RoR: Forum

Interesting discussion. It might help to consider the various factors that lead to a change in demand, as well as those that lead to a change in supply, both of which can affect the market price. A change in demand is a change in a consumers' willingness to buy more, or less, of a given product at the same price. A change in supply is a change in producers' willingness to sell more, or less, of a product at the same price.

A change in demand can be caused by any of the following six factors:

1. A change in consumer income. If consumer incomes rise or fall, it can cause their demand for a product to rise or fall.
2. A change in the number of consumers. If the number of consumers rises or falls (if people move in or out of an area, say), it can cause the demand for a product to rise or fall. More or less of the product will be sold at the same price.
3. A change in the price of a related good. If the price of beef rises (or falls), the demand for a substitute product like pork or chicken will rise (or fall). If the price of a product, like tennis rackets, rises (or falls), the demand for a complementary product like tennis balls will fall (or rise).
4. A change in people's expectations. If people expect the price of a good, like an IPad, to fall, they may postpone purchase of the product, causing the current demand to fall as well. If they expect prices to increase, their demand for the product(s) will increase.
5. Demographic changes. If college students move into a college town after summer vacation, the demand for pizza and beer at the local restaurants and bars will increase, and fall when they leave for the summer. Or if, a large Mexican population moves into town, the demand for Mexican food like tortillas and beans will increase.
6. Changes in consumer tastes and preferences. If people discover that certain foods like tomato products can protect against cancer, their demand for them will increase. If they discover that foods high in saturated fat and sugar are bad for one's health, their demand for them will decrease.

A change in supply can be caused by any of the following five factors:

1. Changes in the prices of resources or inputs. If the cost of inputs like labor rises, producers will supply less of the product at the same price; if costs of production fall, they'll supply more.
2. Changes in technology. The discovery of new lower-cost production techniques can reduce production costs and increase supply.
3. Events in nature. Changes in weather conditions, like droughts or floods, can affect supply. A freeze in Florida can reduce the supply of oranges. Favorable weather conditions can increase their supply.
4. Political disruption. Revolutionary upheavals in oil producing countries like the Middle East or Africa can reduce the supply of oil.
5. Changes in taxes. If the government increases taxes on a seller's product, it has the same effect as an increase in costs of production.

All of these factors affect demand and supply. And since the price of a product it determined by the intersection of the demand and supply curves -- which is the market clearing price -- all of these various factors bear on the price that consumers eventually wind up paying.

Of course, if the demand for a product increases, driving up its price, while the product's average costs of production remain the same, profit margins will increase. The higher profit margins will attract new competitors into the market, whose competition will then drive the price back to its original level.

So, price is not determined simply, or even predominantly, by consumers' subjective whims, but by a whole host of objective conditions, including the tendency towards a uniform rate of profit given the same costs of production.

(Edited by William Dwyer on 9/13, 11:12pm)

Post 21

Wednesday, September 14, 2011 - 3:35am

Thanks Bill.

Let me just comment, without the suggestion of disagreement. Demand is different from value. It can be thought of as an expression of value, as well as an aggregation. If you imagine a person with some kind of value system, how it would be expressed as demand changes based on the situation. More income means more values can be pursued (your point 1.). Changes in the relative prices of other goods will affect it (your point 3, although I'd suggest that it doesn't have to be related goods, since every possible value competes with every other value when you have to choose). Values also are compared over the course of time, so changes in expectations about the future prices or available goods will change how you choose (your point 4). Other changes in context can also affect this expression of a person's value system. Any needs that are satisfied will likely change future decisions. The value system isn't some fixed set of priorities that never change. A person's values change all of the time. If they didn't, they'd continue to purchase the one thing they value the most. Given a system of values, regardless of their foundation, changes in context will change how a person acts on those values.

Your point 6 describes the possibility that their value system itself changes. Instead of changing the expression of a value system, it changes the value system itself.

Points 2 and 5 deal with changes in how individual demand is aggregated, by changing the number or types of people.

The supply side is more complicated. I can think of a few conditions that you left out.

One is that expectations can affect supply as well as demand. In some ways, they are the same phenomena. So if an oil company thinks price is going to increase, they may hold some in reserve. The expectations can be about what other suppliers will do, what consumers will do, how technology might change, or how unrelated products might change in price making them relatively more or less attractive.

Another factor is the choices of individuals that produce the product or service. If someone like Steve Jobs decides to retire, it can have a significant impact on supply unrelated to the points you mention. Maybe you could say that this is just a change in the price of an input, but that gives the impression that production is an automatic process and human initiative doesn't really contribute.

This, I believe, is why Objectivists so frequently want to rewrite economics. Demand is sort of a bland, generic force. While the people aren't exactly homogenous, no single individual dominates the demand side of the equation. But when it comes to supply, it's not accurate to think of it as a semi-homogenous blob where each contributor plays an insignificant role. When it comes to supply, there are productive giants who change the whole world. Individuals matter a lot more. Supply doesn't happen automatically in response to demand. It requires initiative, intellect, innovation, and entrepreneurship. Individuals are supremely important, and to treat supply as an automatic response to demand ignores just how important the individuals are.

