Twenty Questions On Mises, Part III: The Stars, Like Prices…
Jason Kuznicki on Nov 28th 2006
Beneath this silly headline, I would like to discuss what seems to me one of the most profound passages I have read so far in Mises’ Theory of Money and Credit.
In chapter 2, section 3, Mises writes,
The objective exchange value of a given commodity unit may be expressed in units of every other kind of commodity. Nowadays exchange is usually carried on by means of money, and since every commodity has therefore a price expressible in money, the exchange value of every commodity can be expressd in terms of money. This possibility enabled money to become a medium for expressing values when the growing elaboration of the scale of values which resulted from the devleopment of exchange necessitated a revision of the technique of valuation.
So far, so good: A money value on an item, as established in a market, expresses the (”objective”) exchange value of the item. (A money value assigned to the item by an individual is an expression of the “subjective” value of that same item.)
Now comes something really clever:
That is to say, opportunities for exchanging induce the individual to rearrange his scale of values.
Why? Because if an item has an exchange value greater than the subjective value assigned to it by an individual, he will promptly consider selling it — and using the money, which contains an objective value, to obtain some other good with a higher subjective value than the original item.
Money is the lingua franca that makes such comparisons possible at all; without it, I would be forced to compare barley to cabbage, cabbage to wheat, wheat to cotton, cotton to stenography, and stenography to the value of a hotel room in Tokyo. Assuming, that is, that I could assemble the unlikely chain of bartering that would lead to the desired goal. (It’s far more likely that, without the aid of money, I would fail to find the optimum exchange rates for these goods and services, and thus I would never see the inside of that coveted hotel room.)
And yet — this is not the true definition of money; money is not primarily a measure of prices. In a passage I found particularly beautiful — and evocative — Mises writes,
If in this sense we wish to attribute to money the function of being a measure of prices, there is no reason why we should not do so. Nevertheless, it is better to avoid the use of a term which might so easily be misunderstood as this. In any case the usage certainly cannot be called correct—we do not usually describe the determination of latitude and longitude as a “function” of the stars.
This is brilliant writing. If money is indeed an ordinary commodity — and, despite my earlier doubts, I’m coming around to the idea that it is — then the relationships that emerge through money’s function as an index of prices, are not created so much as they are disclosed by money; what creates this ordering is the aggregate of supply and demand in a market. Money simply reveals an order which is every bit as man-made as latitude and longitude.
My question is simple: What is price? Money is the guide by which we measure it. But what is the thing that we are measuring?
The trouble here is that there are many different kinds of prices: There are prices high and low; prices asked and offered; prices that clear the market and those that do not. There are prices I would and would not pay, irrespective of the market price of a good. There are prices that no one would pay. How can we define the one thing that unites all of them, without any recourse to money, which is merely the index, and not the determinant, of price? (I’m aware, as well, that some of these usages may simply be wrong, and not part of a proper concept of price.)
It’s rather like the old riddle: “What is time?” The answer? “The thing a stopwatch measures.” Right now, that’s just how I feel about price.
Updates: Regarding my first question, on ordinal marginal utility and indifference, it seems that I came independently to some of the same conclusions that Bryan Caplan reached in his essay “Why I am Not an Austrian Economist.” His sections 2.1 - 2.2 are the relevant passages here, and they square well with my conclusion, expressed in the comments at Liberty & Power, that the notion of ordinal marginal utility does not conflict with the presence of an indifference curve, albeit perhaps a discontinuous one.
I am puzzled, however, by section 2.3 of Caplan’s anti-Austrian essay; in the sections of his piece concerning microeconomics, this is the one that seems most doubtful to me. Simply put, it does not seem a sufficient reason, as Caplan implies, to reject a discontinuous indifference curve merely because we cannot use calculus to analyze it. Still less does it seem fatal to the science of economics to concede, in light of discontinuous indifference curves, that supply and demand will only rarely be at an exact equilibrium. If this is indeed how the world is — why then should we abandon a description of the actual world, simply because it does not conform to either a given set of mathematical tools, or to our preconceived notions? Perhaps we should tell it like it is, and admit that supply and demand curves are always imprecise abstractions. Although I recognize that this methodology — admitting that supply and demand curves are only continuous as illustrations of a general principle, and almost never in practice — is neither neoclassical nor precisely Austrian, I am unclear on what the discipline of economics would stand to lose in admitting this.
Filed in The Boardroom
I’m not sure there’s any economist who wouldn’t admit that supply and demand are discontinuous, any more than there are physicists who wouldn’t admit that in the real world (on Earth, at least) objects do not fall in a vacuum. Assumptions about continuity just aid in developing models. As someone (maybe Friedman?) once said: “All models are wrong, but some models are useful.”
How’s this?
Price is merely the relative value you place on something versus all of your (other) assets, including your future labor.
I think, as far as the update and indifference curve, the major argument against the indifference curve is that it contravenes the human action axiom. If you are truly indifferent, you will do absolutely nothing. As far as the coke/pepsi thing, it’s not a decision between two choices, but between three - coke/pepsi/neither. Since you don’t choose “neither”, you are not indifferent, you just value coke or pepsi equally more than neither.
