When Austrians Throw Reality to the Wind


I am sternly lectured here by an internet Austrian commenting on my last post that my empirical evidence supporting the statement that many businesses use administered prices is all for naught, because, well, empiricalrealitydoesnotmatter:

“First, there is the role of empirical evidence in economic theorising. A chronicler like you will never get that part. Second, there is the important point that what people say is irrelevant to an economic theorist. It may be to an accountant (which you seem to be) but not to a person dabbling in Economics.”

The words highlighted in yellow say it all: vulgar Austrians do not care about empirical reality. If an Austrian economic theory is contradicted by reality, then reality is irrelevant.

For example, if one wants to create a theory about how prices are actually set in the real world, then obviously surveys of how business people actually do set prices must be “irrelevant to an economic theorist.”

Thus the findings of the Oxford Economists’ Research Group (OERG) in the 1930s, on real world price setting, confirmed by numerous studies since then (Andrews 1964; Means 1972; Okun 1981; Blinder et al. 1998, with Downward and Lee 2001; Fabiani et al. 2006), must be totally irrelevant to how prices are set:

“For several years a group of economists in Oxford have been studying problems connected with the trade cycle. Among the methods adopted is that of discussion with business men, a number of whom have been kind enough to submit to questioning on their procedure in various circumstances: and among other matters in the questionnaire were inquiries about the policy adopted in fixing the prices and the output of products.” (Hall and Hitch 1939: 12).

“The most striking feature of the answers was the number of firms which apparently do not aim, in their pricing policy, at what appeared to us to be the maximization of profits by the equation of marginal revenue and marginal cost. In a few cases this can be explained by the fact that the entrepreneurs are thinking of long-run profits, and in terms of long-run demand and cost curves, even in the short run, rather than of immediate profits. This is expressed to some extent by the phrase commonly used in describing their policy – ‘taking goodwill into account’. But the larger part of the explanation, we think, is that they are thinking in altogether different terms; that in pricing they try to apply a rule of thumb which we shall call ‘full cost’, and that maximum profits, if they result at all from the application of this rule, do so as an accidental (or possibly evolutionary) by-product.

An overwhelming majority of the entrepreneurs thought that a price based on full average cost (including a conventional allowance for profit) was the ‘right’ price, the one which ‘ought’ to be charged. In some cases this meant computing the full cost of a ‘given’ commodity, and charging a price equal to cost. In others it meant working from some traditional or convenient price, which had been proved acceptable to consumers, and adjusting the quality of the article until its full cost equalled the ‘given’ price. A large majority of the entrepreneurs explained that they did actually charge the ‘full cost’ price, a few admitting that they might charge more in periods of exceptionally high demand, and a greater number that they might charge less in periods of exceptionally depressed demand. What, then, was the effect of ‘competition’? In the main it seemed to be to induce firms to modify the margin for profits which could be added to direct costs and overheads so that approximately the same prices for similar products would rule within the ‘group’ of competing producers. One common procedure was the setting of a price by a strong firm at its own full cost level, and the acceptance of this price by other firms in the ‘group’; another was the reaching of a price by what was in effect an agreement, though an unconscious one, in which all the firms in the group, acting on the same principle of ‘full cost’, sought independently to reach a similar result.” (Hall and Hitch 1939: 18–19).

However, for those of us not blinded by Mises’s crazy methodology, empirical reality must ground all economic theories.

Andrews, P. W. S. 1964. On Competition in Economic Theory. Macmillan, London.

Blinder, A. S. et al. 1998. Asking about Prices: A New Approach to Understanding Price Stickiness. Russell Sage foundation, New York.

Downward, Paul and Frederic Lee. 2001. “Post Keynesian Pricing Theory ‘Reconfirmed’? A Critical Review of Asking about Prices,” Journal of Post Keynesian Economics 23.3: 465–483.

Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2 (May): 12–45.

Means, G. C. 1972. “The Administered Price Thesis Reconfirmed,” American Economic Review 62: 292–306.

Okun, A. 1981. Prices and Quantities: A Macroeconomic Analysis. Blackwell. Oxford.

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