I'm sympathetic to that view, while still disagreeing with all of these attempts to rewrite economics into some kind of "study of entrepreneurship". Demand is still important. The economic context is critical to understanding how it all works together. It's critical in understanding the price system, and how supply and demand interact, and how economic incentives create long-term trends towards "equilibrium points".

Post 22

Wednesday, September 14, 2011 - 7:42am

Thank you, Joe!

You wrote,

The supply side is more complicated.

I can think of a few conditions that you left out. is that expectations can affect supply as well as demand. In some ways, they are the same phenomena. So if an oil company thinks price is going to increase, they may hold some in reserve.

Ah, yes. Good point.

The expectations can be about what other suppliers will do, what consumers will do, how technology might change, or how unrelated products might change in price making them relatively more or less attractive.

True, again.

Another factor is the choices of individuals that produce the product or service. If someone like Steve Jobs decides to retire, it can have a significant impact on supply unrelated to the points you mention. Maybe you could say that this is just a change in the price of an input, but that gives the impression that production is an automatic process and human initiative doesn't really contribute.

Perhaps technology? If Steve Jobs retires, that could affect technological innovation. I wouldn't say these factors are automatic; they are the product of peoples' goals, values, interests and incentives. We assume that by and large people prefer goods and services that improve their lives and make them better off, and that this preference motivates their choices in a relatively predictable way. To be sure, if many other producers (not just Steve Jobs) were to retire or go on strike a la Atlas Shrugged, that could have a profoundly disruptive and unexpected impact on the economy, but incentives would explain that event as well. They've had it "up to here" and aren't going to take it any more. That scenario may not be too far away!

Post 23

Wednesday, September 14, 2011 - 5:42pm

I've got a long thought experiment that might shed some light on this issue. If Joe is right and I have Austrian Economics all wrong (I haven't been able to find a book on it yet), then this post will surely serve to highlight that deficiency in my understanding.

***************************************************************************************
Let's say that hyper-intelligent space aliens (is there any other kind?) look at Earth and decide to study "utility transfer among humans" (i.e., economics). They do not know what it is "like" to be a human, but they can study our economic behavior -- i.e., the transfer of utility from one or some humans to others (and back).

They note that there is a bunch of people in N. Korea that are forced to work in order to produce things, but that those produced things are then expropriated away from the workers and redistributed to people elsewhere. They can see the transfer of utility from some humans to others, as well as the use of force in expropriation. They make a mental note that this is also the "economic" behavior of both ants and bees.

Then, they look at 19th Century America. Oh, I forgot to tell you that they have a time machine, so that they can go back and look at history. Anyway, when they look at America in the 19th Century, they see that utility transfer is dominated by individual production and free trade. Lots of different kinds of things get produced, and the aliens aren't always sure how some of the things produced could really be of value or utility to the humans. They fail to understand the utility of Britney Spears records and the TV shows "Jerry Springer" and "Jersey Shore." Troll dolls also have them dumbfounded. Why would any human want an "ugly" doll? What value could be gained from having that around?

Out of disgust, they decide not to look any further into trying to understand the economic choices that actually are made, and they work to build up a science, an economic science, based only on the simple fact that choices are routinely made. Like BF Skinner, they are not concerned with the human process of valuation, only the behavior. They decide that the only way that they can make sense of the behavior is to tabulate it and refer back to the tabulations. They begin to wonder about hypothetical circumstances and whether or not they could predict the outcomes. Half of the purpose of science, they tell themselves, is to get into the position where you can successfully predict outcomes. They ask themselves:

How would economic behavior change in country "X" if it doubled its "rate of expropriation" of goods from its citizens?

Then they become sad. They realize that all they have, in their version of economics, is basically just tabulation -- and that all they can ever predict are those occurrences that have, at some point in time, already happened (and have been previously tabulated). They can tell you how economic behavior will change in response to a doubling of the rate of expropriation, if and only if such a doubling has occured before (and they tabulated the results). They begin to wonder if all of their work is for naught. Finally, one of them stands up in frustration and yells:

"If you want to understand utility transfer among humans (economics) as a science, then you have got to understand what it means to be human. One of us is going to have to be human for a while."

Oh, I forgot to tell you that they also have a 'nature-changing device', which let's you change your nature to that of any living creature. Anyway, one of them becomes human and enters the market. After building up a fortune by production and trade, he then asks himself the scientific question that was asked before:

How would (my) economic behavior change if my country doubled its "rate of expropriation" of goods from (me)?

