> 00:34:35.440 You know, exactly how these things balance out, again, cannot be determined ex ante, but depends on the particulars of this process. 353 00:34:35.440 --> 00:35:05.440 Oh, he also makes this point about, well, sorry, along the same lines, you know, what, so the bottom line, what's the optimal scale of production, or if there's not something, this is something that the entrepreneur is trying to figure out, right, so the entrepreneur tries different combinations of inputs and different output levels and, you know, experiments and realizes profits and losses and makes adjustments and so on. So this is a real, the idea is that these 354 00:35:05.440 --> 00:35:11.440 Decisions about how to use factors are made, you know, in real time by real flesh and blood entrepreneurs 355 00:35:11.440 --> 00:35:15.440 as they experiment with different combinations of inputs and outputs, okay? 356 00:35:15.440 --> 00:35:18.440 It's not merely a blackboard exercise. 357 00:35:18.440 --> 00:35:25.440 Okay, one other thing I want to talk about, just before we sort of open it up a little bit more widely 358 00:35:25.440 --> 00:35:27.440 because I think it's extremely important. 359 00:35:27.440 --> 00:35:33.440 It's one of my favorite sections of the book is this part on business income, okay? 360 00:35:33.440 --> 00:35:38.000 and it gets into a little bit of accounting and management and I do most of my own research 361 00:35:38.000 --> 00:35:39.580 in sort of business administration. 362 00:35:39.580 --> 00:35:45.760 So this is actually quite a lot of insight and novelty in this section, in particular 363 00:35:45.760 --> 00:35:53.000 the treatment of vertical integration and firm size is innovative and I think even today 364 00:35:53.000 --> 00:35:59.000 has not really been incorporated into not only the mainstream but even into some Austrian 365 00:35:59.000 --> 00:36:04.200 analyses of questions of the firm. 366 00:36:04.200 --> 00:36:13.040 Okay, remember that we talked yesterday about these ERE returns in the evenly rotating economy 367 00:36:13.040 --> 00:36:16.120 to different factors of production, right? 368 00:36:16.120 --> 00:36:24.320 And we said that in the ERE there's no profit and loss because there's no uncertainty about 369 00:36:24.320 --> 00:36:26.180 the future, right? 370 00:36:26.180 --> 00:36:33.560 So all factor prices are bid up to equal their DMRPs or DMVPs, so there's nothing left over 371 00:36:33.560 --> 00:36:37.400 for the entrepreneur, there's no residual for the entrepreneur. 372 00:36:37.400 --> 00:36:50.900 So in the ERE, land and labor earn rents, they get a per unit price for the use of their 373 00:36:50.900 --> 00:36:51.900 services. 374 00:36:51.900 --> 00:36:56.800 Again, remember, this is the Rothbard-Feder kind of rent, just the payment per unit of time. 375 00:36:56.800 --> 00:37:02.300 It's not the Ricardian or Marshallian or the rent-seeking notion of rent that Walter mentioned yesterday. 376 00:37:02.300 --> 00:37:08.600 It's not something bad. It's not a monopoly gain. It's not something over and above, sort of the factor of payment. 377 00:37:08.600 --> 00:37:10.400 It simply is the factor of payment. 378 00:37:10.400 --> 00:37:13.700 So factors of production, land and labor get paid rents. 379 00:37:13.700 --> 00:37:17.700 Capital does not get a rent. Capital goods don't earn a rent, remember, 380 00:37:17.700 --> 00:37:23.100 because the value of the capital goods is imputed back to the original factors, 381 00:37:23.100 --> 00:37:26.100 the land and labor that were used to produce those capital goods. 382 00:37:26.100 --> 00:37:30.000 So capital gains are an interest. 383 00:37:30.000 --> 00:37:32.100 What about, you know, what about business owners? 384 00:37:32.100 --> 00:37:34.700 What about capitalist entrepreneurs? 385 00:37:34.700 --> 00:37:38.500 Well, they earn dollar amounts of income, 386 00:37:38.500 --> 00:37:44.100 but these dollar amounts can be decomposed into different elements. 