Noob q about calculation problem and socialism

I read this http://mises.org/story/2401

I am new to economics. If someone has the time and patience to tell me if I got this right, and if I didn't, where I erred, I would appreciate it.

The article says that the one problem Mises said socialism cannot solve is how to make the kind of calculations an entrepeneur makes.

Mr Socialist shuffles his papers. It turns out the public wants so many Ipods, so many TV sets, so much bread and pizza. He has the exact numbers. An honest and brilliant man with only the public good at heart, he now has to to decide how many tons of steel will go towards making each of these products, how much electricity to allocate each factory, and so on for all the raw materials and land and labor at his disposal. He has perfect technical knowledge of how to produce everything.

He puts his data into a computer and it spews out the answers he seeks. In a few days everyone gets their Ipods and TVs, and everyone is happy.

But there is something very wrong with this picture. Why? Because let's say in capitalist America no one is making TVs anymore because they are guessing there will be no profit in it. They are predicting that in six months people won't be willing to pay more than $100 for even the best TV sets, because they find computers make them pretty happy. But the cost of building a TV in raw materials and wages and rent comes to $200. Computers, so the educated guessing assumes, people will pay for handsomely. So everyone has stopped making TVs and is instead making computers, which they hope will bring in good profits.

In short, in the future people will be willing to pay $100 for a TV and $200 for a computer. Mr Socialist also has guessed this to be true. He is brilliant, after all. [At one point Mises says he can't really be that brilliant, because unlike the Americans, he is not staking his own personal fortune on guessing the future. If the personal stakes are lower, the guessing is of inferior quality. Let us grant, however, that he has predicted correctly]. But the q is, how will he know to stop making TVs now? And don't say, "Because they cost too much to make, given that people will pay only a hundred bucks for them." How does he know how much they cost to make? Steel has no price now; he owns all the steel in the country. Same with every other factor of production.

One may ask, "OK, so he doesn't know; what's so terrible? After all no one is the wiser; no one knows how much it cost to make the TVs, because they were made with things that have no price. He'll make TVs that cost $200 to make in the USA, and will get back $100. Big deal. So the common man finally got a bargain. Good."

The answer is that the steel will now be missing for something people really wanted much more than TVs. There isn't an infinite supply of the stuff. He has wasted all kinds of resources making TVs nobody wanted that much, when he could have been making something people wanted much more.

The bottom line? The stores are filled with things nobody wants, exactly what happened in Russia all those years. [Of course they grabbed it anyway because there was nothing else.]

Keep this up long enough, making things people don't want, year after year after year, and what do you have? A failure right there. How bad is this? Will it bring an economy to its knees in total collapse? I'm not sure about that part, whether it will or won't and why.

 

 

 

 

 

Not sure what your question is, you seem to have a pretty good handle on it

That's what I wanted to know. TY

Good. It's cool to see someone learning. Let me be devil's advocate here for a moment.

Smiling Dave:

It turns out the public wants so many Ipods, so many TV sets, so much bread and pizza

The public will claim they want everything. The problem is scarcity means you can't have everything you want. Without wages and a pricing system the state will have to find another way of prioritizing production. Couldn't they just use something like Maslow's Hierarchy of human needs? Producing food and water first... moving up to iPods and tvs later? This would ensure everyone would be clothed and fed! Yay socialist utopia...

Smiling Dave:

How does he know how much they cost to make? Steel has no price now; he owns all the steel in the country

He could still measure the price of steel in man-hours. Your counter is that he does not know the value of this labor because he has simply coerced his plan into action.

Smiling Dave:

The answer is that the steel will now be missing for something people really wanted much more than TVs.

If he is so brilliant why did he make this mistake? It is theoretically possible for the planner to guess what the market would do. In this way, the calculation argument does not a priori stop a socialist state from functioning. It merely points out that in real life central planners will have many problems they don't know how to solve.

Smiling Dave:

The answer is that the steel will now be missing for something people really wanted much more than TVs

You're assuming that the market would not have also produced TVs in the same way. After all, entrepreneurs can make mistakes too... But this is all theoretical.

Smiling Dave:

The bottom line? The stores are filled with things nobody wants

If the state produced according to Maslow then this would not be true.

Smiling Dave:

Will it bring an economy to its knees in total collapse?

Maybe. But it would be possible to brainwash all your citizens so they are willing to die for you and then have them mass reproduce then take over the world or something.

 

 

Let me begin by thanking you for your detailed input.