He is immediately struck by how much more predictive power he has -- how his grasp of the science of utility transfer among humans (economics) has vastly improved -- when he takes into account the internal wants and needs (the valuation, and reasons for valuation) of actual humans. He immediately beams back to the spaceship claiming he is now able to re-write economic science into something even more scientific with even more predictive potential.
***************************************************************************************
In the above, the aliens started out by being Austrian economists -- making note only of behavior, and only of past behavior. The alien who chose to be human for a while came to accept a more 'Objectivist' (a more "man-centered") view of economics.

Ed

Post 24

Wednesday, September 14, 2011 - 7:15pm

Hi Ed,

You wrote,

In the above, the aliens started out by being Austrian economists -- making note only of behavior, and only of past behavior. The alien who chose to be human for a while came to accept a more 'Objectivist' (a more "man-centered") view of economics.

I don't know where you got your understanding of Austrian economics, but what you're describing is the exact opposite of what Austrian economists believe.

A cardinal feature of Austrian economics is its concept of action which they characterize as purposeful behavior. According to the Austrians, a falling rock is not "acting," because it doesn't "wish" to get closer to the ground. Accordingly, the economist must impute subjective intentions or goal-directed action to the object of his study, which is acting man. In order to understand purposeful or goal-directed behavior, one must do so introspectively through an awareness of one's own motivations and intentional behavior. One cannot simply view a human being's actions externally with no understanding of his internal mental processes.

So your characterization of Austrian economics is not only false; it is the exact opposite of what the Austrians believe and make a point of stressing in their epistemology.

Post 25

Wednesday, September 14, 2011 - 7:50pm

Bill, perhaps my example indicated technology was the main effect, but that wasn't what I was getting at. There are many ways individuals can have a profound impact on supply in an industry. They can create a culture of achievement in their company. They can inspire their employees. They can forecast future trends better. They can innovate ways of reducing costs, like just-in-time manufacturing, which isn't new technology but is a better utilization of existing technology. They can create demand by convincing consumers to buy a product. They can aggressively compete on price. Or they can retire early, or dedicate more time for family, or whatever else.

It doesn't really matter what specific ways they affect supply, the fact that individuals can have a huge impact is the important point. If you read your initial list of supply factors, the choices and actions of individuals weren't mentioned. And as I mentioned, demand can be treated like a nameless, faceless blob since no single individual has much of an impact. Supply is often treated the same way, especially in macro-economics where they are trying to use a formula to derive economic output from input factors. But in real life, individuals matter a lot.

To take an example from fiction, when Hank Rearden's metal was taken by the government and given to his competitors, they couldn't produce like he could. It isn't simply a force of nature, created ultimately by demand, where production will take care of itself. Individuals are critical. Yes, demand can create incentives, but execution is dependent on who is doing the execution. In a previous company I worked at, one selling point was that the market we were going into was huge and very profitable, and all we needed to do was execute well and we'd make real money. In the end, it was precisely because execution mattered that the company went under. The economic incentive creates the potential for success, but execution comes down to individuals.

Post 26

Wednesday, September 14, 2011 - 8:26pm

Ed and Bill,

I agree fully with Bill's comment. Let me add a few points.

Ed, you mentioned that the aliens wouldn't be able to tell why Britney spears, Jerry Springer, Jersey Shore, or troll dolls could have utility. That would actually be closer to a criticism of the "Objectivist economics", which suffers from the same kind of problem as the classical economics. By trying to treat value as equal to "utility", or usefulness, they would be dumbfounded. But only because they would be assuming that value is a product of usefulness, or objective needs, and wouldn't understand that there are many possible sources of value all of which produce economic effects. (BTW, I don't think you meant the 19th century, which is the 1800s.)

You suggest that the aliens have to become humans so they can understand and accept our values. But they shouldn't need to agree with anything that we do. Economists don't need to understand why people like Jersey Shore to understand that there are economic effects.

If they were to take the Austrian approach, they would recognize the individuals have some kind of value system. They would recognize that when the act, the seek to maximize their value. They would note that individuals act when they believe it will benefit them. They are, in effect, exchanging one set of circumstances for a more valuable set of circumstance. And then they'd see how when they trade with others, they are doing the same thing. It doesn't matter whether the values were rationally derived, accepted as second-hand judgments, provided as moral commandments, or were based on whim. They only note that people act purposefully to exchange one set of circumstance with a more valuable one.

Now what happens when a government increases the rate of expropriation? Let's talk specifically about an income tax increase. The individuals will find that certain activities have become costlier, while others haven't. Leisure cost and benefit doesn't change, but economic activity has a higher cost for the same value. How might this affect a person's choices? The values that have the increased cost would become relatively less valuable compared to the ones without that cost. The likely result is that individuals in that system will shift their pursuit of values towards those that didn't have an increased cost. So maybe they'll take time to read, watch more television, hang out with friends, etc. And maybe they'll give up extra work.

