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Austrian Microeconomics, Lecture 4 with Peter Klein - Mises Academy

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Austrian Microeconomics, Lecture 4 with Peter Klein - Mises Academy

  1. 1. Peter G. Klein | Mises Academy 20121 | Production and the FirmPeter G. KleinUniversity of MissouriAugust 9, 2012Austrian MicroeconomicsProduction and theFirm
  2. 2. 2 | Production and the Firm Peter G. Klein | Mises Academy 2012Definitions► Production: “the use by man of available elements of hisenvironment as indirect means — as co-operating factors — to arriveeventually at a consumers’ good that he can use directly to arrive athis end” (Rothbard, Man, Economy, and State, p. 9). Central idea: transformation Focus on purposeful human action — doesn’thappen automatically! Implications► Passage of time► Original versus produced factors of production Importance: five chapters of MES► Firm: locus of productive activity Entrepreneurs Factors of production
  3. 3. 3 | Production and the Firm Peter G. Klein | Mises Academy 2012Basic principles of factor pricing► Rental prices of factor services that are rented, and purchaseprices of factors, are determined by demand and supply infactor markets.► What determines the demand for factors?► Austrian theory of imputation Rental prices of nonspecific, isolable factors used in variableproportions tend to equal their discounted marginal revenue products. Rental prices of other factors set by bargaining between resourceowners and entrepreneurs.
  4. 4. 4 | Production and the Firm Peter G. Klein | Mises Academy 2012Marginal products and the law of returns► Law of returns: holding constant the quantities ofcomplementary factors, there always exists an optimum amountof a variable factor. Marginal physical product of a factor: addition to total product fromadding an additional unit of the factor, holding other factors fixed Diminishing marginal returns: as units of a factor are increased, itsmarginal product eventually falls. Marginal revenue product (MRP) of a factor: marginal product of thefactor × the price of the final good Discounted marginal revenue product (DVRP): MRP discounted by therate of interest
  5. 5. 5 | Production and the Firm Peter G. Klein | Mises Academy 2012MRP examples► Variable proportions 4A + 10B + 2C → $100(isolable factors): 3A + 10B + 2C → $80MRP(A) = $20► Fixed proportions 4A + 10B + 2C → $100(non-isolable factors): 3A + 7.5B + 1.5C → $75MRP(A) = $25► Specific, non-isolable, 1A + 2B + 3C → $200and indispensable 0A + 2B + 3C → $0factors: MRP(A) = $200
  6. 6. 6 | Production and the Firm Peter G. Klein | Mises Academy 2012DMRP for an isolable factor► Entrepreneurs demand factors based on DMRP; factorowners have reservation demandsFactors1st2nd3rd4th5thDMRP$30$27$25$22$20Pmin$ 9$11$13$15$17FactorownersO1O2O3O4O5
  7. 7. 7 | Production and the Firm Peter G. Klein | Mises Academy 2012DMRP for an isolable factor1 2 3 4 51st2nd3rd5th4thO4O5$30$27$25$22$20$17$15stock ofthe factorDMRP ofthe factorreservationdemand for thefactorQ* = 5, P* = $20
  8. 8. 8 | Production and the Firm Peter G. Klein | Mises Academy 2012► Classical view: costs determine prices► Austrian view: prices determine costs All costs are opportunity costs. Factor prices tend to equal their DMRPs(marginal productivity theory). Factors tend to be allocated to their highest-valued uses in production. The purchase price of a capital asset tends toequal the sum of its future DMRPs.► Common fallaciesMore on imputation
  9. 9. 9 | Production and the Firm Peter G. Klein | Mises Academy 2012Changes in factor prices► Changes in supply (stock) of factor► Changes in demand for factor (DMRP) Changes in time preferences (rate of interest) Changes in productivity of the factor (marginal physical product)
  10. 10. 10 | Production and the Firm Peter G. Klein | Mises Academy 2012Change in supply (stock)PQSD = DMRPP1P2S′ Example: increase insupply (stock)
  11. 11. 11 | Production and the Firm Peter G. Klein | Mises Academy 2012Change in demandPQSP2P1D′ = DMRP′D = DMRPExample 1: increase ininterest rateMRP
  12. 12. 12 | Production and the Firm Peter G. Klein | Mises Academy 2012Change in demandPQSP1P2D = DMRPD′ = DMRP′Example 2: increase inmarginal physicalproductMRP′MRP
  13. 13. 13 | Production and the Firm Peter G. Klein | Mises Academy 2012The labor market► More on the demand for labor Prices of final goods and services Quantity and quality of complementary capital goods► Note on the secular increase in wage rates – increases in capital per worker,not unions, government… Employer tastes for discrimination► More on the supply of labor Worker tastes for occupations► Compensating differentials
