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# Can someone summarize the economic calculation problem?

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fegeldolfy posted on Wed, Nov 7 2012 8:23 PM

I'm trying to explain it to a fried on facebook, but I don't understand it that well.

Thanks.

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Fool on the Hill replied on Sun, Nov 25 2012 9:00 PM

Anenome: But it's probable that if the price of that thing is rising, it's because another producer has found a use for that good for which people are willing to pay much more. Thus, the first producer stops using that good if its price rises too high because the second producer has found a more efficient use of that good, and the means of that communication is price level.

It is only probable that raised prices indicate that another producer has found a better use of the good if we assume that the producer's expectations are accurate--since it is the expectations that determine the price and not the actual consumer demand.

(forums seem to be working again)

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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z1235 replied on Sun, Nov 25 2012 9:19 PM

Fool on the Hill:
In other words, the entrepreneurs guess that people will prefer x to y, z to x, etc., and this determines the price of the production goods. And somehow when entrepreneurs form these prices through their guesses, that makes them necessarily accurate guesses!

Buyers (entrepreneurs) "determine" the prices of the (production) goods they are buying? How exactly do they do this?

Because if they weren't accurate, they couldn't serve as a rational basis for economic calculation. Yet when "central planners" makes such guesses about future consumer preferences, the planners are unable to rationally allocate the productive goods because these goods have no prices!

What exactly is confusing you about this? Without prices you can't calculate. Without voluntary exchanges you can't have prices. Entrepreneurs are making guesses about the prices at which they could sell their final product tomorrow given the known prices of the production goods today. What exactly would the "central planners" be making guesses about?

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Fool on the Hill replied on Sun, Nov 25 2012 9:32 PM

Buyers (entrepreneurs) "determine" the prices of the (production) goods they are buying? How exactly do they do this?

By bidding on them.

Nothing. You mean what is wrong about it?

What exactly would the "central planners" be making guesses about?

Whether consumers prefer x to z.

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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z1235 replied on Sun, Nov 25 2012 9:50 PM

Fool on the Hill:

Buyers (entrepreneurs) "determine" the prices of the (production) goods they are buying? How exactly do they do this?

By bidding on them.

And the sellers have no say in the matter?

Nothing. You mean what is wrong about it?

No, you seem to be confused about a perfectly sensible statement.

What exactly would the "central planners" be making guesses about?

Whether consumers prefer x to z.

Let's assume they guessed (right or wrong, regardless) by perusing the results of an online poll that most consumers prefer x (Ferrari 458 Italia) to z (Toyota Corolla). Now what?

Btw, you missed addressing the most important part: voluntary exchanges => prices => calculation.

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Fool on the Hill replied on Sun, Nov 25 2012 10:02 PM

Jon: It isn't a "system". It isn't a single isolated organisation. It is the sum total of all owners of capital goods competing for ownership of said resources, bidding for them. These individuals and organisations are comparing their performance and valuations against each other, and that is what allows them to calculate.  This means it also encompasses any socialist states exchanging resources.

It has boundaries, and it has rules. That's what I think of as a system.

No, this is what profits or losses do. Not prices. As for the "unknowable" future, that is where the risk element of entrepreneurship comes in. I agree with Anenome re his comments on this.

Prices tell the producers whether there is a profit or loss.

Your problem is that you think of the market as some special "system". It isn't. It is competition between all institutions, organisations and individuals. You would be correct if you were referring to a single corporation i.e. a single owner of all capital goods, which would indeed have no external point of reference in the form of competition for ownership by other market agents, whatever they may be, but we are not comparing a single corporation as an organisation to a socialist state/commune.

Competition according to rules. A corporation is also an organization based on rules. A football league also consists of organizations competing against each other. Yet the points that the teams score don't serve as an external reference point to the system of football that allows us to evaluate its merits over those of cricket.

Can you tell me what "should" be produced by peering into people's heads? I asked you to do this already. Can you provide me of a better indication of what "should" be produced absent individuals allocating their spending, within their resource constraints?

I think surveys and such can be useful. I agree with the Mises quote I posted earlier that said only "understanding" (I would prefer the term "empathy" or "perspective-taking") of people's reasons for acting can allow us to make accurate predictions.