Snowflake:

Good. It's cool to see someone learning. Let me be devil's advocate here for a moment.

Smiling Dave:

It turns out the public wants so many Ipods, so many TV sets, so much bread and pizza

The public will claim they want everything. The problem is scarcity means you can't have everything you want. Without wages and a pricing system the state will have to find another way of prioritizing production. Couldn't they just use something like Maslow's Hierarchy of human needs? Producing food and water first... moving up to iPods and tvs later? This would ensure everyone would be clothed and fed! Yay socialist utopia...

1. I stated that the Mr Socialist  knows what the public wants not as necessarily true, but meant it to mean "even if we will grant that Mr S knows what they want after they know they can't have everything [as you pointed out this important piece of the puzzle], he will still have other problems." I took this approach from reading a Rothbard summary where he stated that apparently some sort of trail and error approach might find out what the consumer wants to take home and consume. So I leave the field uncontested here; I [personally as a noob] don't really know if Mr S can find out what they want.

2.About using Maslow to draw up priorities. Yes, that would work partially. Mr S would know to give something more basic higher priority than something less basic. Make sure everyone has food, then worry about TVs. But he will still have huge problems if this was all he had to go by.

Maslow's Hierarchy, as you say, is one of needs. And he identifies at most ten or twenty different levels of need [I'm being very generous here]. However he did not and cannot create a hierarchy of the best way to fulfill a particular need. Each need can be satisfied in many ways. Take food for example. I assume there are literally millions of combinations of food that will keep one alive and healthy. And same with housing, and all the other needs. I don't think Maslow ever intended the impossible, i.e. to make a hierarchy of desires, which is a very individual thing. Some want more sports on TV, some want more movies, some want more news.

The consumer chooses based on his desires as well as needs. So Maslow's hierarchy won't tell Mr S if more people will want TVs or Ipods or computers, since they are all in the same place in Maslow's pyramid. They are all less important than basic food and clothing and shelter, but there is no hierarchy amongst them. 

Make a little survey among your friends. Write down 100 random consumer goods and ask them to list which ones they would buy first [if they only could buy one] and which ones second [if they could buy exactly two] etc. Would they all say "Cuban cigars before jewelry before meal at fancy restaurant before latest movie?" Or milk before eggs before cheese before bacon?

Smiling Dave:

How does he know how much they cost to make? Steel has no price now; he owns all the steel in the country

He could still measure the price of steel in man-hours. Your counter is that he does not know the value of this labor because he has simply coerced his plan into action.

!. I heard tapes about man-hours being used as measure of price. The gist of them, as I understand it, can be brought out in a little story. Say diamonds and coal were unknown today. Suddenly some clever scientist manages to discover that buried in the desert 1 mile down there are 25 beautiful diamnds, 2 miles down there are 25 ugly industrial diamonds, and 100 miles down there is an almost endless supply of coal, millions and milions of tons of the stuff. Man hours needed to extract anything depends only on how deep down it is.

After everything is dug up, clearly the price of each of the three treasures will be inversely proprtional to the man hours used to get them out, because other factors of supply and demand outweigh the man hours factor.

Moral of the story is that man hours can't tell you much about the price is going to be.

Smiling Dave:

The answer is that the steel will now be missing for something people really wanted much more than TVs.

If he is so brilliant why did he make this mistake? It is theoretically possible for the planner to guess what the market would do. In this way, the calculation argument does not a priori stop a socialist state from functioning. It merely points out that in real life central planners will have many problems they don't know how to solve.

The answer to that q is really the very heart of the matter. Assume Mr S knows by taking a poll or by trial and error or by some other way  what people are willing to pay for something they consume. So he knows they will pay $100 for a TV. [We are generously giving him the maximum possible knowledge here. I gather this is because other economists have argued that there are ways of finding out that particular nugget of information].

So he sits down and cogitates. "Hmm, they will pay $100 for a TV, will they? That means if I use $200 worth of stuff to make the TV, I have made something that uses up two dollars of resources for every dollar of satisfaction. I better not do that. I have to find a way to make that TV for $100, so that I have an extra $100 worth of materials left over to make something else.

So let me, in my brilliance, make a list of things needed to make a TV, and see how much the costs add up to.

A. Two pounds of steel. Cost: Uh oh, I'm stuck. How can I know the price of steel when there is no one to sell it to? I own it all, and I'm going to use it all for something or other. No one is buying it from me or anyone else. It has no price because there is no market buying and selling it.

