Liberty Matters

Price Theory and the Competitive Market Process


Peter Klein has challenged my reading of Kirzner’s contributions to economic science.  Some of these are going to remain disagreements in judgment and intellectual tastes – similar to our dispute over whether UNC or Duke basketball is the better team to be cheering for.  Others are more resolvable by looking at the “facts.”  But even there, we will disagree.  If we compare Kirzner’s CV to Gary Becker’s or James Buchanan’s, then, yes, Peter has a strong point that Kirzner didn’t have the same level of success at publishing in the top three journals (American Economic Review, Journal of Political Economy, Quarterly Journal of Economics).  But compared to other contemporaries, he did publish in a variety of professional journals, including the JPE, and by the 1970s he was widely acknowledged as the leading representative of the Austrian perspective in economic theory. This can be seen not only in his contribution to the Daniel Bell-edited volume, The Crisis of Economic Theory, but also his contributions to the New Palgrave Dictionary of Economics (in which he wrote the essay on the Austrian school) and his Journal of Economic Literature survey of the Austrian school.  These were all, more or less, enterprises of the intellectual mainstream, and Kirzner is singled out as the go-to representative among his professional peers.  He was the one to communicate the message of Mises and Hayek to these outlets.  Why would that be the case unless he was at least quasi-successful in the intellectual enterprise I attributed to him?
He did write a lot for outlets that were favorably inclined to the Austrian message – but I mentioned that in my acknowledgement that he spent a significant portion of his intellectual energy to “education” – writing to students and others about the power of the Austrian tradition to yield valuable insights about the market economy.   But his desire to do so by situating the Austrian contributions in the long history of the scientific and scholarly tradition of economic thought, from the classics to his day, was not something unique to him. It was a trait he shared with Mises and Hayek.  One must remember that even late in their careers, neither Mises nor Hayek thought the Austrian school was a unique alternative to neoclassical economics, but rather neoclassical economics at its finest.  This was an opinion shared by their Viennese colleagues such as Fritz Machlup.  In retrospect we can see that a variety of themes from the Austrian school could never be absorbed effectively into what became the mainstream discourse in neoclassical economics, but it is also a mistake, I’d contend, to see a complete disconnect between traditional price theory and the Austrian school.
In studying the history of ideas we must distinguish between plausible readings, productive readings, and “correct” readings.  We cannot jump back in time and know exactly what was inside an author’s head, and the words on the page are never enough. So instead we are left with sets of plausible and productive readings of an author and thus assessments of his/her contributions. We contrast those not with “correct” readings, but with implausible and unproductive readings.  My point isn’t any concession to postmodernist philosophy; it is just a fact of intellectual life.  We read with our glasses on, even if we try to pretend that we don’t.  And in a great scientific enterprise like economics, this is true across the board, whether we are dealing with Adam Smith and David Hume or Mises and Hayek.   There can be multiple plausible readings, and even multiple productive readings, though the set of productive readings will narrow from the scope of plausible.
In answering a question his teacher Mises put to him, Kirzner clarified the history of the discipline, from a science of wealth to a science of human action.  This put purposiveness at the center of all economic explanations and understanding.  The centrality of purpose would result ultimately in a theory of the economic process that focused on exchange relations and the institutions within which exchange relationships are formed.  Kirzner focused primarily on one specific institutional environment, namely, the private-property order and then studied how exchange relations relied on relative prices and profit and loss to guide, lure, and discipline.  Entrepreneurship in essence just follows from purposiveness, but the entrepreneurial market process follows from purposiveness operating within a private-property market economy.
Kirzner’s plausible and productive reading of Mises and Hayek for the construction of the modern Austrian theory of the price system and the competitive market process follows from developing key passages from Mises and Hayek about the nature of the price system.  Consider carefully Mises’s discussion in Socialism about the role of prices in the economic system:
In an exchange economy, the objective exchange value of commodities becomes the unit of calculation. This involves a threefold advantage. In the first place we are able to take as the basis of calculation the valuation of all individuals participating in trade. The subjective valuation of one individual is not directly comparable with the subjective valuation of others. It only becomes so as an exchange value arising from the interplay of the subjective valuations of all who take part in buying and selling. Secondly, calculations of this sort provide a control upon the appropriate use of the means of production. They enable those who desire to calculate the cost of complicated processes of production to see at once whether they are working as economically as others. If, under prevailing market prices, they cannot carry through the process at a profit, it is a clear proof that others are better able to turn to good account the instrumental goods in question. Finally, calculations based upon exchange values enable us to reduce values to a common unit. And since the higgling of the market establishes substitution relations between commodities, any commodity desired can be chosen for this purpose. In a money economy, money is the commodity chosen.[22]
Property, prices, and profit/loss provide the constellation of institutions and commercial practices that make advanced material production possible. Without them, economic calculation would not be possible. For this constellation provides "a guide amid the bewildering throng of economic possibilities."[23]
Rational economic calculation is able to sort out from among the feasible those commercial activities that are viable.  It does so by constantly exerting its influence on decision makers.  But again it is not always the case that the existing entrepreneur is the one who responds more effectively to the situation.  As Hayek stressed in responding to the model of market socialism, the competitive process itself cannot be undersold in the theory of the coordination of economic activities through time. 