Note that the kind of expropriation matters a lot. If the government simply demanded money, no matter what you do, even if you are unemployed, it might have a very different effect. In order to survive and stay out of jail, you might have to put a certain amount of work to make money. The value of being alive and not imprisoned is likely to be much more important than most other values. Once that minimum is paid and you have enough to survive, you can then make choices between alternatives that are more typical. You might work more to gain material wealth. But since you already consume time and effort to pay off the government, the value of leisure time or relaxation may increase compared to what it would be if you didn't have those costs.

The point is that the aliens don't need to know what exactly is the appeal of Jersey Shore. They only need to recognize that people do have a value system, and do act purposefully.

Now will they ever know exactly what will be the effect if the rate of expropriation is doubled? No. Even if they saw that exact event happen and tabulated the results, the next time it happened could lead to very different results. But predicting exactly how every individual is going to react quantitatively is not (or should not be) the goal of economics. Having the alien transform into a human isn't going to give him any magic tools for calculating it. The best they can do is show that if the cost of an activity goes up relative to others, it will encourage individuals to choose the other activities. And for that, they don't need a detailed understanding of what values you have or why you have them.

Post 27

Wednesday, September 14, 2011 - 10:16pm

Joe,

All good points. I'm reminded of what economists refer to as the "factors or production," usually referred to as "land, labor and capital," but sometimes called "natural resources, human resources and manufactured resources." What is left out of this classification is entrepreneurship. The Austrians don't include it, because the entrepreneur is thought of as organizing the factors of production. Contemporary neoclassical economists include it as a factor or production, because it is considered as important in the production process as the other factors or production.

What you are referring to in terms of individual talent, innovation and ingenuity could involve entrepreneurship; they could also be classified under "human resources" or alternatively under "labor," which broadly understood subsumes all forms of human productivity.

When I mentioned "technology" as affecting a change in supply, I equated it with the discovery of new lower-cost production techniques, but clearly these cost-cutting techniques do not have to be limited to technological innovation; they can also result from better managerial skills and improved workforce organization and motivation.

(Edited by William Dwyer on 9/14, 10:18pm)

Post 28

Thursday, September 15, 2011 - 1:13am

Hey Bill,

In Human Action, Mises defines entrepreneurship in a very specific way different from the way we are casually using it. He points to the fact that the future is unclear, and people have to speculate in their economic activity. Entrepreneurship describes the fact that people have to speculate.

You mentioned land, labor, and capital. Mises discussed these in the context of entrepreneurship. I think he combines land and capital together. He then discusses a distribution of income. Entrepreneurs make a profit or a loss. Owners of the means of production (capital/land) earn interest. And labor earns wages.

The interesting point is that everyone, to some extent, is an entrepreneur. Everyone must speculate about future conditions, and act accordingly. The laborer must speculate on the best place to be employed, whether to save his money or spend it, etc. The capitalist also makes speculations about where to invest his capital. Everyone is an entrepreneur. But income can be thought of as being one of those three types. Wages, profits, and interest. The income is caused by one of those three sources (labor, capital, entrepreneurship).

Mises recognized that "entrepreneur" is often used to refer to people who start companies, have initiative, innovate, etc. He considers this view a narrower view of the term, since it refers to a much smaller number of people, whereas the way he uses it is applies to everyone to some extent.

So it seems like the Austrian approach does include entrepreneurship, but with a slightly different meaning. I suspect individual talent, innovation, and ingenuity would be considered labor. In that sense, the genius businessman who starts a company is acting not only as entrepreneur (figuring out what business to go into), but also as labor (all of the work of actually running the company).

As for whether the fact that technology and innovation aren't exactly identical, it makes sense that your original list would include any "change in innovation" instead of simply changes in technology. We agree on the underlying fact, and the rest is semantic.

I do want to point out that it isn't just a matter of using a new formula, though. An inspirational leader can't simply be copied or easily replaced. It's not that he has a technique for making managerial decisions that others can simply copy. So I'm sticking with my point that individuals matter in significant ways on the supply side (and usually they don't matter much on the demand side). If you were to take any one person from the demand side and remove them from the equation, it would have little effect (unless the market is tiny). But do the same for key people on the supply side, and the whole market can change.

Post 29

Thursday, September 15, 2011 - 2:52am

Schumpeter's economic theory (contemporary with the Austrians, but not an Austrian) talks about business cycles that are entrepreneurial in nature. That there is a long boom and bust cycle that is from the run of a major technological advance, and then the conversion to the next technology which might involve destruction of some of the old structures - collapse of the buggy whip factories as the automobile came into being - that kind of thing.

From Wikipedia: "...the central point of his whole life work [is]: that capitalism can only be understood as an evolutionary process of continuous innovation and 'creative destruction'... The hero of his story is the entrepreneur.
The entrepreneur disturbs [the] equilibrium and is the prime cause of economic development, which proceeds in cyclic fashion along several time scales."