387 00:37:44.100 --> 00:37:52.100 Now remember that outside of the ERE, entrepreneurs earn entrepreneurial profit and loss. 388 00:37:52.100 --> 00:38:04.100 So if the real prices, the PSR prices of the factors of production are less than the discounted value of the output when it's sold, 389 00:38:04.100 --> 00:38:07.100 that remainder, that residual is money in the entrepreneur's pocket. 390 00:38:07.100 --> 00:38:11.100 That's Mises' definition of entrepreneurial profit. 391 00:38:11.100 --> 00:38:25.100 If the entrepreneur ends up paying more for the factors of production than the prices that are realized for the output in the future, taking discounting into account, the entrepreneur suffered a loss, an entrepreneurial loss. 392 00:38:25.100 --> 00:38:34.100 So outside the ERE, entrepreneurs get profits and losses. What do business owners get in the ERE? Well, it kind of depends how they're used. 393 00:38:34.100 --> 00:38:49.100 Right and Rothbard points out that there are two sources of income for the business owner, even in the ERE, independent of profit and loss, even if there are no profits and losses. 394 00:38:49.100 --> 00:38:59.100 Well, one is if the business owner is actually employed in the business, sort of running things on a day-to-day basis, think of an owner-operated mom-and-pop store. 395 00:38:59.100 --> 00:39:06.100 Well, part of the compensation going to the owner is what we might call an implicit wage, right? 396 00:39:06.100 --> 00:39:13.100 So think of it in an opportunity cost sense, that I need someone to manage the firm and if I manage it myself, 397 00:39:13.100 --> 00:39:21.100 then the money I save from not having to hire somebody else to manage it, right, that's money in my pocket. 398 00:39:21.100 --> 00:39:25.100 So the money I would have paid to somebody else but paid to myself, that's like a wage. 399 00:39:25.100 --> 00:39:27.580 So that's a rent in the federal sense. 400 00:39:27.580 --> 00:39:32.860 So the entrepreneur, the business owner who runs the firm is getting paid, at least implicitly, 401 00:39:32.860 --> 00:39:36.820 I'm paying myself some rent for being the manager. 402 00:39:36.820 --> 00:39:44.540 Rothbard also has the, he introduces this sort of interesting concept of, you know, ownership 403 00:39:44.540 --> 00:39:53.540 and he says the owner does exercise a kind of a function that's different from simply 404 00:39:53.540 --> 00:39:55.540 and really providing labor services. 405 00:39:55.540 --> 00:39:57.540 That's also what he calls the ownership function 406 00:39:57.540 --> 00:40:00.540 or the decision-making function. 407 00:40:00.540 --> 00:40:03.540 We'll talk about that a little bit later, 408 00:40:03.540 --> 00:40:07.540 but there's this idea that by virtue of owning assets, 409 00:40:07.540 --> 00:40:11.540 alienable assets, there's a certain kind of decision authority 410 00:40:11.540 --> 00:40:13.540 that is tied up with ownership 411 00:40:13.540 --> 00:40:16.540 and can't be delegated to hired hands. 412 00:40:16.540 --> 00:40:19.540 And exercising that decision authority, 413 00:40:19.540 --> 00:40:21.540 providing that decision authority 414 00:40:21.540 --> 00:40:25.740 is like providing a service and it earns some rent as well. 415 00:40:25.740 --> 00:40:29.540 It earns an implicit rent or an implicit wage payment as well. 416 00:40:29.540 --> 00:40:34.140 That turns out to be important when we get to this issue about vertical integration. 417 00:40:34.140 --> 00:40:40.140 Rothbard also points out just almost sort of in passing 418 00:40:40.140 --> 00:40:44.140 a point that I think is vastly underappreciated in the literature 419 00:40:44.140 --> 00:40:55.140 that the standard Marshallian intermediate micro cost curve analysis leaves out a lot of the really important issues 420 00:40:55.140 --> 00:41:04.140 in governance and management and entrepreneurship because it's told strictly from the perspective of the manager, of the plant manager, 421 00:41:04.140 --> 00:41:09.140 not from the perspective of the entrepreneur or the business owner. 