Yeah, hence market socialists concede that markets for final consumer goods are necessary to efficiently allocate these goods. They think that this solves the calculation problem, because then you can just plug in equations and voila, now you know how to allocate capital goods! It doesn't, because the problem concerns the fact that capital goods themselves need to be priced and allocated, and there are always different ways of doing things, determined by the profitability of doing so (which is impossible to determine absent prices and therefore competing ownership of these goods.)

I completely reject the basis that Lange and Taylor et al made arguments. They were working from neoclassical assumption through and through and were hence just as wrong as Mises was in the debate.

What determines whether the good was "worth" producing was whether it went to satisfying some want, which the consumer is willing to sacrifice resources for in exchange. That is, unless you think you know better than the consumer constrained by scarcity as to what they "should" consume and therefore what "should" be produced.

And what resources are they willing to sacrifice? Other resources that also need to be evaluated as to whether they were worth producing or not. Thus the criteria is circular.

No, not really. They are determined by the demand of said goods, which in turn determines whether it is worth incurring costs to supply the good. Entrepreneurs can attempt to close supply/demand gaps and identify new forms of goods to supply for which they anticipate demand. But they do not determine prices. They only control the supply element, and that in turn is only worth bringing to existence if there is demand for it.

But didn't Say point out that demand is supply? Then the demand of said goods is merely the supply of another. Who produces this second supply? The entrepreneurs, the producers.

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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Anenome replied on Sun, Nov 25 2012 10:12 PM

Fool on the Hill:

Anenome: But it's probable that if the price of that thing is rising, it's because another producer has found a use for that good for which people are willing to pay much more. Thus, the first producer stops using that good if its price rises too high because the second producer has found a more efficient use of that good, and the means of that communication is price level.

It is only probable that raised prices indicate that another producer has found a better use of the good if we assume that the producer's expectations are accurate--since it is the expectations that determine the price and not the actual consumer demand.

It doesn't actually matter, actually. Because if the producer is incorrect, he will quickly realize this fact or be forced in short order to go out of business. By virtue of losing money he will be unable to bid up the price of that good anymore.

If he is correct then he makes a profit and any use of that raw material not worth equal or more to end users cannot compete and is priced out of the market.

Actual consumer demand is tested every day, through actual sales. Businessmen then use that as data today to change strategy for tomorrow and longer-term generally. Thus prices are like an ocean in turmoil, always seeking equilibrium but never finding it, but certainly finding a median value.

Absent prices, how would a planner know which of a thousand coal producing pits to buy coal from? He cannot know. Which coal producers are the most efficient? No idea. Which should be rewarded for good management and oversight? Can't tell. Pick one out of a hat.

There is no point in arguing against a price-based economy in terms of the effectiveness of using prices in economic calculation. There is simply no replacement.

I suspect your true motivation is one of those irrational hatreds for money that leftists sometimes display. Am I right?

Autarchy: rule of the self by the self; the act of self ruling.
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Anenome replied on Sun, Nov 25 2012 10:24 PM
Suggested by Jon Irenicus

Fool on the Hill:

No, this is what profits or losses do. Not prices. As for the "unknowable" future, that is where the risk element of entrepreneurship comes in. I agree with Anenome re his comments on this.

Prices tell the producers whether there is a profit or loss.

Not solely. Price goes much beyond that. It motivates market activity on both sides. Let's say you sell coal, and the price of coal suddenly begins to increase sharply. You, as a coal producer, can make much more money by increasing production. And if you expect this trend to continue for awhile, that is for prices to stay high, then you might even be willing to take out loans for new equipment to get at certain coal patches that would be otherwise difficult and more expensive to mine. But with coal prices as high as they are now and no end in sight, it will be economical to mine that coal. So you do it, and use price as a signal to increase production.

The above is actually a great description of how oil supply increases, for there are many oil fiels profitable only once the price of oil reaches a certain amount. The amount of oil that could be supplied profitably at \$200 / barrel is probably 20 - 50 times that at \$87 a barrel. Heck at \$200 a barrel it would be profitable to prospect for oil in radically hostile locations.

Fool on the Hill:
Competition according to rules.