It reminds me of Kruzweils' "The Singularity is Near" where he talks about the key feature of human nature - the drive to make improvements and the way that results in what could be seen as cycles (technological revolutions coming in waves).

These are like two different windows into economics - one is the static model that describes things with natural laws, and is either a slice in time or all-thing-remaining-equal equilibrium period, and the other is the view of human nature where it interacts with those natural laws to propel the evolution of economic development. Marx, Veblen, Schumpeter and others see a story where economics evolves. I like the way that Schumpeter tied this dynamic to not just human nature, but to the individual entrepreneur.

(Edited by Steve Wolfer on 9/15, 3:04pm)

Post 30

Thursday, September 15, 2011 - 3:42am

you gotta stop just looking at Praxigirl and start paying more attention to what she says, Ed.....;-)

Post 31

Thursday, September 15, 2011 - 12:40pm

Hi Joe,

You wrote,

In Human Action, Mises defines entrepreneurship in a very specific way different from the way we are casually using it. He points to the fact that the future is unclear, and people have to speculate in their economic activity. Entrepreneurship describes the fact that people have to speculate.

Right, the entrepreneur is a risk taker. The original meaning of the term "entrepreneur" (from the French) was "undertaker." The entrepreneur undertakes a new and risky process of production, and is the "residual claimant" of what's left over after all the costs are paid. If the sales revenue exceeds the costs, he earns a profit; if the costs exceed the revenue, he suffers a loss. Israel Kirzner characterizes the entrepreneur is someone who is "alert" to new opportunities for profit. Alertness is not something you can "bottle and sell," but it defines the successful entrepreneur.

You mentioned land, labor, and capital. Mises discussed these in the context of entrepreneurship. I think he combines land and capital together.

Not as factors or production. He makes a distinction, as did the classical economists, between "original means of production" and "produced means of production." The original means of production are divided into that which is human ("labor") and that which is non-human ("land"). So land (which includes natural resources) and labor are "original means of production." Produced means of production are capital goods. So a tree branch is considered "land" (an original means of production), but if I whittle it into a spear and use it to catch fish, I've created a capital good (a produced means of production).

He then discusses a distribution of income. Entrepreneurs make a profit or a loss. Owners of the means of production (capital/land) earn interest. And labor earns wages.

I thought that, even according to Mises, the income earned on land is rent. So the return to capital is interest; the return to land is rent (although one could rent out capital goods as well), the return to labor is wages, and the return to a successful entrepreneur is profit.

Yes, I'm familiar with the view that every worker can in some sense be considered an entrepreneur, but usually the term refers to someone who employs the factors of production (land, labor and capital) in order to produce a product. And every entrepreneur can also be considered a worker who "labors" on behalf of his company. In that respect, part of his profit could be considered an implicit wage.

Good point about the impact and importance of individual talent on the supply side.

Post 32

Thursday, September 15, 2011 - 3:19pm

Hey Bill,

Do you have the Scholar's Edition? On page 255 (which is at the end of chapter title The Scope and Method of Catallactics), he describes the "functional distribution" of interest, wages, and profit/loss.

Later, on pages 632-633 (in Nonhuman Orignal Factors of Production) he has a lot to say about the flaws in Ricardian economics. Let me quote some:

The modern theory of value and prices is not based on the classification of the factors of production as land, capital, and labor.

and

When it distinguishes within the class of factors of production the original (nature-given) factors and the produced factors of production (the intermediary products) and furthermore within the class of original factors the nonhuman (external) factors from the human factors (labor), it does not break up the uniformity of its reasoning concerning the determination of the prices of the factors of production. [Emphasis mine]

and

The greatest merit of the Ricardian theory of rent is the cognizance of the fact that the marginal land does not yield any rent. From this knowledge there is but one step to the discovery of the principle of valuational subjectivism.

I take this to mean the main advantage of the theory is that it recognized the evidence that debunked it.

And

While the differential-rent idea, by and large, can be adopted by the subjective-value theory, the second rent concept derived from Ricardian economics, viz., the residual-rent concept, must be rejected altogether.

And finally:

Classical economics erred when it assigned to land a distinct place in its theoretical scheme. Land is, in the economic sense, a factor of production, and the laws determining the formation of the prices of land are the same that determine the formation of the prices of other factors of production.

Now here's my interpretation:

Going back to the Austrian view of rent, the first point is that they are different from the classical school. Classical economics viewed rent as different in substance from interested paid on capital. There was supposed to be some kind of inherent value there, whereas capital goods could be seen as being equal to their costs (or valued by labor theory, or whatever). Since land frequently had value even when no costs had been put into it, it was viewed as a different kind of factor of production, and rent was viewed as being derived from this special nature of land. Yes, you could improve your land, but those improvement would act like capital.

The Austrians reject this economic distinction. They don't need to differential land and capital. It doesn't matter how much labor or cost or whatever went into land or capital. The value of it is not derived from inputs. It's derived from the economic interplay of subjective valuations. In that sense, land and capital are the same. They are simply factors of production. The money that they earn is of the same kind and for the same reason. You might call one interest and the other rent, but in the economic sense, they are the same phenomena.

