Austrian Economics

1. Austrian Economics D. Allen Dalton ECON 325 – Radical Economics Boise State University Fall 2011

2. OriginsandDevelopment

3. Pre-History • Italian Subjectivist Tradition • Pierre de Jean Olivi (1248-1298) • San Bernardino of Siena (1380-1444) • Ferdinando Galiani (1728-1787) • School of Salamanca • Martin de Azpilcueta Navarrus (1493-1586) • Luis de Molina (1535-1601) • Juan de Mariana (1536-1624)

4. Pre-History French Tradition Richard Cantillon (1680?-1734?) Essai sur la Nature du Commerce en General (1755) A.R.J. Turgot (1727-1781) Reflections on the Formation and Distribution of Wealth (1766) Etienne Bonnot de Condillac (1714-1780) Commerce and Government (1776) Jean-Baptiste Say (1767-1832) Treatise on Political Economy (1803) Frederic Bastiat (1801-1850) “A Petition” (Petition of the Candlemakers) (1845) Economic Sophisms (1845)

5. The Founders • Carl Menger • Grundsatze (1871) trans. Principles of Economics • emphasis on causal-genetic explanations • centrality of subjective utility, uncertainty, adjustments in disequilibrium, and time • Investigations on the Method of the Social Sciences (1883) • Methodenstreit

6. The Founders Eugen von Bohm-Bawerk (1851-1914) Capital and Interest (1884,1889,1912) Mixture of productivity and time preference theories of interest Karl Marx and the Close of His System (1896) Critique of Marx, especially his failure to solve the “transformation problem”

7. The Founders Friedrich von Wieser (1851-1926) Natural Value (1889) cost is marginal utility foregone from application of unit of input to produce one good rather than another imputation problem; expected prices of first-order goods determine the prices of higher order goods Social Economics (1914)

8. 20th Century Giants • Ludwig Mises (1881-1973) • Theory of Money and Credit (1912) • Socialism (1922) • Human Action (1949) • Friedrich Hayek (1899-1992) • Prices and Production (1931) • The Pure Theory of Capital (1941) • Individualism and Economic Order (1948)

9. Renaissance • Murray Rothbard (1926-1995) • Man, Economy and State (1962) • America’s Great Depression (1963) • Power and Market (1970) • An Austrian Perspective on the History of Economic Thought (1995) • Israel Kirzner (1930 - ) • Competition and Entrepreneurship (1973) • The Meaning of Market Process (1992)

10. Modern Representatives • Roger Garrison • Time and Money: The Macroeconomics of Capital Structure (2000) • Steven Horowitz • Microfoundations and Macroeconomics (2000) • Jesús Huerto de Soto • Money, Bank Credit, and Economic Cycles (2006) • Roger Koppl • Big Players and the Economic Theory of Expectations (2002) • J. Guido Hulsmann • Mises: The Last Knight of Liberalism (2007) • Walter Block • Labor Economics from a Free Market Perspective (2008)

11. Methodology

12. Methodology • Methodological Individualism • “A Priori” Method • Praxeology – science of human action; logic of relationship between the categories of ends and means • Critique of Mathematics and Econometrics in theory

13. Methodology “..economics is not about things and tangible material objects; it is about men, their meanings and actions.” – Mises, Human Action, p.92 “Action is guided by plans, i.e., by thought, and all action has to be interpreted as the outward manifestation of such plans… In fact all phenomena are intelligible only as the oucome of planned action.” – Lachmann, “From Mises to Shackle,” p. 57

14. Methodology • Nature of economics is that all economists can do is to attempt to explain the general patterns arising from choice • Behavior is tied to individual perceptions of means and ends; problem of knowledge and expectations is of fundamental concern • Economizing, not maximizing, behavior

15. AustrianMicroeconomics

16. Market as a Process • Critique of “Perfect Competition” • “…the perfectly competitive model portrays (as does each and every equilibrium model of a market) a pattern of mutual anticipations and executed decisions which, if somehow attained, would lead no participant to wish that he had acted differently.” – Kirzner, “The Driving Force of the Market,” p. 39