  14. 14. 14 | Production and the Firm Peter G. Klein | Mises Academy 2012Changes in reservation wages1 2 3 4 51st2nd3rd5th4thO4O5$30$27$25$22$20$17$15stockDMRPoriginal reservationdemandQ1 = 5, P1 = $20Q2 = 4, P2 = $22O4O5O3O2O1new reservationdemand
  15. 15. 15 | Production and the Firm Peter G. Klein | Mises Academy 2012The labor market► More on the demand for labor Prices of final goods and services Quantity and quality of complementary capital goods► Note on the secular increase in wage rates – increases in capital per worker,not unions, government… Employer tastes for discrimination► More on the supply of labor Worker tastes for occupations► Compensating differentials Wages in alternative occupations Costs of entry (e.g., licensing)
  16. 16. 16 | Production and the Firm Peter G. Klein | Mises Academy 2012Occupational licensingPQSD = DMRPP2P1SExample: market forlawyerssupply curvewith Bar Examsupply curvewithout Bar Exam
  17. 17. 17 | Production and the Firm Peter G. Klein | Mises Academy 2012More on compensation► Non-monetary compensation Compensating differentials The quality of the work environment Salaries versus fringe benefits► Note on minimum-wage laws► Careers and lifetime pay► The entrepreneur’s implicit wage
  18. 18. 18 | Production and the Firm Peter G. Klein | Mises Academy 2012Applications and extensions► No distinction between production and “distribution”► In the absence of uncertainty, only land, labor, and the “timefactor” earn net incomes. Gross income of capital goods is imputed back to the “original” factorsthat produced it, less interest.► Land consists of two components. Economic land: part that’s inexhaustible (“original,” “basic,” “groundland”) – earns its DMRP. Geographic land: part that embodies capital improvements – earnsinterest.
  19. 19. 19 | Production and the Firm Peter G. Klein | Mises Academy 2012Applications and extensions II► Rent = unit price of services of any good (Fetter) Ricardian rent: payment to a factor beyond that necessary to attract thefactor into production Marshallian “quasi-rent”: payment to a factor beyond that necessary toretain a factor in production► Prices of durable goods (i.e., their capital values) determined bycapitalizing the stream of expected future rents.► Note on positive time preference
  20. 20. 20 | Production and the Firm Peter G. Klein | Mises Academy 2012Entrepreneurship, profit, and loss► In the evenly rotating economy (ERE) Factors (including management) earn theirDMRPs. Capitalists earn interest (reward for forgoingcurrent consumption). No profits and losses!► Outside the ERE Entrepreneurs earn profits and losses based on anticipations offuture prices (Frank Knight calls “judgment”)
  21. 21. 21 | Production and the Firm Peter G. Klein | Mises Academy 2012The firm as an organization► Neoclassical view: firm as production function► Austrian view: firm as ownership of assets The firm is the capitalist-entrepreneur (or a group of capitalist-entrepreneurs) plus the alienable assets he owns. Ownership conveys authority Firms can own many, or no, production processes (functions).
  22. 22. 22 | Production and the Firm Peter G. Klein | Mises Academy 2012The theory of the firm► Why do firms exist? Transaction costs of market exchange (Coase 1937) Entrepreneurial judgment is non-contractible (Knight, 1921)► What determines the boundary of the firm? Internal and external transaction costs Entrepreneurial talent Need for economic calculation (Rothbard)► How should the firm be organized? Costs and benefits of delegation (Foss, Foss, and Klein, 2007)
  23. 23. 23 | Production and the Firm Peter G. Klein | Mises Academy 2012The limits to the firm► Incremental limits: indivisibility in the entrepreneurial judgment► Ultimate limit: need for external markets for all internallytransferred factors The vertical stages of production Divisional profit and loss Need for market-based transfer prices► Calculational chaos As external markets disappear, “islands of noncalculable chaos swell tothe proportions of masses and continents. As the area of incalculabilityincreases, the degrees of irrationality, misallocation, loss,impoverishment, etc., become greater” (p. 548).► Relationship to socialist calculation debate
  24. 24. 24 | Production and the Firm Peter G. Klein | Mises Academy 2012Takeaways► Austrian economics offers a unique theory of production, notmerely a verbal rendition of neoclassical production theory. Causal, realistic analysis of factor pricing and use Grounded in marginal utility theory Emphasis on economic, not technological, aspects ofproduction Focus on the entrepreneur► More work remains to be done in this area. Rent theory, internal organization of the firm, microeconomicsof business cycles, critique of neoclassical cost-curve analysis,more. . . .

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