422 00:41:09.140 --> 00:41:14.740 And again, think of your intermediate micro-theory course, your advanced micro-theory course, 423 00:41:14.740 --> 00:41:20.500 where the professor gives you a problem to solve and says, okay, here are the cost curves, 424 00:41:20.500 --> 00:41:24.940 here's the demand curve, find the profit-maximizing level of output. 425 00:41:24.940 --> 00:41:32.420 Okay, well, MR equals MC, or I take derivatives or I do something and I solve it. 426 00:41:32.420 --> 00:41:36.020 What real-world problem is that equivalent to? 427 00:41:36.020 --> 00:41:45.020 Well, you know, it's like a movie. You wake up one morning and there you are, the manager of the local Wal-Mart down there in Opelika. 428 00:41:45.020 --> 00:41:52.020 And, you know, the Wal-Mart's just there. The store is there, the customers are there, all the products are on the shelves. 429 00:41:52.020 --> 00:41:58.020 All you've got to figure out is how much stuff to sell, or maybe if you have downward sloping demand curve, 430 00:41:58.020 --> 00:42:03.020 what sticker prices to put on the things, so marginal revenue equals marginal cost. 431 00:42:03.020 --> 00:42:07.020 You know, how did the store get there? 432 00:42:07.020 --> 00:42:10.020 How did the merchandise get on the shelves? 433 00:42:10.020 --> 00:42:14.020 How did this operation even come to be in existence in the first place? 434 00:42:14.020 --> 00:42:17.520 That's totally outside the scope of the problem, right? 435 00:42:17.520 --> 00:42:20.520 So the problem that you solve in so-called profit maximization, 436 00:42:20.520 --> 00:42:24.020 you know, the theory of the firm in standard micro-text, 437 00:42:24.020 --> 00:42:28.520 is really just a managerial problem of equating marginal revenue and marginal cost. 438 00:42:28.520 --> 00:42:32.520 It doesn't have anything to do with the decision about 439 00:42:32.520 --> 00:42:41.220 Establishing the enterprise and the important decision of how much capital to invest in this particular line of business, right? 440 00:42:41.220 --> 00:42:48.020 The investment decision is completely exogenous from the point of view of the plant manager. 441 00:42:48.020 --> 00:42:57.520 You know, Mises has the famous line in Human Action where he's talking about he's responding to the market socialist response. 442 00:42:57.520 --> 00:43:03.420 He's giving a rejoinder to the market socialist response to Mises' original critique, right, 443 00:43:03.420 --> 00:43:10.420 where he said socialism cannot lead to an efficient allocation of resources because there are no factor prices, 444 00:43:10.420 --> 00:43:19.220 there's no way to rationally calculate profits and losses to allocate resources efficiently and so on. 445 00:43:19.220 --> 00:43:24.920 The market socialist said, oh, well, you know, the government can own all the factories 446 00:43:24.920 --> 00:43:28.320 and we put a manager in charge of each factory 447 00:43:28.320 --> 00:43:32.620 and we tell that manager to equate marginal revenue and marginal cost, 448 00:43:32.620 --> 00:43:35.020 you know, choose output so MR is equal to MC. 449 00:43:35.020 --> 00:43:39.120 Isn't that exactly what managers of firms in capitalism do? 450 00:43:39.120 --> 00:43:42.020 What difference does it make that the government owns things? 451 00:43:42.020 --> 00:43:45.420 Right, and Mises, you know, great response is to point out that 452 00:43:45.420 --> 00:43:48.720 that's not the real problem, okay? 453 00:43:48.720 --> 00:43:54.320 The genius of capitalism is not that it allows managers to, you know, 454 00:43:54.320 --> 00:43:57.360 Maximize Profits by setting it MR equals MC, right? 455 00:43:57.360 --> 00:44:05.840 What capitalism does is allocate resources to different activities in the economy. 456 00:44:05.840 --> 00:44:09.360 How much capital should be allocated to each plant? 