So no matter how brilliant he is, he can't figure out "If there was a market, how much would Jones pay for it? It depends on how badly jones needs it, what he's going to use it for, how many other people were trying to outbid Jones. Brilliant as I am, I can't make up the correct hypothetical situation. Shoudl I imagine 300 Jones's? !,000? Should I imagine that Jones has found a way to turn steel into some new marvelous invention that he can sell for millions, and is therefor willing to pay dear for steel?" Mr S is just stuck. 

Smiling Dave:

The answer is that the steel will now be missing for something people really wanted much more than TVs

You're assuming that the market would not have also produced TVs in the same way. After all, entrepreneurs can make mistakes too... But this is all theoretical.

1. Yes, Mr S might have indeed lucked out and decided what the market would have decided in every single one of the millions of decisions involved in making every possible consumer good. But it's a stab in the dark he's making. The odds of success, though not zero, are very very small.

As an example, say our overworked Mr S needs a doctor badly. This one Doctor D can save his life, and no one else can. But he forgot the doctors phone number, including area code and international prefix. "That's no problem," his wife says. Just peck out any 12 numbers at random, maybe you will end up dialing his number. I dunno. There must be a better way.

2. Entrepeneurs do indeed make mistakes. Sometimes costly ones indeed. But they have a much much better chance at success than Mr S does, because they know something important that he has to guess blindly at.

Say you are about to invest your life savings in a business. Mr S tells you "I run a TV factory. Before I build a single TV, I consult my Ouija board to find out how much every single material will cost me, then I build." Mr E tells you the same thing, except that he finds out the prices of his materials by calling up suppliers. Who would you hire, and why?

Smiling Dave:

The bottom line? The stores are filled with things nobody wants

If the state produced according to Maslow then this would not be true.

See above.

Smiling Dave:

Will it bring an economy to its knees in total collapse?

Maybe. But it would be possible to brainwash all your citizens so they are willing to die for you and then have them mass reproduce then take over the world or something.

Oh, in that case, no problem.

Once again, thanks for taking the trouble to critique my post

Ya know, reading it again, I think I missed something. I have to think some more about the q I wrote was the heart of the matter.

Smiling Dave:

The consumer chooses based on his desires as well as needs

So couldn't you have a planned economy centering around providing for everyone's needs and then let the free market dictate their unknowable wants?

Smiling Dave:

I assume there are literally millions of combinations of food that will keep one alive and healthy

So the planner could just pick one and he'd be fine. If people don't like the taste they can get their own food from the market but at least the state provides you with a safety net.

Smiling Dave:

After everything is dug up, clearly the price of each of the three treasures will be inversely proprtional to the man hours used to get them out, because other factors of supply and demand outweigh the man hours factor.

Moral of the story is that man hours can't tell you much about the price is going to be.

the price on the free market doesn't mean anything to a socialist. They'll say its good that diamonds aren't worth as much because then society can focus on solving its energy crisis instead of worrying about something superficial like looking good. And measuring goods in man-hours brings us to a new era of equality because the schoolteacher and traffic conductor's labor is judged by the state to be equal.

Smiling Dave:

As an example, say our overworked Mr S needs a doctor badly. This one Doctor D can save his life, and no one else can. But he forgot the doctors phone number, including area code and international prefix. "That's no problem," his wife says. Just peck out any 12 numbers at random, maybe you will end up dialing his number. I dunno. There must be a better way.

The point was that the calculation problem doesn't solve things a priori, not that the planner has an easy job. Obviously he doesn't.

 

Snowflake:

Smiling Dave:

The consumer chooses based on his desires as well as needs

So couldn't you have a planned economy centering around providing for everyone's needs and then let the free market dictate their unknowable wants?

Smiling Dave:

I assume there are literally millions of combinations of food that will keep one alive and healthy

So the planner could just pick one and he'd be fine. If people don't like the taste they can get their own food from the market but at least the state provides you with a safety net.

This is a new wrinkle, a partly socialist partly market economy. The article I was trying to understand didn't address this, and I certainly don't pretend an ability to discuss it intelligently.

 

Smiling Dave:

After everything is dug up, clearly the price of each of the three treasures will be inversely proprtional to the man hours used to get them out, because other factors of supply and demand outweigh the man hours factor.

Moral of the story is that man hours can't tell you much about the price is going to be.

the price on the free market doesn't mean anything to a socialist. They'll say its good that diamonds aren't worth as much because then society can focus on solving its energy crisis instead of worrying about something superficial like looking good. And measuring goods in man-hours brings us to a new era of equality because the schoolteacher and traffic conductor's labor is judged by the state to be equal.

