• hayek

    Production: The Structure

    READINGS

    Chapter 5: Production: The Structure
    Man, Economy, and State, Murray N. Rothbard

    Chapter 5 Study Guide
    Study Guide to Man, Economy, and State, Robert P. Murphy

    AUDIO

    5.01 Some Fundamental Principles of Action

     

    5.02 The Evenly Rotating Economy

     

    5.03 The Structure of Production: A World of Specific Factors

     

    5.04 Joint Ownership of the Product by the Owners of the Factors

     

    5.05 Cost

     

    5.06 Ownership of the Product by Capitalists: Amalgamated Stages

     

    5.07 Present and Future Goods: The Pure Rate of Interest

     

    5.08 Money Costs, Prices, and Alfred Marshall

     

    5.09 Pricing and the Theory of Bargaining

     

    STUDY QUESTIONS

    1. How does Rothbard justify study of the ERE, when Austrians are so critical of unrealistic assumptions in mainstream economics? (pp. 322-23)
    2. Why is the ERE not only unrealistic, but indeed self-contradictory? (pp. 328-29)
    3. How would Rothbard Classify those goods that produce second order capital goods? (pp. 330-31)
    4. Describe the structure of production in a world of purely specific factors. (pp. 330-31)
    5. In the case of joint ownership, where the final product is a diamond ring, arrange the following in order of their respective waiting times to be paid: (a) the truck driver bringing diamonds to the jeweler, (b) the laborer in the diamond mine, and (c) the jeweler who sets the diamond on a ring (pp. 334-37)
    6. What is wrong with the “freedom-to-starve” argument (p. 339)
    7. How can a sale be costless (p. 341)
    8. What is the problem with so-called “cost-plus” pricing schemes for public utilities (in which the utility companies are allowed to charge consumers what their “costs” are plus a certain percentage markup)? (pp. 341-342)
    9. By what process does one pure rate of interest arise in the ERE? (p. 351)
    10. Can a landowner earn interest in the ERE? (pp. 351-353)
  • federal-reserve-dc

    What Is Austrian Business Cycle Theory?

    Summary

    • The Austrian School is an under-respected economic school which unequivocally embraces free markets in favor of central planning.
    • Austrian Business Cycle Theory attempts to explain the business cycle through the actions of central banks.
    • Austrian Business Cycle Theory offers foresight into the effects of the Federal Reserve’s Quantitative Easing program.

    Austrian Business Cycle Theory

    abct-chartThe six main steps of the business cycle can be seen in my flowchart above.

    1. The first step to understanding an economic bust is knowledge of central bank policy prior to the bust period. The actions that explain the entire cycle are interventions undertaken by the central bank. For this example, we’ll use the fictitious island of Senyek. In the fictitious land of Senyek, central bank policy maker Eknanreb chooses to fix interest rates at near .1% to stimulate economic growth. Eknanreb can hold interest rates near .1% through an incredible inflation of the monetary supply.
    2. Eknanreb’s actions bring us to the second phase of the cycle, actions taken by banks in response to central bank policy. As the monetary supply increases rapidly under Eknanreb’s direction, more funds are able to be lent out. As more funds are able to be lent out, banks incentivize taking on a loan by offering a low interest rate.
    3. Once banks offer credit at low interest rates, businesses respond to the market signal and start to take on debt. Businesses then overinvest in projects with easy credit. The fundamental problem exists in that the credit offered at low interest rates by banks is not a real market signal. Sure, it’s a market signal in that it provokes another action, however, the origination of the market signal is inherently fake. In a free market, low interest rates arrive as a result of decisions made by market participants. For example, interest rates naturally reach low levels if market participants choose to save instead of borrow. As market participants stop borrowing and start saving, banks respond by lowering interest rates to incentivize borrowing. Decisions made by banks to lower interest rates in response to market signals from other market participants create real market signals as the signals represent actions of other market participants. Decisions made by banks to lower interest rates in response to policy directives from a central bank create false market signals, as the signals fail to come from the market.
    4. The next phases of the cycle can be explained by malinvestment. Malinvestment, the misallocation of resources, occurs once businesses have over-invested in projects with easy credit. A great way to explain malinvestment comes from Mises’s Human Action. Mises uses the example of a master builder who planned to build a large house. The builder, unaware that he doesn’t have enough bricks to complete the house, continues to build a house he can’t complete. The building of the house creates a great economic boom, and everyone involved in the project is thrilled. Once the builder reaches the last brick, he realizes what has happened, and the project comes to a grinding halt and an economic bust ensues. This example does a great job explaining what is happening on the island of Senyek. On Senyek, businesses are unaware of the false market signals driving their malinvestment. Likewise, the builder is unaware his great house has too few bricks. The builder has been fooled into allocating resources into building a giant house while Senyek businesses have been fooled into investing in projects derived from an artificial market signal. At last, the unsustainable boom period fueled by easy credit and fake market signals leads to a severe bust period. If only someone told the builder that he had too few bricks earlier, the fallout of the bust would be less severe. Likewise, if the central bank hadn’t created an artificial market signal, the economic bust period would be less severe.