17. Market as a Process Critique of “Perfect Competition” “the model cannot be used to ‘explain’ market prices; the model presumes that everyone has, somehow, correctly and self-fulfillingly guessed what the market price is going to be. …the model treats each market participant as a price-taker…” Kirzner, “The Driving Force of the Market,” p. 39

18. Market as a Process Hayek’s Foundational Articles “Economics and Knowledge” “The Use of Knowledge in Society” “The Meaning of Competition” (all in Individualism and Economic Order) Kirzner’s Competition and Entrepreneurship

19. Market as a Process “Equilibrium…exists if the actions of all members of the society over a period are all executions of their respective individual plans on which each decided at the beginning of the period.” – Hayek, “Economics and Knowledge” p. 37

20. Market as a Process “The problem which we pretend to solve is how the spontaneous interaction of a number of people, each possessing only bits of knowledge, brings about a state of affairs in which product prices correspond to costs, etc., and which could be brought about by deliberate direction only by somebody who possessed the combined knowledge of all those individuals. But in our analysis…

21. Market as a Process …instead of showing what bits of information the different persons must posess in order to bring about that result, we fall in effect back on the assumption that everybody knows everything and so evade any real solution of the problem.” Hayek, “The Use of Knowledge in Society”

22. Market as a Process “The overambitious plans of one period will be replaced by more realistic ones; market opportunities overlooked in one period of time generate systematic alterations in the corresponding decisions for the succeeding period. Taken over time, this series of systematic changes in the interconnected network of market decisions constitutes the market process.” – Kirzner, C&E, p.10

23. Market as a Process “As the market process unfold, with one period of market ignorance followed by another in which ignorance has been somewhat reduced, each buyer or seller revises his bids and offers in the light of his newly acquired knowledge of the alternative opportunities…In this sense the market process is inherently competitive.” – Kirzner, C&E, , p. 12

24. Market as a Process “Into… a world of men unable to learn…introduce a group of outsiders who are able to perceive opportunities …where a good can be sold at a price higher than that at which it can be brought. This group of entrepreneurs…notice profit opportunities that exist because of the initial ignorance of the original market participants and that have persisted because of their inability to learn…” – Kirzner, C&E, , p. 14

25. Market as a Process Revision of plans by disappointed individuals constitutes the market process. Entrepreneurs, alert to unperceived opportunities, help in this revision of plans. As plans are revised, the subjective data on which individuals base their plans comes closer into correspondence with the objective data – reducing market ignorance.

26. Analytical Tools Supply and Demand – distinction between supply and production (supply curves are not based on production) Market period and reactions to disequilibrium Ordinal marginal analysis rather than indifference curve analysis Verbal rather than graphical analysis

27. AustrianMacroeconomics

28. Time and Money • Time is the medium of action in all markets. • Money is the medium of exchange in all markets • In “macroeconomics,” focus is upon growth and deviations in production. • Production takes time – as capital goods are turned into consumer goods.

29. Time and Money Macroeconomics has to concern itself with capital structure. Money is a “loose joint” that binds the supply of capital goods and the subsequent demand for the corresponding consumer goods. Monetarist tight joint Keynesian broken joint

30. Capital-Based Macroeconomics Based on the Business Cycle Theory of Ludwig von Mises and F. A. Hayek With acknowledgment to Professor Roger W. Garrison, Auburn University

31. Friedrich A. Hayek 1899 - 1992 Prices and Production (1931, 1935) Nobel Prize in Economics 1974 --for pioneering work in the theory of money and economic fluctuations and for penetrating analysis of the interdependence of economic, social, and institutional phenomena.

32. Ludwig von Mises 1881 - 1973 “The period of production must be of such a length that exactly the whole available subsistence fund is necessary on the one hand and sufficient on the other for paying the wages of the labourers throughout the duration of the productive process.” The Theory of Money and Credit (1912)

33. The Elements of Capital-Based Macroeconomics

34. “Loanable funds” is the generic term that refers both to lending (which constitutes the supply side of the market) and to borrowing (which constitutes the demand side). Each side of the market for loanable funds is governed by the rate of interest. Saving, broadly conceived, underlies the supply of loanable funds. Consumer borrowing is netted out on the supply side. That is, the focus is on the funds lent collectively by income-earners/savers to the business community. The Market for Loanable Funds The demand for loanable funds represents demand by businesses for investment.