457 00:44:09.360 --> 00:44:13.360 How much capital should be allocated to each branch of industry and so on? 458 00:44:13.360 --> 00:44:17.920 These are problems that market socialism doesn't address at all, okay? 459 00:44:17.920 --> 00:44:21.360 And Mises has this line about playing market, right? 460 00:44:21.360 --> 00:44:29.360 You can have socialist managers and give them a little socialist factory to run and let them pretend it's like a game, let them play market. 461 00:44:29.360 --> 00:44:38.360 So you can simulate that, but under socialism, even under market socialism, you don't have entrepreneurs who are playing speculation and investment. 462 00:44:38.360 --> 00:44:43.360 That is impossible when the means of production are owned by the state or owned in common. 463 00:44:43.360 --> 00:44:52.860 And this is a reference here that, right, that the real, the critical problem is not this sort of managerial problem, 464 00:44:52.860 --> 00:44:56.360 but the entrepreneurial problem, the investor's problem, okay? 465 00:45:00.360 --> 00:45:06.360 I don't, I guess the reason this point about implicit incomes is so important is because, right, 466 00:45:06.360 --> 00:45:15.000 He points out that for the entrepreneur to calculate the profitability of a venture, 467 00:45:15.000 --> 00:45:24.000 he needs to have cardinal numbers, he needs to have costs and receipts expressed in monetary 468 00:45:24.000 --> 00:45:28.720 units because otherwise you have heterogeneous capital goods and heterogeneous outputs and 469 00:45:28.720 --> 00:45:31.760 you need some way to aggregate them and you do that by putting everything in money in 470 00:45:31.760 --> 00:45:33.960 monetary terms. 471 00:45:33.960 --> 00:45:42.460 So, the entrepreneur needs to have some understanding of the opportunity costs of the factors that he employs, right? 472 00:45:42.460 --> 00:45:50.960 So, you know, for example, if the entrepreneur has a certain amount of capital invested in some line of production that's earning, you know, a 3% return on investment, 473 00:45:50.960 --> 00:45:57.960 whereas there are other investment opportunities in the market, you know, I could take that money out and invest it in the stock market, 474 00:45:57.960 --> 00:46:02.160 or I could put it in a bank vault and earn a 5% return, 475 00:46:02.160 --> 00:46:09.760 but I'm not going to be very satisfied with the 3% return on the investment I get from producing automobiles or widgets or whatever. 476 00:46:09.760 --> 00:46:18.160 Okay, so the entrepreneur needs to take these implicit costs, opportunity costs into account, right? 477 00:46:18.160 --> 00:46:25.160 So he needs to know how much interest am I forgoing on my invested capital? 478 00:46:25.160 --> 00:46:28.560 If I own land, right, how much could I rent this land? 479 00:46:28.560 --> 00:46:32.960 What can I get for renting this land out of the market? 480 00:46:32.960 --> 00:46:38.760 And the fact that I'm using the land myself, right, I'm forgoing that implicit rent. 481 00:46:38.760 --> 00:46:43.160 And the same thing with my own labor, right, I need to have a sense of what I could earn on the market 482 00:46:43.160 --> 00:46:46.960 to know what's my opportunity cost of running the business myself. 483 00:46:46.960 --> 00:46:58.960 Rothbard's point is, you need external markets for these factors to be able to calculate their implicit values, to be able to compute these implicit incomes. 484 00:46:58.960 --> 00:47:02.960 So there has to be a market for my capital, an alternative investment vehicle. 485 00:47:02.960 --> 00:47:10.960 There needs to be a market for land and a market for my labor services to be able to put a number to what my labor is really worth. 486 00:47:10.960 --> 00:47:21.460 Okay, if you don't have those market, if there are no markets for those factors, I don't have a very clean way of computing my implicit wage. 487 00:47:21.460 --> 00:47:35.960 To use your labor specificity example, right? If I run my own, you know, business giving economics lectures, but no one else would hire me to do anything, even to be a ditch digger, right? 