For the purpose of this argument it may be granted that they [socialist managers] will be as capable and as anxious to produce as cheaply as the average capitalist entrepreneur.  The problem arises because of the most important forces which in a truly competitive economy brings about the reduction of costs to the minimum discoverable will be absent, namely, price competition.  In the discussion of this sort of problem, as in the discussion of so much of economic theory at the present time, the question is frequently treated as if the cost curves were objectively given facts.   What is forgotten here is that the method which under given condition is the cheapest is a thing which has to be discovered, and to be discovered anew sometimes almost from day to day, by the entrepreneur, and that, in spite of the strong inducement, it is by no means regularly the established entrepreneur, the man in charge of the existing plant, who will discover what is the best method.  The force which in a competitive society brings about the reduction of price to the lowest cost at which the quantity saleable at that cost can be produced is the opportunity for anybody who knows a cheaper method to come in at his own risk and to attract customers by underbidding the other producers.[24]
So what do we see Hayek emphasizing?  Discovery, adaptation, adjustment, and competitive behavior, with the result being the rather traditional price theory conclusion that if the process worked its way to completion and if we froze all subsequent changes, then price would equal marginal costs, and all least-cost methods of production would be utilized.  Of course, the process never ceases precisely because of constant change.  Economic problems arise, as Hayek put it in his famous “The Use of Knowledge in Society” (1945), precisely as a consequence of change.[25]  Kirzner synthesized the complementary yet distinct contributions of Mises and Hayek into his own coherent account of the entrepreneurial market process, which, just like Mises’s and Hayek’s accounts before him, sought to communicate to his scientific peers what was missing from their explanation and how it might be repaired.
The Mises-Hayek-Kirzner view on the problems of rational economic calculation within socialism should be flipped so we can see how they view what the market economy is able to accomplish. If we do so we will highlight in that discussion the role that monetary calculation plays in enabling advanced material production and the systemic order we experience in the market.  The production plans of some are meshed with the consumption demands of others such that at any point in time the mutual gains from trade are being explored and the gains from technological innovation are being exploited.  This, I would argue, is the mechanism by which Mises is able to discuss the social cooperation under the division of labor that modernity was able to realize.  Absent the ability to realize the gains from social cooperation under the division of labor, mankind is reduced to a miserable existence and a war of all against all for control of vital scarce resources. 
Our ability to understand the mechanism by which markets coordinate the plans of decision makers through time in such a way that they realize the mutual gains from trade and innovation is critical.  Yet much of the 20th-century philosophical movements cut against such an understanding.  The alliance of scientism and statism fueled by formalism and positivism on the one hand and socialism and progressivism on the other distorted economic understanding.  Mises-Hayek-Kirzner offer a serious warning about the consequences not only for scientific understanding, but also for social-philosophical questions about a just and humane social order, which is made possible only by the advanced material production of the unhampered market economy.
That is the project which Kirzner’s body of work contributed to and advanced so that the next generation of economic thinkers could pick it up and improve on it for their time and place.  It is up to us to engage in the plausible and productive readings of the Mises-Hayek-Kirzner contributions to price theory and the competitive market process and to develop the argument in a way that persuades our professional colleagues that the more traditional models based on formalism and the empirical approaches based on positivism have misled and distorted rather than improved and clarified our understanding.
[22.] Mises, Ludwig von. 1922 (1951). Socialism: An Economic and Sociological Analysis. New Haven, CT: Yale University Press. Quote, 115, emphasis added. Online version: Ludwig von Mises, Socialism: An Economic and Sociological Analysis, trans. J. Kahane, Foreword by F.A. Hayek (Indianapolis: Liberty Fund, 1981). </titles/1060#Mises_0069_236>.
[23.] Ludwig von Mises, Socialism: An Economic and Sociological Analysis, trans. J. Kahane, Foreword by F.A. Hayek (Indianapolis: Liberty Fund, 1981). </titles/1060#Mises_0069_241>.
[24.] Hayek, F.A. 1940. “Socialist Calculation: ‘The Competitive Solution.’” Economica 7(26): 125-149. <>. Quote p. 523.
[25.] Hayek, F.A. 1945. “The Use of Knowledge in Society.” The American Economic Review  35(4): 519-530. Online version: Friedrich August von Hayek, “The Use of Knowledge in Society,” American Economic Review, XXXV, No. 4; September, 1945, pp. 519–30. </titles/92#Hayek_0766_3>.