1. About repricing diamonds: This too is a new wrinkle. You are describing a situation where the guys in charge are not trying to give the people what they want, but to give the people what they don't want, because it's for the people's own good. The article was describing a situation where Mr S wants to give the people what they want, and was trying to prove that he doesn't stand a chance.

My only modest contribution to discussing the new situation you describe is to wonder how popular socialism would be if they came out and said "We won't give you what you want, but what we think is good for you"?

2. About repricing labor: This is really the same same situation as 1., repricing diamonds. Say we have a super star NFL player. He is toid, Peyton, from now on you're getting minimum wage for tossing that football." His response, "In that case I'd rather work on Poppa's farm." Once again the people get what they don't want. They want Peyton on the playing field, and are willing to pay the full price for it. But they won't get it.

Smiling Dave:

As an example, say our overworked Mr S needs a doctor badly. This one Doctor D can save his life, and no one else can. But he forgot the doctors phone number, including area code and international prefix. "That's no problem," his wife says. Just peck out any 12 numbers at random, maybe you will end up dialing his number. I dunno. There must be a better way.

The point was that the calculation problem doesn't solve things a priori, not that the planner has an easy job. Obviously he doesn't.

I don't understand the first half of your first sentence. But like I said, I am not clear about things that I wrote. There's something vague there that eludes me.

I do think I missed the boat in my original description. I get confused now trying to go through things step by step, first in a market, then in a socialist situation. With luck I'll post a new improved version, enriched by my having read [part of] Chapter 26 of Mises' Human Action.

Let me try and go through things step by step and see where the socialist dream breaks down.

Market: Mr Entrepeneur is trying to make a buck. He realizes that his only chance is to give people what they want, want so badly they are willing ot pay him more than what it cost him to make it.

Socialism: Mr S trying to give people what the want.

[Score one for Socialism so far. It directly seeks the goal we all are interested in, making everybody happy. Unlike the market, that gets to that end very dubiously and indirectly, it seems.]

Market: Eager to make a buck, Mr E sits down first thing and looks at his pile of moolah. He has enough to buy 1,000 tons of steel. He figures that with the latest downturn people will soon be sewing torn clothing rather than just buying new clothing. He also figures that to drown their sorrows in noise, people will be wanting Ipods. He estimates people will pay a dime for a steel needle, but it will cost him 11 cents to make. "Not worth it for me to make steel needles," he says. "They just don't want needles desperately enough to pay me 12 cents."  He notices that if he uses the 1,000 tons of steel to make Ipods it will cost him $90. He estimates people will pay him $100 for an Ipod. So he makes Ipods.

Mr F also has an idea. He figures if he makes needles from cheap tin, people will pay 5 cents a needle, and it will cost him 3 cents to make one. He goes into the needles business.

As luck would have it, people really are willing to pay $100 for an Ipod. They buy one and are happy. They are buying crappy needles, but they don't care. They don't want steel needles [not enough to pay for them].

Were Mssrs E and F lucky? Yes and no. They could have been totally wrong in guessing people will want Ipods and cheap needles. They were lucky about that. But it wasn't all luck. They did have some info to guide them, such as the current price of steel, the current price of needles, the current price of Ipods. They combined that with their business acumen and luck and struck it rich.

Socialism: Mr S wants to make something people really want. He is in charge of all the steel in the country. He knows they will probably pay a dime for a needle, and $100 for an Ipod. [A concession about Mr S's wisdom that Rothbard makes for the sake of argument]. "OK, should I make Ipods or needles with my steel, or a little of both? Or maybe make some tin needles too?" HOW WILL HE DECIDE? Unlike Mr E, he can't say "I will lose money if I make steel needles." There is no price on steel. Therefor he doesn't know if he is making or losing money. Or, to put it in his way of thinking, if he is doing what people really want him to do with the steel. That's his problem that can't be solved, no matter how smart he is.

He has this predicament [what to use it for] with every single scrap of steel, of land, of labor, with everything. And there so many thousands, or is it millions, of possibilities, all looking equally likely as far as he can tell.

Can't he just put an ad in the paper? If you want an Ipod and tin needles tell me, if you want steel needles andno Ipods tell me? No he can't. They would have to fill out a million page questionaire, that they couldn't possibly answer either. Because they would have to tell him what they want done with every last resource he has for him to get it right. And they don't know either, really. They know what they want in the stores, and the maximum they will pay for things. That's it.