488 00:47:35.960 --> 00:47:39.960 Then it's very hard for me to come up with a number for my opportunity wage. 489 00:47:39.960 --> 00:47:42.960 I mean, I make an educated guess. I make something up. 490 00:47:42.960 --> 00:47:49.960 But my decisions made on the basis of those educated guesses will be less accurate, right? 491 00:47:49.960 --> 00:47:57.960 Less informative, less correct than decisions I make if I actually have a market wage that I can use as a benchmark. 492 00:47:57.960 --> 00:47:59.960 So you need external markets. 493 00:47:59.960 --> 00:48:04.960 That's where Rothbard gets his vertical integration story, his vertical integration argument. 494 00:48:04.960 --> 00:48:13.960 He says that, well, you know, he's trying to address the problem that was an issue commonly raised at the time. 495 00:48:13.960 --> 00:48:24.960 Well, what if firms either just sort of start to grow internally or they merge, a bunch of firms get together and merge into one, 496 00:48:24.960 --> 00:48:31.960 into bigger firms, you get bigger and bigger firms until the whole world is just run by one huge corporation. 497 00:48:31.960 --> 00:48:41.960 Like, you get these science fiction movies, you know, dystopian movies where, you know, the corporation runs the whole world, Google, let's call it, okay. 498 00:48:41.960 --> 00:48:47.960 I used to say Microsoft when I gave this lecture before, but they're an old hat, obviously. 499 00:48:47.960 --> 00:48:50.960 So, Rothbard says, is this something that we should worry about? 500 00:48:50.960 --> 00:48:54.960 And then he tries to establish here, and then also, this is in the monopoly chapter, right? 501 00:48:54.960 --> 00:49:07.960 The fact that on the free market there could never emerge one huge firm that controls everything, right, or all the corporations couldn't get together and form one big cartel that controls everything. 502 00:49:07.960 --> 00:49:19.960 Why? Well, he points out that as firms expand, right, there are some costs of expansion that have to do with indivisibilities in this decision-making factor. 503 00:49:19.960 --> 00:49:27.240 The decision-making factor cannot be applied over an infinite range of activities. 504 00:49:27.240 --> 00:49:30.360 There's finite capabilities to the human mind. 505 00:49:30.360 --> 00:49:33.760 So some limits begin to creep in at that point. 506 00:49:33.760 --> 00:49:37.440 But there's sort of an ultimate limit to firm size, and it has to do with this need for 507 00:49:37.440 --> 00:49:39.720 external market prices. 508 00:49:39.720 --> 00:49:46.920 So he describes a vertically integrated production process in which the firm sells intermediate 509 00:49:46.920 --> 00:49:48.920 products to itself. 510 00:49:48.920 --> 00:49:57.800 He says, well, if the firm becomes so large that there are no external markets for these 511 00:49:57.800 --> 00:50:03.460 intermediate products, then the firm doesn't have any way of computing what's the appropriate 512 00:50:03.460 --> 00:50:09.420 transfer price or accounting charge to use when Division A sells to Division B. So the 513 00:50:09.420 --> 00:50:16.320 entrepreneur can't keep accurate records of the profitability of the individual units 514 00:50:16.320 --> 00:50:18.320 of the Vertically Integrated Production Process. 515 00:50:18.320 --> 00:50:20.320 This leads to inefficient production. 516 00:50:20.320 --> 00:50:26.320 He uses this concept of calculational chaos. 517 00:50:26.320 --> 00:50:28.320 I think it's a great metaphor. 518 00:50:28.320 --> 00:50:32.320 As external markets disappear, meaning the firm becomes so large, 519 00:50:32.320 --> 00:50:37.320 Google gets so large that it employs all the computer programmers in the world, 520 00:50:37.320 --> 00:50:41.320 and it owns all the computer hardware in the world, and so on. 521 00:50:41.320 --> 00:50:44.320 As external markets begin to disappear, 522 00:50:44.320 --> 00:50:51.600 disappear, islands of non-calculable chaos swell to the proportions of masses and continents. 