35. Capital-based macro features consumption and investment as alternative ways to use resources. The alternative uses are depicted as a Production Possibilities Frontier (PPF). Production Possibilities Frontier

36. Capital-based macro features consumption and investment as alternative ways to use resources. The alternative uses are depicted as a Production Possibilities Frontier (PPF). The PPF shows the maximum sustainable level of output as a locus of points representing all possible combinations of consumption and investment for a fully employed economy. Production Possibilities Frontier

37. Consider a particular point on the frontier. This point represents an economy that is fully employed (with the unemployment rate in the 5%-6% range). Hence, output is being produced at a sustainable rate. Production Possibilities Frontier

38. Consider a particular point on the frontier. This point represents an economy that is fully employed (with the unemployment rate in the 5%-6% range). Hence, output is being produced at a sustainable rate. Now consider a disequilibrium point inside the PPF. Production Possibilities Frontier The distance below the frontier reflects the idleness of labor and other resources. The unemployment rate is higher than 6%, suggesting significant cyclical unemployment. This point represents an economy in recession, producing fewer consumption goods and/or fewer investment goods than it could.

39. Now consider a disequilibrium point beyond the PPF. This point represents an overheated economy. The unemployment rate is below 5%. The level of output is unsustainable. (Points very far beyond the PPF are, of course, literally impossible.) Production Possibilities Frontier

40. Increased saving moves the economy along the PPF in the direction of more investment; decreased saving moves the economy along the PPF in the direction of consumption. Investment in this framework is measured in gross terms. Suppose an investment of $600 billion is needed just to offset depreciation. DEPRECIATION = $600 As long as gross investment is greater than depreciation, the economy will grow, as will be represented by an outward shift in the PPF itself.

41. CONSUMABLE OUTPUT Beyond the two-way division of resource usage captured by the PPF, capital-based macro tracks the intertemporalallocation of investable resources. Production time is measured along the horizontal axis. P R O D U C T I O N T I M E The vertical axis tracks the value dimension—with value at the end of the production process representing consumable output.

42. At a given point in time, an ongoing production process is characterized by activities in all the separate stages. CONSUMABLE OUTPUT STAGES OF PRODUCTION MINING REFINING MANUFACTURING DISTRIBUTIING RETAILING Identifying the stages as “mining” through “retailing” is only suggestive. The actual intertemporal structure of capital, of course, entails a complexity of interconnected production activities.

43. C The resulting figure is known as the Hayekian triangle. First, it depicts the production process that plays itself out over time. Second, it depicts the full complement of stages that exist at a given point in time; the second interpretation suggests that resources can be reallocated in either direction from one stage to another. P R O D U C T I O N T I M E For analytical purposes, the economy’s production process is conceived as a continuum of stages and is represented as goods in the making that gain value as they near completion.

44. Integrating the Elements

45. The market for loanable-funds—a.k.a. investable resources—shows that the market-clearing rate of interest is 5%, at which saving and investment are in equilibrium at $800 billion.

46. The market for loanable-funds—a.k.a. investable resources—shows that the market-clearing rate of interest is 5%, at which saving and investment are in equilibrium at $800 billion.

47. The PPF shows that with $800 billion committed to investment activities, $2200 billion are available for current consumption. The market for loanable-funds—a.k.a. investable resources—shows that the market-clearing rate of interest is 5%, at which saving and investment are in equilibrium at $800 billion.

48. The Hayekian triangle depicts current consumption as the output of the economy’s multi-stage production process. The rate of interest governs the allocation of resources among the stages. The slope of the hypotenuse of the Hayekian triangle reflects a rate of interest consistent with the rate that prevails in the loanable- funds market.

49. An initial full-employment equilibrium is defined by: the Loanable-Funds Market, the PPF, the Hayekian Triangle,...

50. …plus the representative stage-specific labor markets.