Production & the Market Process: Rothbard's Approach to Factor Pricing

Production & the
Market Process
Robert P. Murphy
Mises Academy
August 6, 2011
Lecture 4: Chapter 7 of Man, Economy, and State
Guest Lecture by
Peter G. Klein

Production: General Pricing of the Factors
(ch. 7)
●Role of production theory in MES
○ Structure (ch. 5)
○ Interest (ch. 6)
○ Factor pricing (general) (ch. 7)
○ Entrepreneurship (ch. 8)
○ Factor prices and incomes (ch. 9)
●Importance
○ Step-by-step development of production
theory: a Rothbardian innovation
■ Menger: general principles
■ Böhm-Bawerk, many insights, but not systematic
■ Only tangentially addressed by Mises
○ Small role in alternative, currently fashionable Austrian approaches

Background: Austrian theory of imputation
●Definition
●Characteristics
●Comparison to other approaches
●Significance

General principles of pricing for higher-order goods
If, as the result of a change in tastes, the need for tobacco should disappear
completely, the first consequence would be that all stocks of finished tobacco
products on hand would be deprived of their goods-character. A further
consequence would be that the raw tobacco leaves, the machines, tools, and
implements applicable exclusively to the processing of tobacco, the specialized
labor services employed in the production of tobacco products, the available
stocks of tobacco seeds, etc., would lose their goods-character. The services,
presently so well paid, of the agents who have so much skill in the grading and
merchandising of tobaccos in such places as Cuba, Manila, Puerto Rico, and
Havana, as well as the specialized labor services of the many people, both in
Europe and in those distant countries, who are employed in the manufacture of
cigars, would cease to be goods. Even tobacco boxes, humidors, all kinds of
tobacco pipes, pipe stems, etc., would lose their goods-character. This apparently
very complex phenomenon is explained by the fact that all the goods enumerated
above derive their goods-character from their causal connection with the
satisfaction of the human need for tobacco. With the disappearance of this need,
one of the foundations underlying their goods-character is destroyed. [Menger,

General principles of pricing for higher-order goods
(cont.)
[This is the] general law of the determination of the value of a
concrete quantity of a good of higher order. Assuming in each
instance that all available goods of higher order are employed in the
most economic fashion, the value of a concrete quantity of a good of
higher order is equal to the difference in importance between the
satisfactions that can be attained when we have command of the
given quantity of the good of higher order whose value we wish to
determine and the satisfactions that would be attained if we did not
have this quantity at our command. This law corresponds exactly to
the general law of value determination. [Menger, Principles, pp. 164-
65]

Background: Austrian theory of imputation
●Definition
●Characteristics
○ What is being priced: unit factor services
○ Assignment of a good to an “order” is subjective (e.g., bread)
●Comparison to other approaches
○ Classical economists, Marx
○ Neoclassical economics: assumptions of variable
proportions, profit maximization, and perfect competition
●Significance
○ Central to Misesian critique of socialism
Schumpeter (1942): feasibility of economic calculation under socialism
follows “from the elementary proposition that consumers in evaluating
(‘demanding’) consumers’ good ipso facto also evaluate the means of
production which enter in the production of those goods.”

Rothbard’s approach to imputation
●Like neoclassical model: inputs (land, labor, capital),
outputs, profits, and losses
●Some unique aspects
○ No cost curves
○ Economic (causal-realist), not technological, explanation: emphasis
on means and ends (implies time and uncertainty)
○ No assumptions about perfect competition in factor markets
○ Emphasis on factor specificity, not merely variability, for marginal
productivity theory
○ Explains prices of real-world, discrete factors (units of labor, capital
goods, etc.), not generic aggregate categories of “capital,” “labor,”
etc.
○ Entrepreneur is present!

Rothbard’s approach to imputation (cont.)
●Discounted marginal value product (DMVP = DMRP)
○ Drop assumption of purely specific factors and consider
substitution across lines of production
○ Money revenue attributed (“imputed”) to one service unit of a
factor, discounted by social rate of time preference (i.e., pure
rate of interest)
○ Establishes entrepreneur’s maximum willingness to pay for
one service unit of a factor.
○ Given competitive bidding by entrepreneurs, ERE factor
prices (rents) will equal the factor’s DMVP – as long as the
factor is isolable.
■ Variable proportions
■ Nonspecific factors
Examples

Calculating DMRP and ERE price
●Nonspecific factors 4A + 10B + 2C → $100
used in variable proportions: 3A + 10B + 2C → $80
MRP(A) = $20
P(A) = $20

MRP(A) = $20
P(A) = $20
used in fixed proportions: 3A + 7.5B + 1.5C → $75
MRP(A) = $25
P(A) = no more than $25

MRP(A) = $20
P(A) = $20
MRP(A) = $25
●An indispensable 1A + 2B + 3C → $200
(non-isolable) factor: 0A + 2B + 3C → $0
MRP(A) = $200

MRP(A) = $20
P(A) = $20
MRP(A) = $25
●An indispensable 1A + 2B + 3C → $200
(non-isolable) factor: 0A + 2B + 3C → $0
MRP(A) = $200
● The adding-up problem
● The $20,000 steering
wheel

Böhm-Bawerk’s “law of costs”
● Classical and Marxian versus Austrian
value theory
● Böhm-Bawerk’s law: prices of reproducible
goods, produced under competitive conditions,
tend to equal their money costs of production
● But, this doesn’t mean that cost determines
price, because the “costs” are determined by
foregone utilities elsewhere in the economy!
● Distinction between proximate and ultimate
costs

Neoclassical model of factor pricing
S
A
isocosts: X = pS
S + pA
AX2
/pA
X2
/pS
X1
/pA
X1
/pS
Q100
A
B
Q200
Q300

Neoclassical model of factor pricing II
S
A
X2
/pA
X2
/pS
X1
/pA
X1
/pS
Q100
A
B
price of aluminum
rises from pA
to pA
’
X1
/pA
’
X2
/pA
’
C
X3
/pA
’
(use this to derive factor
demand curves which,
combined with a supply
curve, determines the
price of the factor)

Neoclassical model of factor pricing III
S
A
Leontief technology
X2
/pA
X2
/pS
X1
/pA
X1
/pS
Q100
A
B
Q200
Q300
(conclusion:
prices are
indeterminate)

production function
isoquant
Isocost
○ Take factor prices as given, let them vary,
and trace out factor demand curves.
○ At given prices, find cost-minimizing bundles
for each output level, then trace out short-
run total cost curve.
utility function
indifference curve
budget constraint
○ Take goods prices as given, let them vary,
and trace out demand curves.
○ At given prices and income (wealth), find
the utility-maximizing bundle of goods.
®
Note: close parallel to neoclassical utility theory

Average and marginal physical product

Land, labor, and capital
●Differences
○ Land and labor: original or primary factors,
irreproducible
○ Capital: reproducible
○ Note on “human capital,” “knowledge capital,” “social
capital,” etc.
●Rents
○ Marshall-Ricardo
○ Fetter
●Rent and capitalization
●Gross and net rents
●ERE returns to land, labor, and capital

Takeaways
●Important task of price theory: explain factor prices, not just
consumer-goods prices
●Role of factor pricing the socialist calculation debate
●Austrian challenge to cost-of-production theories
●More to come in chapter 9!

Production & the Market Process: Rothbard's Approach to Factor Pricing

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