523 00:50:51.600 --> 00:50:56.880 As the area of incalculability increases, the degrees of irrationality, misallocation, 524 00:50:56.880 --> 00:51:00.600 loss, impoverishment, etc. become greater. 525 00:51:00.600 --> 00:51:06.960 So the firm can never become so large that it is the exclusive buyer and seller of particular 526 00:51:06.960 --> 00:51:13.080 intermediate products because it has no way to calculate whether its activities are generating 527 00:51:13.080 --> 00:51:19.720 Profits are generating losses and it will suffer in market competition against its smaller, 528 00:51:19.720 --> 00:51:27.200 more nimble and more efficient competitors who don't face this problem. 529 00:51:27.200 --> 00:51:34.480 This relates to this question if you look at the historical record of socialism, right? 530 00:51:34.480 --> 00:51:40.780 Many critics of the Austrians, critics of Mises will say, look, Mises writes this article 531 00:51:40.780 --> 00:51:47.780 in 1920 and says socialist economic, rational economic planning under socialism is impossible. 532 00:51:47.780 --> 00:51:52.780 He doesn't just say hard, difficult, it can't be done. 533 00:51:52.780 --> 00:51:55.780 Okay, well, the Soviet Union didn't turn out so well. 534 00:51:55.780 --> 00:51:58.780 But, you know, it didn't disappear immediately. 535 00:51:58.780 --> 00:52:06.780 I mean, from 1920 to, you know, 1991, sorry, 1917, 1921, that's not bad. 536 00:52:06.780 --> 00:52:11.280 It wasn't prosperous, but it kind of eeked out a living for quite a few decades. 537 00:52:11.280 --> 00:52:13.780 Doesn't that prove that Mises was wrong? 538 00:52:13.780 --> 00:52:18.780 That socialism is possible, maybe it's just not as good as capitalism, but it certainly is possible. 539 00:52:18.780 --> 00:52:23.780 One thing to keep in mind is that, and this is the point that Rothbard makes, 540 00:52:23.780 --> 00:52:33.780 that ironically, the fact that they were never successful in achieving their goal of total worldwide socialism 541 00:52:33.780 --> 00:52:38.780 made it feasible for existing socialist economies to survive as long as they did. 542 00:52:38.780 --> 00:52:46.780 Why? Because, you know, the Soviet Union, you know, the practical question, the Soviet central planner, 543 00:52:46.780 --> 00:52:49.780 you know, has to build a railroad from point A to point B. 544 00:52:49.780 --> 00:52:54.780 You know, what material should he use to build the railroad tracks? 545 00:52:54.780 --> 00:53:00.780 And the structural engineers come back and say, well, here's a list of metals that would work. 546 00:53:00.780 --> 00:53:09.780 work, steel, iron, aluminum, titanium, platinum, gold, all of these would work to build railroad ties. 547 00:53:09.780 --> 00:53:13.780 But we didn't see them build railroad ties out of gold. 548 00:53:13.780 --> 00:53:21.780 Mises' argument says, well, if there are no factor markets, there's no market for steel, there's no market for platinum, 549 00:53:21.780 --> 00:53:27.780 there's no market for gold, the planner has no way of knowing, which is the least costly way to build railroad tracks. 550 00:53:27.780 --> 00:53:29.780 Why not use gold? 551 00:53:29.780 --> 00:53:33.780 Well, I mean, what did the Soviet central planners actually do? 552 00:53:33.780 --> 00:53:35.780 Yeah, they didn't have markets for steel. 553 00:53:35.780 --> 00:53:40.780 They didn't have markets for gold inside the Soviet Union. 554 00:53:40.780 --> 00:53:46.780 Okay, but, I mean, for one thing, they did have knowledge of historical market prices. 555 00:53:46.780 --> 00:53:51.780 They knew that before the abolishment of factor markets, factor prices had been this or that. 556 00:53:51.780 --> 00:53:55.780 Now, as you go forward in time, those historical memories become less and less relevant. 557 00:53:55.780 --> 00:54:00.420 But the other thing they could do is pick up a copy of the Wall Street Journal and look 558 00:54:00.420 --> 00:54:04.580 at what was the world market price of steel, what was the world market price of platinum 559 00:54:04.580 --> 00:54:05.580 or gold or whatever. 