If you’re stating that this argument is essentially semantics, I’d agree, but it is an issue of accuracy and clarity in speech to recognize that one is actually never “indifferent” when one is acting.
Quasibill –
Your definition of price strikes me as problematic on two fronts. First, there is no clear way to derive it from an ordinal ranking of my wants, which to Mises is the only proper way of talking about how individuals value goods. Second, this definition excludes market price, which might not (indeed probably won’t) reflect the purely internal values I place on goods.
As to indifference curves and the human action axiom, I don’t see the conflict: Isn’t the indifference curve merely the line along which you would no longer act? Can’t we measure it by the point at which actors stop acting?
Imagine I’m throwing a party, and I know that 3/4 of the guests prefer Coke. One fourth would rather have Pepsi. I go to the store and start buying. One Coke, one Pepsi, two Cokes, three Cokes, and I’m done. I have reached a point along my indifference curve, so I stop acting. But then, I reconsider: Perhaps each guest will want to drink two beverages of their preferred type. So I repeat my steps, and I am again at my indifference curve.
What’s wrong with this way of thinking? And how does it conflict with Mises’ theories at all?
“First, there is no clear way to derive it from an ordinal ranking of my wants”
To me, it is exactly that - an ordinal ranking of my wants = relative value I place on some end (be it a good or a service) in terms of every other asset I possess (again, I place future labor in this category). I can only “pay” for the end with some asset I currently possess, and I will only find the end “worth it” if I value one of these assets less than the end.
“Second, this definition excludes market price, which might not (indeed probably won’t) reflect the purely internal values I place on goods.”
Well, I think it is all in the way you look at it. This definition is the building block of market price, which is truly only the interaction between two (or more) sets of relative values. “price” is merely where the two values intersect, if they do at all (if they don’t, there wouldn’t be a price there). “Market price” is merely a revealed average preference - it isn’t an independent entity.
As for the indifference curve and your party - you ARE acting by buying pepsi and coke for your party - you are not indifferent to not having coke/pepsi, you just value coke/pepsi equally more than not not having either.
As far as how it contravenes Mises, I kinda agree that it doesn’t really, as long as you are specific about how you use the language. In my experience much of the arguing arises from someone using an indifference curve to say that human action can arise from indifference, and not from people who uses the general concept that you can be indifferent between two choices out of three or more (i.e., including non-action as a choice). Austrians are quick to criticize such an argument, because again it is a categorization mistake - the action doesn’t arise from indifference, the action arises from a preference of action over non-action.
[...] Regarding my earlier question — How does Mises define price? — I’m not sure I have gotten a fully satisfactory answer yet. Commenter Quasibill writes, Price is merely the relative value you place on something versus all of your (other) assets, including your future labor. [...]
As to indifference curves and the human action axiom, I don’t see the conflict: Isn’t the indifference curve merely the line along which you would no longer act? Can’t we measure it by the point at which actors stop acting?
No, because you don’t stop acting when you’ve hit an indifference curve. You stop acting when the indifference curve you’re on is tangent to your budget constraint.
Also, your example is not one of indifference. You are not indifferent between three Cokes and a Pepsi. That is, if someone told you, “Jason, I’ll give you three Cokes, or one Pepsi, which would you prefer?” you would tell them “Three Cokes, please!” because that way you could satisfy three quarters of your guests, not just one quarter (I’m assuming that the Pepsi prefering quarter aren’t made up of people like your Mother, your Boss, etc.)
A better example would be buying a cola drink for yourself. If you really can’t tell the difference between Coke and Pepsi, but you always preferred more soda to less, then you would be indifferent between any two bundles of cola drinks that contained the same quantity of soda.
Jason,
Price is the ratio of what you give up to what you receive. In a non-money economy, prices are in terms of all sorts of goods. Let’s say I could go into the market and trade one cow for twenty pairs of sandals, or I could trade it for seven pigs, or I could trade it for 100 hours of labor from an average tradesman. So what is the price of a cow? It’s twenty sandals. Or seven pigs. Or 100 hours of labor.
But now, let’s say I’m in a money economy, and I can sell that cow for $500. Now what’s the price of a cow? $500. And by extension, the price of a pair of sandals is $25, and the price of a pig is (roughly) $71.43.
You are right that price is not a relative value. Because maybe I would be willing to take just $270 for my cow, and the guy who buys it would be willing to pay up to $630. The price says nothing about our value for the cow, but given that our values are ordinal rankings of want satisfaction, we can say that the price will be no greater than the buyer’s subjective value for the cow, nor less than my subjective value for same.
[...] This was because properly speaking, prices were not to be measured in money of any sort. Von Mises did maybe more than any other writer to demonstrate that money measurements were measures of relative value, susceptible of being made proportionate to money, but also of being made proportionate to any other good. Money itself is a value like any other, and it passes through its own changes over time. But these same relative values, so often expressed in money, could be expressed in sugar or wheat or silk stockings for that matter, and these proportions would in any case be neither more nor less relative than in any other. The Archimedian point on which the whole world turns is shown not to be the value of money, but the act of evaluating — a point that is itself unstable. (For more on this theme, see my piece “The Stars, Like Prices.”) [...]