So that leaves three real types of distribution. Interest (which rent is just an instance of), wages, and profit/loss.

Now it might still make sense to use the term 'rent' since it refers to something real and substantial, but it is robbed of the previous economic significance.

This explains why when Mises discussed the functional distribution, he does not mention rent as a special category. It's only later that he explains why.

Post 33

Friday, September 16, 2011 - 6:59pm

Adding to Steve's point that Schumpeter viewed entrepreneurs (producers) as the prime movers of markets (and therefore, of market values), here's what Heilbroner wrote about Schumpeter in the book "The Worldly Philosophers" (p 295):

Profits, he said, did not arise from the exploitation of labor or from the earnings of capital. They were the result of quite another process. Profits appeared in a static economy when the circular flow failed to follow its routinized course.

Now we can see why the wildly unrealistic circular flow is so brilliant a starting point. For all the forces leading to disruptions in routine, one stands out. This is the introduction of technological organizational innovations into the circular flow--new or cheaper ways of making things, or ways of making wholly new things. As a result of these innovations a flow of income arises that cannot be traced either to the contribution of labor or of resource owners. ... the innovating capitalist now receives a "rent" from the differential in his cost. ...

Entrepreneurs and their innovating activity were thus the source of profit in the capitalist system.

Here, Schumpeter appears to have called the transient profits of innovators a form of "rent." On the next page, though, he says that while entrepreneurs are the sole generators of profit, they are not necessarily the primary recipients of profit. Instead, the owner of the enterprise (which may or may not be the entrepreneur) profits.

Ed

(Edited by Ed Thompson on 9/16, 7:03pm)

Post 34

Saturday, September 17, 2011 - 5:54pm

There is a difference between risk and uncertainty. Risk is calculable. It is the basis for investment. Uncertainty is the province of the entrepreneur: no one has done this before, therefore, we cannot calculate the percentages of risks.

Ayn Rand placed the origins of capitalism - versus mere merchantry - in the Enlightenment with the recognition of natural rights. It may be that rather than a singular event, this was an aspect of a complex cultural formulation. In Against the Gods, Peter L. Bernstein placed the origin of capitalism with Fermat and Pascal who made risk calculable. True capitalism as we know it - from natural rights to the Bank of England - was a consequence of the Age of Reason.

The blog Organizations and Markets devotes many posts from its professors to the nature of enterprise and entrepreneurship. They cite (and argue) Schumpeter and many others. Put "entrepreneurship" and variants in the search box to see some of the discussions. What enterprise is is complicated. It cannot be encapsulated in a dictionary definition.

I recommend a recent anthology, The Invention of Enterprise: Entrepreneurship from Ancient Mesopotamia to Modern Times, David S. Landes, Joel Mokyr, and William J. Baumol, eds., Princeton University Press, 2010, which I reviewed for The Libertarian Papers here.

Ed's view of capitalism assumes that the entrepreneur is omniscient. In fact, as classical economics asserts, it is the consumer, not the producer, who decides the value of an offering. Granted that capitalism is producer-driven, the inventor can only offer, not compel. It is true that no one asked for a telephone or a television or a home computer or a personal jet aircraft. Entrepreneurs provided these things. However, there was a television technology in 1890 based on selenium crystrals but it was a market failure, as were "vitamin waters" in the mid-1980s. The consumer - buyer - decides whether this exchange will bring profit.

In that, every consumer (so-called) is a producer and all "consumer goods" (so-called) are capital goods. In other words, the lawn mower, the dishwasher, the laundry washing machine, the microwave, these are all capital goods, no less no for being owned by households rather than hotels and golf courses.

(Edited by Michael E. Marotta on 9/17, 6:05pm)

Post 35

Sunday, September 18, 2011 - 11:05am

Mike,

Ed's view of capitalism assumes that the entrepreneur is omniscient.

No, you are over-stating my case. I don't assume that the entrepreneur is omniscient. In fact, no man is omniscient. But some men -- in some areas -- see farther, broader, or deeper than other men. When it comes to economic activity, it is like some men (consumers) are "partially blinded" and are being led through a dark cave by other men (entrepreneurs). The market is as epistemological as it is economic. Let's walk through several examples from the Villard Books book, "The Experts Speak", by Christopher Cerf and Victor Navasky:

1)
In 1899, there was a "partially blinded" man, Charles H. Duell (Commissioner of U.S. Office of Patents) who said:

Everything that can be invented has been invented.

So, Mr. Duell would plan his budget so as to include the "fact" that everything had already been invented, but men who could see farther, broader, and deeper would widen his limited perspective. In other words, folks would invent things, such as television for example, which would affect his purchasing habits. The prime movers of the market would help to instruct him on how to spend his money. His original "veil of ignorance" would be removed by the productive people around him.