Not really. His point about an external reference is a reference exteneral to each individual viewer. A price serves that function of external reference. And it arises from realities in other invisible parts of the economy that the individual doesn't need to know about, he only has to see that those events cause an increase or decrease in price to understand what action is in his interest as a result.

Thus, there might be five oil field that dry up. He doesn't need to know this or be told to increase production. He only sees the price of oil rise and realizes it's in his interest to increase production, and thus he will. Absent a price structure, and thus absent that level of fine-grained communication, a planner could not approximate the same result through other communication channels.

Autarchy: rule of the self by the self; the act of self ruling.
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filc replied on Sun, Nov 25 2012 10:42 PM

FOTH

You have been around these parts for some time yet you offer no new reasoning.

Your hope is to find a flaw in a person(s) argumentation as a means to refute Mises and/or praxeology. As opposed to standing up to the theory itself you attack the argumentative abilities of individuals who represent it.

This does not defend your position or glorify it. Your endeavors do not progress your argument. You seem, only, desperate. Grasping at straws.

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filc replied on Sun, Nov 25 2012 11:02 PM

Anenome:
Let's say you sell coal,

It is not necessary to spend time providing examplestp  FOTH sincce he is not interested in these types of deductive exercises. What items may be revealed from the premise is immediately dissmissed. Instead, his underlyng goal is to be personally vindicated by revealing an error or flaw in your post. The attack is not on the theory or the logic itself but in our unfortunate inability to present it. His goal is not to find or explore a general truth of social nature. His desperation reveals the weakness that he owns.

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Jon Irenicus replied on Mon, Nov 26 2012 12:34 PM

Prices tell the producers whether there is a profit or loss.

They do only in conjunction with the prices of inputs and volume of sales realised, if you mean the sale price of the producer's goods. Again I think Anenome's post provides a good explanation of the role of prices in the economy. Even if the producer manages to sell at a profit, they might have been able to do even better, which the profits of other firms will communicate to them. Or they might take a more proactive approach and determine that utilising alternative inputs they could realise an even greater profit (or curtail losses even more.)

Competition according to rules. A corporation is also an organization based on rules. A football league also consists of organizations competing against each other. Yet the points that the teams score don't serve as an external reference point to the system of football that allows us to evaluate its merits over those of cricket.

The point of economies is to fulfill the wants of their participants. This provides a ready "yardstick" by which to compare them, i.e. economic efficiency. But I do not object to the usage of the speak of systems for that reason, but rather because you are in so doing conflating the market with a single owner of capital goods, on par with the socialist world state, and then asking what is the external point of reference for this arbitrary construct, which you would have to argue in terms of for the analogy to actually work.

Well in both instances the point of comparison will be economic efficiency insofar as one evaluates them as economies. However, that is not what is at stake; rather, the question is what means do decision-makers with respect to capital goods in a world where private ownership and therefore trade of capital goods is prohibited possess to evaluate what uses to put these goods to (and so on), if any, external to themselves? This is part and parcel of the overall question of which system delivers economic efficiency best. The answer is one that admits of degrees. Mises was dealing with the position where markets for capital goods are totally supplanted.

I think surveys and such can be useful. I agree with the Mises quote I posted earlier that said only "understanding" (I would prefer the term "empathy" or "perspective-taking") of people's reasons for acting can allow us to make accurate predictions.

A survey is just a wishlist. One can wish for anything.

I completely reject the basis that Lange and Taylor et al made arguments. They were working from neoclassical assumption through and through and were hence just as wrong as Mises was in the debate.

Then I am sure you can step in for them, since they are all wrong, and provide an explanation that occured to neither Lange nor Taylor nor Mises, as to how consumer goods will be allocated in an economically efficient manner absent market pricing. Lange and Taylor only got as far as they did because they bypassed the problem consumer goods posed. Additionally, what do you propose as the unit of account?

And what resources are they willing to sacrifice? Other resources that also need to be evaluated as to whether they were worth producing or not. Thus the criteria is circular.

Criteria for what? Determining whether the good was worth producing? That isn't the criterion. The criterion, on the consumer's end, was fulfilling the consumer's want, which they valued more highly than the resource already in their possession. In turn for the producer it was obtaining the good which they in turn valued more highly than the good produced (whether directly, or indirectly e.g. with money.) I can't see any "circularity" involved.