    Applying Austrian Business Cycle Theory

    In the U.S., the Federal Reserve buys $65B worth of bonds every month. In accordance with the Austrian School, this fake stimulation is currently fueling malinvestment and overconsumption. Once the “Fed” completes the “taper” of Quantitative Easing, the current bond buying program, the master builder will realize the market signals he received were false, and his house will crumble. Likewise, the next catastrophe in the U.S. is not too far in the future. Actions taken by the Federal Reserve in response to the Great Recession have fueled a boom period characterized by overconsumption, and a severe bust will follow.

  • Buyers-Offering-Cash

    Consumers Can Fight Back

    I cannot count the times I have heard the following critique of libertarian philosophy:

    Yeah, the “free market” is great and all, but without the government, businesses would just screw over the little guy.

    This, however, is what they’re really telling you:

    You’re powerless. There is absolutely nothing you can do to arm yourself against those big bad capital hoarders who just want to oppress the people so that they can get rich at your expense. You need the government to take care of you because you’re a helpless little human being who is incapable of making the best decisions for you and the rest of society.

    This argument could not more condescending toward the average person, the very guy those who make this argument purport to protect. Are the people really this helpless?

    Simply put: no. In the typical business transaction, the consumer holds as much power, if not more, than the seller of whatever good is in question. Even in today’s corporatist environment (the economy of the United States resembles almost nothing of a true free-market, capitalist system), the consumer still retains the ability to singlehandedly decide whether most transactions take place or not, and therefore, is not powerless in the market.

    But, let’s take a step back and look at why people exchange goods in the first place. In any voluntary transaction, both parties experience mutually beneficial trade, otherwise such a trade would not occur in the first place. If a farmer trades eggs with his neighbor, a cobbler, for shoes, he values the shoes more than he does the eggs. The cobbler feels the same way; he values the eggs more than he does the shoes. And in the end, both parties are better off than before the trade occurred.

    The scenario is no more complicated in a moneyed society, either. If the farmer desires shoes, he goes to the nearest shoe store and picks out a pair he likes. He then proceeds to pay the storeowner for them with money (and for the sake of this article, I am not going to differentiate between sound money and fiat money, the latter of which cannot really be considered money at all). Now, in this case, the farmer still values the shoes more than he valued what he traded in order to get the shoes, in this case money, in the other, eggs. And the storeowner still values what he gets in exchange for the shoes more than the shoes themselves. If either party did not agree with the trade, the trade would not occur, and similarly, if either side did not feel like he was getting the better deal, the trade would not occur either.

    It is the principle of mutually beneficial trade that leads to consumer power. So long as the consumer maintains the ability to refuse a transaction, he is just as powerful as the other guy, even the supposed all-powerful capitalist pig. And it must be pointed out that the only way a consumer loses this ability is when the government forces such a transaction, such as the payment of taxes or the forceful purchase of a good (the recent debacle over health insurance comes to mind). In these cases, the government forces the citizen to participate in a trade that would not normally occur. And while the government, or government subsidiary, may be better off afterward, the citizen has a net loss. This is fairly obvious when it comes to taxes, but even in the case where the government forces its citizens to buy health insurance, ostensibly to better their lives, the people who did not have health insurance (and it does not matter the reasoning behind such a decision) are now worse off because they are forced to do something they did not want to do in the first place. It is only through the government that anyone, or any business, can benefit at the expense of someone else.

