Lord Keynes — Why Hayek’s Theory of Prices and Knowledge is Flawed

Frederic S. Lee explains in the passage below from insights by the British economist George Richardson....

Social Democracy For The 21St Century: A Post Keynesian Perspective
Why Hayek’s Theory of Prices and Knowledge is Flawed
Lord Keynes

Lord Keynes — Lavoie on Mark-up Pricing in Neoclassical Theory

The lesson is to beware of neoclassical re-interpretations of administered pricing.

One must not confuse the neoclassical concept of marginal costs with average costs of production per unit. The two are not the same thing.

And, above all, the administered pricing behaviour of many firms is inconsistent with the idea of profit-maximisation in neoclassical theory.

Social Democracy For The 21St Century: A Post Keynesian Perspective
Lavoie on Mark-up Pricing in Neoclassical Theory
Lord Keynes

Lord Keynes — Lavoie on Administered Prices

The consequences of this are the following:

(1) one of the major (alleged) mechanisms driving an economy to Walrasian full employment equilibrium collapses and the whole notion that market economies have a strong tendency to general equilibrium must be abandoned, and

(2) the Austrian (or Misesian) notion that market economies have a strong tendency to economic coordination effected by firms’ adjusting their prices towards market clearing values is fundamentally flawed and wrong.

As we've argued many times here at MNE.

Social Democracy For The 21St Century: A Post Keynesian Perspective
Lavoie on Administered Prices

Lord Keynes

Lord Keynes — Lee’s Post Keynesian Price Theory: Chapter 6

Short account of why marginalism is wrong. Business does not operate in terms of marginal price since it is inefficient, contrary to what neoclassical economics, which is defined by marginalism, holds, as well as to Hayek's market approach to information economics.

Social Democracy For The 21St Century: A Post Keynesian Perspective

Lee’s Post Keynesian Price Theory: Chapter 6

Lord Keynes

Lord Keynes — Lee’s Post Keynesian Price Theory: Chapter 1

Fixed price v. flex price.

What is immediately apparent to business people seems to be missed completely by conventional economists, most of whom have no experience in the business world where actual prices are set. Just as they erroneously think that the market sets the interest rate rather than the central bank in a modern economy; so too, they think that price discovery happens in markets based on matching bids and offers. This is rather puzzling, since even most of those with no business experience must do a least some shopping and see that prices are set by management rather than the open to negotiation. Why would firms compete rigorously with each other without receiving bids instead of setting the offer at a fixed price in the market.

It can be explained away by "price elasticity" and "stickiness," but when I studied Samuelson half a century ago, it seemed quirky to me at the time — like there is the general law of supply and demand but it doesn't always work the way it is supposed to. WTF!

Social Democracy For The 21St Century: A Post Keynesian Perspective
Lee’s Post Keynesian Price Theory: Chapter 1

Lord Keynes

Lord Keynes — Gardiner Means on Administered Prices

Gardiner’s conclusions are worth quoting:

“... the actual behavior of administration-dominated prices … tends to differ so sharply from the behaviour to be expected from classical theory as to challenge the basic conclusions of that theory. However well the theory may apply to market-dominated prices, it would not seem to apply to the bulk of the administration-dominated prices in the sample or to that part of the industrial world which they typify. Until economic theory can explain and take into account the implications of this nonclassical behavior of administered prices, it provides a poor basis for public policy. The challenge which administered prices make to classical economics is as fundamental as that made by the quantum to classical physics.” (Means 1972: 304).

Administered price behaviour in real world economies really does lead to revolutionary conclusions for economic theory: so much of neoclassical economics and Austrian economic theory simply collapses and must be abandoned once one understands its implications.

Disequilibrium prices are deliberately created and maintained by fixprice enterprises in a vast swathe of the economy, simply because they prefer it that way. Such businesses are not generally in the habit of using flexible prices as their normal method of clearing supply, or equating demand with supply.

Social Democracy For The 21St Century: A Post Keynesian Perspective
Gardiner Means on Administered Prices
Lord Keynes