Dirk Ehnts — The problem with the supply curve

Eiteman and Guthrie conclude their paper with this statement: “If the beliefs of businessmen in general coincide with those included in this sample, it is obvious that short-run marginal price theory should be revised in the light of reality.” That was in 1952….

Another thing conventional economics reverses and gets backwards. "Reality is a bitch."

econoblog 101
The problem with the supply curve
Dirk Ehnts | Lecturer at Bard College Berlin

 

Lars P. Syll — James Buchanan’s flabbergasting gibberish on demand theory

Economics is a science? Or, don't believe your lyin' eyes.

I have already said on a number of occasions to compare and contrast an economics text on price as discovered in market by the law of supply and demand and a business book on marketing and pricing. Economists theorize based on rationality. Firms know from experience that demand is sensitive to perceived value, which can be manipulated using cognitive bias. The goal is to maximize price by end-running "the law of supply and demand" responsible for price discovery, which so-called rational agents follow.

However, most retail pricing is administered pricing, based on average cost and markup. For example, the sticker price is the anchor price that establishes the value in the consumer mindset. The retailer only expects to sell a relatively few items at this price. Most of the prices are promotional prices at a discount from the sticker price. Price changes are used to attract different types of customers so the whole range of prospects can be served, including impulse buyers (think Black Friday). The remainder will have to be factored at a liquidation price. 

The arithmetic mean of all these prices at the their respective volumes is the average sale. Cost of goods is relative to quantity ordered, so it benefits the retailer to order as a great a quantity as possible in order to get the best markup. The retail business is highly competitive, so this is an art (advertising and sales) and a science (marketing).

For example, positioning is very important in marketing and sales. A price set too low can reduce demand just as can a price set too high. Obviously, when a price is set too high affordability is a factor, whereas this is not the case on the low side. What is going on? Marketers know that consumers buy the sizzle and not the steak. The product just has to meet the promise sufficiently not to be returned in excess of standards.

A price set too low damages the perceived value. This is a reason that there is a low end to promotions below which the firm will factor the excess inventory rather than "cheapen the brand." 

I had a friend who had a chain of specialty shops that he bought very advantageously. He used to say that the secret of buying is knowing the real price and getting it. He had a rule that nothing be marked up over 20 times cost. He was continually frustrated to find items marked up 30 and 40 times and when he confronted the pricing manager the story was always the same — very few want to the item at only 20 times. It was not credible that the product had value.

In many cases demand curves are non-monotonic (wavy) rather than downward sloping. Marketers know this, and they also know that this differs in different locales. So they spend considerable money to do elaborate testing in order to identify the sweet spot.

James Buchanan’s flabbergasting gibberish on demand theory
Lars P. Syll | Professor, Malmo University

Lars P. Syll — Economics textbooks – how to get away with scientific fraud

Lars is on a tear.

As is well-known, Keynes used to criticize the more traditional economics for making thefallacy of composition, which basically consists of the false belief that the whole is nothing but the sum of its parts. Keynes argued that in the society and in the economy this was not the case, and that a fortiori an adequate analysis of society and economy couldn’t proceed by just adding up the acts and decisions of individuals. The whole is more than a sum of parts.

This fact shows up already when orthodox – neoclassical – economics tries to argue for the existence of The Law of Demand – when the price of a commodity falls, the demand for it will increase – on the aggregate. Although it may be said that one succeeds in establishing The Law for single individuals it soon turned out – in the Sonnenschein-Mantel-Debreu theorem firmly established already in 1976 – that it wasn’t possible to extend The Law of Demand to apply on the market level, unless one made ridiculously unrealistic assumptions such as individuals all having homothetic preferences – which actually implies that all individuals have identical preferences.

This could only be conceivable if there was in essence only one actor – the (in)famousrepresentative actor. So, yes, it was possible to generalize The Law of Demand – as long as we assumed that on the aggregate level there was only one commodity and one actor. What generalization! Does this sound reasonable? Of course not. This is pure nonsense!

How has neoclassical economics reacted to this devastating finding? Basically by looking the other way, ignoring it and hoping that no one sees that the emperor is naked.

Economics textbooks – how to get away with scientific fraud

Lars P. Syll | Professor, Malmo University

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.

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Lord Keynes