2)
In 1878, British Parliament set up a committee to look into Thomas Edison's incandescent light bulb. They said:

[Edison's ideas are] good enough for our transatlantic friends ... but unworthy of the attention of practical or scientific men.

Also, in 1879, Henry Morton (President of the Stevens Institute of Technology) said:

How can he [Thomas Alva Edison] call it a wonderful success when everyone acquainted with the subject will recognize it as a conspicuous failure?

So, these "partially blinded" men wouldn't have invested in the incandescent light bulb because they "foresaw" that consumers will recognize it as a failure. But the suppliers of these light bulbs (Edison himself wasn't a good businessman) would eventually lead them to change their purchasing plans.

3)
In 1880, Edison himself (inventor of the phonograph) remarked:

[T]he phonograph ... is not of any commercial value.

Here, we have an actual inventor without good commercial sense or awareness. Entrepreneurial others, picking up on his invention, would eventually change his mind for him -- a fact recorded (no pun intended) by the eventual sales figures of such phonographs. What's important is that some men could see what would become important for folks (in the future), and some men were partially- or totally blinded to that.

4)
In 1845, the U.S. Postmaster General rejected an offer from Samuel Morse to buy the rights to his telegraph for $100,000 and he said:

[I am] not satisfied ... that under any rate of postage that could be adopted, its revenues could be made equal to its expenditures.

And in 1907, the CEO of a cable telegraph company (Western Telegraph Company), Sir John Wolfe-Barry, said:

I do not look upon any system of wireless telegraphy as a serious competitor with our cables. Some years ago I said the same thing and nothing has since occurred to alter my views.

So the Postmaster General and Mr. Wolfe-Barry would plan their budgets a certain way, only to be later altered by the success of things unforeseen by them (but foreseen by others).

5)
In 1876, the US President (Rutherford B. Hayes) commented on the invention of the telephone after he completed a trial telephone conversation:

That's an amazing invention, but who would ever want to use one of them?

So Pres. Hayes could not foresee that anyone would want to ever use a telephone, and I'm sure that he would plan his budget accordingly and fail to invest in a telephone for himself and in telephone stocks. Later, after being shown wrong, he would have the chance to change his spending habits.

6)
In 1913, inventor Lee DeForest was prosecuted for fraud. The US District Attorney in the case said:

DeForest has said in many newspapers and over his signature that it would be possible to transmit the human voice across the Atlantic before many years. Based on these absurd and deliberately misleading statements, the misguided public ... has been persuaded to purchase stock in his company.

So, what we have here, is a district attorney who cannot see the impending value of wireless communication, and an inventor who can. One is "partially blind" to what people can or will want, and the other one sees these things.

7)
In 1926, inventor Lee DeForest -- himself accused of fraud due to making people believe in and hope for the possibility of worldwide communication -- said:

While theoretically and technically television may be feasible, commercially and financially I consider it an impossibility, a development of which we need waste little time dreaming.

So, Mr. DeForest could see the value in his own inventions, but not the value in television. He was "partially blinded" and others helped him see.

8)
In 1946, the head of 20th Century Fox Studios, Darryl F. Zanuck, said:

Video won't be able to hold onto any market it captures after the first six months. People will soon get tired of staring at a plywood box every night.

Yeah, right! Entrepreneurs knew better.

9)
In 1943, the Chairman of the Board of International Business Machines (Thomas J. Watson) said:

I think there is a world market for about five computers.

Yeah, right!

Also, the 1949 March edition of Popular Mechanics reads:

Where a calculator on the ENIAC is equipped with 18,000 vacuum tubes and weighs 30 tons, computers in the future may have only 1,000 vacuum tubes and perhaps only weigh 1 1/2 tons.

Yeah, right! Real 'foresight' from a "forward-looking" magazine! Hah!

In 1957, the Editor in charge of business books at Prentice-Hall publishers said:

I can assure you on the highest authority that data processing is a fad and won't last out the year.

In 1977, the President of Digital Equipment Corporation (Ken Olson) said:

There is no reason for any individual to have a computer in their home.

10)

In 1903, the President of Michigan Savings Bank said:

The horse is here to stay, but the automobile is only a novelty--a fad.

Yeah, right!

Well, Mike, I may not have shown you how entrepreneurs economically "force" people to change their minds about products (and therefore their spending habits), but I hope you will agree that there are some people who are more in the dark than others are -- regarding what it is that man will need and value. And it is this very differential -- this difference in the ability of folks to see what man will want and need -- that explains much of the market, and much of the eventual market value of products.

Ed

(Edited by Ed Thompson on 9/18, 3:21pm)

Post 36

Sunday, September 18, 2011 - 12:02pm

Now, in the spirit of entrepreneurialism, let's take an invented example (an analogy). Let's suppose that you have 2 potential entrepreneurs: Joe Blow and Mr. I.M. Insightful.