    Consumers can choose to purchase, or not to purchase, a good for any reason they want. This is why companies try their best to appease their customers; if they did not, if they sold goods the people did not want, or if they had horrible customer service, that company would lose money, which is a great incentive for them to change their practices. After all, earning a profit is one of, if not the biggest reason to create a business, and it is the best gauge of how well that business pleases its customers.

    And now, at this point, our theoretical opposition usually says:

    That’s fine in theory, but that’s not how things work in real life. In real life, the people are beholden to the businessmen. They need to eat, don’t they? Businessmen can charge whatever they want for whatever they sell, because the people will buy the product no matter what.

    Clearly, this thesis fails the theoretical aspects of human action and voluntary interactions per our earlier proof. But there are many real life examples of how the little people in the economy won battles against their seemingly insurmountable enemies – the corporation.

    New-CokeOne classic example is the tale of New Coke. In 1985, Coca-Cola developed a new version of its famous soda, which, by all of their internal company measurements, supposedly tasted better than the original formula. Coke, excited by the prospect of regaining market share lost to its competitor, Pepsi, quickly debuted the product to the public as New Coke. Public backlash ensued; in June of that year, the company received 1,500 calls per day from angry customers who wanted their “old” Coke back. Protest groups were formed outside the world headquarters in Atlanta, Georgia. And by July, Coca-Cola reintroduced their classic formula to store shelves across America. Did the government ever get involved, claiming that Coca-Cola “illegally” attempting to increase its market share? No. The simple fact that New Coke threatened to affect the company’s profit margin in a negative way was enough for them to correct the decision to drop their classic formulation. Eventually, Coca-Cola dropped the entire New Coke/Coke II product line and focused solely on the product its customers wanted.

    Netflix-QwiksterBut this isn’t just a thing of the past; more recently, the CEO of Netflix, Reed Hastings, thought it would be a good idea to split the company into two, one focusing on DVD rentals (Qwikster) and the other on online movie streaming (Netflix). On paper, this would have theoretically resulted in higher earnings for the company, as customers would now need to register for two separate sites. What Netflix didn’t count on, however, was the customer reaction; many people were so opposed to the split they decided to cancel their subscriptions entirely and switch to one of Netflix’s competitors, Blockbuster or Redbox. Netflix’s stock was suddenly no longer the favorite of tech investors, and promptly dropped 14.6% of its value in one day. Netflix got the message; less than a month later, Hastings announced through the company blog that the split would no longer take place and the current pricing structure would remain in tact, giving its remaining customers exactly what they wanted. There was no need for the government to get involved to protect the general public from the greedy leaders of Netflix. The simple desire of Netflix to not go bankrupt was enough for the company to change its mind about the potential split.

    Baltimore-HonThe problem does not need to be nationally recognized either; consumers also have power within their own community. The owner of Café Hon in Baltimore, Denise Whiting, trademarked the Baltimorean term of endearment – hon. Baltimore was outraged; “hon” is a part of their culture and a defining element of the city. While Whiting claimed she was merely trying to protect her business from competition (something that could never be accomplished without a government infringing on the property rights of everybody else), she went beyond her stated goal and seized thousands of dollars of merchandise from a small business at the airport, threatened to sue the city for using the image of the Baltimore Hon on its metro cards unless she had creative control, and even sent a cease and desist order to the website WelcomeToBaltimoreHon.com. Protests were organized, but Whiting’s abuse of the trademark continued. The people didn’t give up, however. The entire community of Hamden boycotted Whiting’s restaurant, and through the power of blogging, the quiet, background protest spread throughout the city. About a year after the protests began, the business began failing so badly that Whiting enlisted Gordon Ramsay’s help through the show Kitchen Nightmares. Over the course of the show, Whiting was forced to realize how badly viewed she was within the community and that it was her actions with the trademark, and her actions alone, that caused the dissention, and unless she gave up the trademark, her businesses were never going to be profitable. Whiting publicly apologized on Baltimore radio, and gave up her claim on the trademark. Even though the effects from the protests did not appear immediately, they did force Café Hon to completely reevaluate its business decisions and eventually, the community won.

    True capitalism empowers the individual; it is only through the government and its monopoly of force that any business can benefit at the expense of its customers. Profits should not be demonized; in a real free-market – that is, one free from government intervention, regulations, and bailouts – profit is the best measurement of a business’s ability to please its customers and motivates the business to do so. It is the government that has always been the enemy of freedom for the little guy, and should never be confused as their protector.