560 00:54:05.580 --> 00:54:09.840 In other words, there were factor markets, there were market prices, they were just external 561 00:54:09.840 --> 00:54:12.700 to the Soviet Union. 562 00:54:12.700 --> 00:54:17.660 So the existing socialist economies were, and if you want to include Cuba, North Korea, 563 00:54:17.660 --> 00:54:21.660 and whatever today are, like islands of socialism 564 00:54:21.660 --> 00:54:26.660 surrounded by the sea of an external market. 565 00:54:26.660 --> 00:54:30.660 So they're like the position of a large firm in a sense 566 00:54:30.660 --> 00:54:37.660 that has become so large that a lot of relevant internal markets have disappeared, but not all of them. 567 00:54:37.660 --> 00:54:42.660 So they could only survive because there was a capitalist world outside them. 568 00:54:42.660 --> 00:54:48.660 You know, if total world socialism had been achieved in 1917 or 1920 or 1925, 569 00:54:48.660 --> 00:54:52.660 then it would have, you know, probably collapsed in six months, okay? 570 00:54:52.660 --> 00:54:57.660 Not decades later, okay? 571 00:54:57.660 --> 00:55:05.360 Somebody asked a question in the questions that you guys submitted before about Ronald Coase 572 00:55:05.360 --> 00:55:07.660 and the transaction cost approach to the firm. 573 00:55:07.660 --> 00:55:09.160 I don't remember who that was. 574 00:55:09.160 --> 00:55:12.360 I like to talk about Ronald Coase because it makes Walter's blood boil. 575 00:55:12.360 --> 00:55:15.560 The hair on the back of his neck stands up on end. 576 00:55:15.560 --> 00:55:19.840 I'm not talking about Coase's theory of property rights, 577 00:55:19.840 --> 00:55:23.120 his 1960 article that Walter will probably attack later, 578 00:55:23.120 --> 00:55:27.560 but his 1937 paper on the nature of the firm. 579 00:55:27.560 --> 00:55:30.480 And someone asked about transaction cost theory 580 00:55:30.480 --> 00:55:32.800 and then the so-called new institutional economics 581 00:55:32.800 --> 00:55:38.360 that explains characteristics of the firm in a sort of Coase's framework, 582 00:55:38.360 --> 00:55:41.840 right, that the reason we do things in firms 583 00:55:41.840 --> 00:55:46.240 is because there are costs of transacting in the market, 584 00:55:46.240 --> 00:55:49.040 search costs, and costs of writing contracts, 585 00:55:49.040 --> 00:55:52.540 and negotiating with trading partners and so on, 586 00:55:52.540 --> 00:55:55.540 and by internalizing some of those functions, 587 00:55:55.540 --> 00:55:58.240 then the entrepreneur's fiat substitutes 588 00:55:58.240 --> 00:56:01.340 for the market transaction, 589 00:56:01.340 --> 00:56:04.040 and that can lead to cost savings, right? 590 00:56:04.040 --> 00:56:07.040 So if the external transaction costs are high, 591 00:56:07.040 --> 00:56:08.640 it may be more efficient for the entrepreneur 592 00:56:08.640 --> 00:56:11.440 to internalize particular functions. 593 00:56:11.440 --> 00:56:14.800 So is that compatible with the Austrian approach? 594 00:56:14.800 --> 00:56:20.080 I think it is, although there's some disagreement within the Austrian School on this point. 595 00:56:20.080 --> 00:56:30.680 In my mind, what Coase is offering is not really a theory, it's more kind of a heuristic device, I guess, 596 00:56:30.680 --> 00:56:39.680 that the fact that entrepreneurs do internalize certain functions and that they use what Rothbard calls the decision-making factor, 597 00:56:39.680 --> 00:56:43.440 rather than simply delegating all decisions to external parties 598 00:56:43.440 --> 00:56:46.480 indicates that they have some comparative advantage in doing so. 599 00:56:46.480 --> 00:56:48.960 That they have some ability to make decisions. 