Eventually he tosses a coin and decides to make steel needles. He sells the needles for a dime apiece. They get snapped up at such a reasonable price. Everyone is happy. Until they see their American cousins on TV dancing with their Ipods.

"We want Ipods."

"Sorry folks, all the steel is gone, it's been turned into making you the finest needles in the whole world."

"We'll settle for tin needles, just give us Ipods."

"Sorry Charlie, too late now. You never told me you wanted good Ipods and bad needles."     

"You never asked."

"How could I?"

"How did the Americans ask their customers?"

"They have prices to go by."

 

 

 

 

You need to use fewer examples and speak more broadly. You're opening yourself up to be accusing of setting up a one-sided situation where you always win.

If you speak in terms of concepts and definitions you avoid this pitfall and have the advantage of being a priori.

Try to think about this - how long does it take to go from mining to iron, iron to some specific type of steel, sand to silicon/glass, oil to plastics, materials to circuit components, boards and components to assembled circuit boards, final assembly of, say, an ipod - and the shipping from one place to another.  Price must be taken into account at each and every stage which assesses whether each stage is profitable in and of itself.  It is not "a few days" to get an ipod. it is more likely more than a year; the metals in the ipod could have been mined a decade ago.  Removing the price of iron, for example, means we either wastefully extract iron more quickly than we need it and other human needs/wants go unfulfilled because the resources/labor were misplaced in its overextraction, OR we don't assign enough importance to the extraction of iron and future processes must be halted like the house that must be put on hold because they ran out of bricks.  Imagine the same, now, with wood or lumber?  How many trees would be simply left to rot or mashed up into low quality paper because demand for their most valuable or effective use was overestimated? 

Saiphes:

Try to think about this - how long does it take to go from mining to iron, iron to some specific type of steel, sand to silicon/glass, oil to plastics, materials to circuit components, boards and components to assembled circuit boards, final assembly of, say, an ipod - and the shipping from one place to another.  Price must be taken into account at each and every stage which assesses whether each stage is profitable in and of itself.  It is not "a few days" to get an ipod. it is more likely more than a year; the metals in the ipod could have been mined a decade ago.  Removing the price of iron, for example, means we either wastefully extract iron more quickly than we need it and other human needs/wants go unfulfilled because the resources/labor were misplaced in its overextraction, OR we don't assign enough importance to the extraction of iron and future processes must be halted like the house that must be put on hold because they ran out of bricks.  Imagine the same, now, with wood or lumber?  How many trees would be simply left to rot or mashed up into low quality paper because demand for their most valuable or effective use was overestimated? 

I understand what you've written, I think. I get that putting huge efforts into things people don't want is very wasteful. There is one  subtlety, though, that keeps popping in and out of my understanding. How does having a price for the iron mined ten years ago, or the rotting trees, make sure resources get allocated where they are needed?

[Thinks a bit]. If the guy wasn't pretty sure he or others will need it, he wouldn't have spent money mining the iron or planting the trees. Having to pay money for your guesses makes you to make better guesses.

Actually I seem to remember Mises mentioning that in Chapter 26 somewhere along the way. If you play with house money you gamble more recklessly.

Anyway, thanks guys, i benefited greatly from all your inputs.

 

 

 

Smiling Dave:

How does having a price for the iron mined ten years ago, or the rotting trees, make sure resources get allocated where they are needed?

The price is dynamic and is a function of demand for that commodity. Increasing demands for iron will lead to increasing prices. An increase in price level means that you attract investors and more money can be spent getting iron out of the ground. In this way rising prices communicate that more iron needs to be produced.

Took me a while but I summarized the calculation problem in two regards.

 

A) No mathematical equation can detirmin the desires and demands of every man women in child on earth. As the consumer demand is subjectively derived.

B) No mathematical equation can predict the future costs of all ingredients in a given process. In addition, since consumer demand is now un-readable there is no feedback mechanism for when the most efficient process is found.

Hows that sound?

filc:

Took me a while but I summarized the calculation problem in two regards.

 

A) No mathematical equation can detirmin the desires and demands of every man women in child on earth. As the consumer demand is subjectively derived.

B) No mathematical equation can predict the future costs of all ingredients in a given process. In addition, since consumer demand is now un-readable there is no feedback mechanism for when the most efficient process is found.

Hows that sound?

Sounds well thought out to me