Joe Blow has an idea for a back-scratching device that works like a chain-saw. In fact, it is a chain-saw. Joe Blow's idea involves selling chain-saws with extended handles so that you can reach those difficult-to-get-to spots on your itching back.

I.M. Insightful, however, is working on the same problem, and creates a back-scratching device that is wall-mounted (so that you can just stand up against the wall) and contains pliable pieces (so that you cannot ever cut yourself).

Now, before these 2 things ever get to market, can we use our knowledge of man, biology, life needs, and predictable outcomes in order to predict who will win the greatest market share? Economists who believe in the concept of Consumer Sovereignty will answer: "No, that would be an appeal to omniscience." In other words, you cannot foresee how something would do on the market until after it has been brought to market -- and the consumers have had ample time to "vote" with their purchases. They will tell you that consumer choice is subjective, and that there is no way to know, beforehand, which of the 2 products above will serve consumers' (subjective) wants and needs better.

But the trouble with Joe Blow's invention -- as both you and I can and do know, before the device ever gets to market -- is that you are going to get a slew of injuries coming-in from the use of that thing. For instance, someone pressed too hard, or got bumped by someone, while attempting to remove an itch from their back and lo'-and-behold they cut themselves in half! Contrary to "consumer sovereignty" advocates, this insight that we harbor -- an insight about the future market value of a present or merely proposed product -- does not stem from some collective, subjective consumer choice.

It stems, rather, from more objective things like biology and the limits of what we can do to our bodies before losing all possibility of value or benefit.

Ed

p.s. To strengthen my case by making it as weak as is necessary, it doesn't matter whether an entrepreneur always gets it right (in an omniscient way). For instance, perhaps an "off-label" use is discovered for chain-saws with extended, looping handles -- and sales of the chain-saws actually do outperform sales of the wall-mounted back-scratcher (though people are buying the chain-saws for an unintended benefit). This is not counter-evidence to my theory that producers, not consumers, primarily steer markets (and even market values). For every wacky, "off-label" use like this that is discovered, there will be many more times when the "extended-handle chain-saw" (or whatever) is just simply a bad idea with poor market value, even in the long run. In other words, the exception proves the rule.

(Edited by Ed Thompson on 9/18, 3:35pm)

Post 37

Sunday, September 18, 2011 - 12:52pm

Michael wrote, "There is a difference between risk and uncertainty. Risk is calculable. It is the basis for investment. Uncertainty is the province of the entrepreneur: no one has done this before, therefore, we cannot calculate the percentages of risks."

There is a strong element of truth in that statement, but it is also true to say that there is a similarity between risk and uncertainty. Risk is a measure of the degree of uncertainty. When the degree of uncertainty grows to great most businesses and investors will not put up their money. There is an entire range of uncertainty which is not numerically calculable, yet venture capitalists will line up to examine, and in some fashion measure the risk and invest. There are degrees of uncertainty that will cause venture capitalist to become shy, yet not some entrepreneur.

There is no degree of uncertainty that won't find people willing to rationally step and take the risk as long as they see a probability of return that justifies that degree of risk. If I ascertained that for whatever strange occurrence, the number of purchasers of state lottery tickets was certainly going to be less than the size of the prize, I'd buy some lottery tickets... and look at those odds!

The full spectrum of uncertainty that will find a taker is without limit (look at those who buy lottery tickets despite the terrible odds against them!) But the free market works on reason and the unreasonable are separated from their wealth as it flows to those that are better at growing it.

But clearly there are degrees of uncertainty and kinds of uncertainty that totally dry up most lending, most investing, and most normal business practices - as we see in today's economy.

Post 38

Sunday, September 18, 2011 - 1:16pm

Uncertainty is the province of the entrepreneur: no one has done this before, therefore, we cannot calculate the percentages of risks.
Apply that to my 'back-scratching chainsaw' example. Would it hold up in court, for instance, if after a terrible incident involving his product, if the creator of this product told the judge that -- because no one had done this before -- that no one could calculate the percentages of risks?

No.

The judge would tell him that there is an ability to predict some outcomes of various economic activities. That this predictive ability doesn't hinge on subjective consumer preferences, but on biological limits for value or benefit (and for harm).

Ed

p.s. On a related note, here is DH Mellor in a 1977 piece called "The Popper Phenomenon":

We all rely, and believe we should rely, more on well-attested laws or theories than on new or refuted ones. A century of electromagnetic theory has transformed radio from the merest speculation to the firmest of facts. A modern Moore could as well have appealed to radio waves as to hands to show the existence of the external world. No contractor whose transmitter fails can get away in court with a Popperian defence of its failure as merely demonstrating the scientifically falsifiable character of the bold conjectures underlying its design.

(Edited by Ed Thompson on 9/18, 1:25pm)

Post 39

Monday, September 19, 2011 - 11:08pm