600 00:56:48.960 --> 00:56:54.960 And if you want to interpret that as a transaction cost saving, 601 00:56:54.960 --> 00:56:57.120 then I think that's fine. 602 00:56:57.120 --> 00:57:01.640 And, you know, again, not to engage in too much of appeal to authority, 603 00:57:01.640 --> 00:57:04.960 but, you know, very eminent contemporary Austrian economists 604 00:57:04.960 --> 00:57:08.800 such as Kirzner and Rothbard are both pretty sympathetic 605 00:57:08.800 --> 00:57:10.800 to the Kosian Framework. 606 00:57:10.800 --> 00:57:13.800 Kirzner has a statement in his 92 book 607 00:57:13.800 --> 00:57:16.800 where he states the Kosian framework 608 00:57:16.800 --> 00:57:18.800 in kind of Hayekian knowledge terms. 609 00:57:18.800 --> 00:57:20.800 He says, in a free market, 610 00:57:20.800 --> 00:57:22.800 any advantages that may be derived from 611 00:57:22.800 --> 00:57:24.800 quote-unquote central planning, 612 00:57:24.800 --> 00:57:27.800 by which he means from establishing firms. 613 00:57:27.800 --> 00:57:30.800 So Kos even used this language in his 37 piece 614 00:57:30.800 --> 00:57:33.800 that the firm is like a little island of socialism, 615 00:57:33.800 --> 00:57:35.800 an island of command and control 616 00:57:35.800 --> 00:57:44.600 role in this vast sea of the external market, although that's not strictly speaking true, 617 00:57:44.600 --> 00:57:49.920 but Kirzner says, any advantages that may be derived from internalizing activities in 618 00:57:49.920 --> 00:57:55.640 a firm are purchased at the price of an enhanced knowledge problem. In other words, this sort 619 00:57:55.640 --> 00:58:01.400 of Hayekian knowledge problem becomes more important as the firm becomes larger and so 620 00:58:01.400 --> 00:58:02.400 and so on. 621 00:58:02.400 --> 00:58:06.840 So we may expect firms to spontaneously expand to the point where the additional advantages 622 00:58:06.840 --> 00:58:11.840 of central planning, i.e. internalizing activities, are just offset by the incremental knowledge 623 00:58:11.840 --> 00:58:13.960 difficulties that stem from dispersed information. 624 00:58:13.960 --> 00:58:20.440 So it's a Hayekian spin on Coase's theory of the firm. 625 00:58:20.440 --> 00:58:25.960 In a very interesting article that doesn't get read as much as it should on social, I 626 00:58:25.960 --> 00:58:31.680 I think in my mind it's the clearest statement of Rothbard's understanding of the socialist 627 00:58:31.680 --> 00:58:32.680 calculation debate. 628 00:58:32.680 --> 00:58:33.680 This is a 1976 article. 629 00:58:33.680 --> 00:58:40.520 I don't know if we have it online on Mises.org, but we should. 630 00:58:40.520 --> 00:58:42.400 In here he refers to Coase explicitly. 631 00:58:42.400 --> 00:58:46.160 He says, Coase pointed out that there are diminishing benefits and increasing costs 632 00:58:46.160 --> 00:58:51.680 to each of these two alternatives, in other words market and firm, resulting, as he put 633 00:58:51.680 --> 00:58:54.760 it, in an optimum amount of planning in the free market system. 634 00:58:54.760 --> 00:58:59.280 Our thesis, his own thesis, adds that the cost of internal corporate planning become 635 00:58:59.280 --> 00:59:03.600 prohibitive as soon as markets for capital goods begin to disappear. 636 00:59:03.600 --> 00:59:07.740 So that the free market optimum will always stop well short not only of one big firm throughout 637 00:59:07.740 --> 00:59:12.960 the world economy, but also of any disappearance of specific markets, and hence of economic 638 00:59:12.960 --> 00:59:16.080 calculation in that product or resource. 639 00:59:16.080 --> 00:59:22.440 I actually have written an article that was in the Review of Austrian Economics in 1996 640 00:59:22.440 --> 00:59:28.000 that reviews and sort of elaborates on Rothbard's treatment of the limits to the size of the 641 00:59:28.000 --> 00:59:34.760 firm and sort of talks about how that compares to some contemporary approaches in organization 642 00:59:34.760 --> 00:59:39.720 theory and strategic management for dealing with issues of firm size. 643 00:59:39.720 --> 00:59:43.720 That's one of my favorite parts of the chapter.