But didn't Say point out that demand is supply? Then the demand of said goods is merely the supply of another. Who produces this second supply? The entrepreneurs, the producers.

Say was dealing with a specific argument regarding shortages/surpluses on a market. He was not arguing that supplying a good means it will be demanded because it is being supplied. That would be to reject the subjective theory of value. Providing a supply of goods in turn furnishes the supplier with the means to demand other goods and procure them. That is all the argument states.

Freedom of markets is positively correlated with the degree of evolution in any society...

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Fool on the Hill replied on Mon, Nov 26 2012 9:10 PM

Anemone: Entrepreneurs do not set prices. This is one of the great economic fallacies prevalent in the general public's mind.

Price is determined by the intersection of supply and demand, and there are many considerations surrounding that assertion. But one thing you could never say is that price is determined by the entrepreneur.

What is determined by the entrepreneur is asking price, but asking a certain price is no guarantee at all that he'll find buyers willing to pay that price.

That isn't really what I am talking about. Let me put it more clearly (and expand the argument a little). Let us assume for a minute that each person's preferences are constant over time provided their income remains the same.

Premise 1: Person A and Person B if given x dollars will likely spend x dollars on different commodities. You would agree with this premise, yes?

Premise 2: The higher they expect the price of the final goods to sell for, the more the entrepreneurs are willing to spend on the inputs. As Mises says (and Jon agrees), the price of productive goods are determined by the expected prices of final goods. Further, wages equal the expected marginal contribution of labor. Agree?

Premise 3: The wages that are received by laborers becomes the means for consumers to buy commodities. Still agree?

Conclusion: The distribution of dollars among consumers is different depending on what the entrepreneurs expect the final prices of goods to be. Since each person has different spending preferences, the actual demand that results is changed by the predictions of entrepreneurs themselves. Thus, if one industry is reaping high profits, the movement of new entrepreneurs into that sector results in the wages of that sector being bid up while the wages of the sectors that capital was moved away from are lowered. This change in the wage structure then shifts demand to a different set of commodities. It could be that the old industry is reaping profits now. But if the entrepreneurs shift resources back to the old industry, then the wage structure then shifts back and the new industry might once again reap high profits. Thus, there is no inherent tendency towards equilibrium, because any move toward equilibrium is equally a shift in the demand structure. This is only mitigated to the extent that people have the same preferences.

From what I can tell, the calculation argument has two suspicious hidden premises:

1. People's preferences remain constant over time (otherwise past sales wouldn't tell us anything).

2. Everyone has the same preferences (otherwise guesses of the final price would themselves condition the final price).

And how can we know these premises are true? Surely not a priori. Could Mises be a positivist at the core? Does he think experience reveals the truth of these two premises?

All market transactions are essentially auctions. Most are streamlined auctions that do away with bid interactions. Instead the producer puts out a set asking price and if a buyer agrees to pay that, they simply pick up the good and purchase it.

Market transactions are certainly not auctions. Doing away with bid interactions means doing away with auctions. In a real auction, the seller knows that when a product sells, no one else in the room would be willing to pay more for the item. Most market transactions are not like this. When I buy a cheeseburger from McDonald's for \$1, McDonald's doesn't know whether another person would be willing to have paid more.

But again, this wasn't really what I was talking about.

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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Fool on the Hill replied on Mon, Nov 26 2012 10:00 PM

z: And the sellers have no say in the matter?

I would assume from Mises's perspective that the sellers of productive goods would value them in the same way that buyers do--that is, based on the expected prices of consumers goods that they can produce with them. So my point remains. The price of productive goods is based on the expectations of entrepreneurs. If you disagree, then tell me on what basis the sellers would price their productive goods.

No, you seem to be confused about a perfectly sensible statement.

Which statement would that be?

Let's assume they guessed (right or wrong, regardless) by perusing the results of an online poll that most consumers prefer x (Ferrari 458 Italia) to z (Toyota Corolla). Now what?

Well, let's see how entrepreneurs do it. Entrepreneurs expect that there will be a certain amount of money that will go to purchase commodities. They predict that A number of people will be willing to spend x number of dollars on the Ferrari and B number of people will be willing to spend y number of dollars on the Toyota. They look at the inputs they need and figure out how much they are willing to spend on them to produce the minimum expected profit they are willing to settle for. Meanwhile, other entrepreneurs do this same calculation for all other goods that they plan to produce. They then negotiate the price of the inputs based on the expected price of the final goods and the minimum profit they are willing to settle for.

The key question pertains to the role of dollars in the economy. What about the total quantity of dollars in the economy? What if there are twice as many dollars? Simple, the entrepreneurs double their prices. We see then that all the dollars do is serve as an aliquot part of the total social product.

Therefore, the first thing the socialist planners do is to divide the future social product into an arbitrary number of units. Let's say 1 billion. They then predict that A number of people will be willing to "spend" x number of these units on the Ferrari and B number of people will be willing to spend y number of units on the Toyota. They then look at the inputs they need and tentatively assign to them (as a whole) the expected price of the car. Meanwhile, the planners do this same calculation for all other goods that they plan to produce. They then use an algorithm to transform these tentative prices into unique prices of each input that takes into account all expected prices for all the final goods for which they might be used. So the planners determine the "prices" based on the same set of knowledge that the entrepreneurs do. One difference being that the planners aim for zero profits. There wouldn't be a single person making these estimates. The estimates would be made by a large number of people and then be averaged.

(This example is used mainly to illustrate how the predictions that entrepreneurs make are possible outside of a market. It is not the only possible socialist model nor necessarily the most desirable.)

Btw, you missed addressing the most important part: voluntary exchanges => prices => calculation.

Without prices you can calculate (see above).

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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z1235 replied on Mon, Nov 26 2012 10:34 PM

FOTH, you are right and I was wrong. Planners could indeed calculate by using units to form tentative prices which they would translate into actual prices via an algorithm. I'm off to join the Zeitgeist movement and become a planner myself. Peace out.

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Anenome replied on Tue, Nov 27 2012 12:03 AM

1. People's preferences remain constant over time (otherwise past sales wouldn't tell us anything).

They don't have to be constant, they just have to change slowly enough to make statements with reasonable surety. For instance, the best indicator, believe it or not, of how busy a restaurant is going to be tomorrow is how busy it was on that exact same day last year.

Similarly, milk usage is going to vary by a certain amount monthly, but it won't be such a huge amount as to upset the businessman's planning for milk production. Rather he'll be looking at long-term, multiple-month trends to plan scaling production up or down.

2. Everyone has the same preferences (otherwise guesses of the final price would themselves condition the final price).

Mmm, I think it's more correct to say that people are empathic. If someone tells me they have the cure for cancer, it's perfectly reasonable for me to assume that everyone in the world is going to have significant interest in that, for obvious reasons.

Similarly, people need to stay alive, need to be clothed, entertained, need transportation, and consume a million other things.

Those things that people don't prefer aren't being made. But huge fortunes have been earned by discovering new fields people would pay for.

For instance, the first cellular phones were hooked up in the 1930's. Not even kidding. Robert LeFevre called his wife on a demo-unit in 1930. Someone company was doing a test and contracted with the phone companies to tie into their circuits via radio.

Why then did it take 60 more years to mature as an industry? Largely because government got in the way, gave the phone companies a monopoly on communication.

-- To return to the topic: Many leading socialists back in the 50's conceded Mises's point on the economic calculation problem. What makes you so special that you can see what they cannot? And since markets work so well, why is there any need to replace them? Every attempt to communize completely, ie: farming, has led to mass starvation in the countries that tried it--China's great leap forward, 20+ million people died.

That gives you no pause at all?

Autarchy: rule of the self by the self; the act of self ruling.
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Torsten replied on Tue, Nov 27 2012 4:27 AM
 FOTH, you are right and I was wrong. Planners could indeed calculate by using units to form tentative prices which they would translate into actual prices via an algorithm. I'm off to join the Zeitgeist movement and become a planner myself. Peace out.

I think there is some misunderstanding. Is the calculation problem not actually about valuation and estimation. Which can not be provided by a central planner?

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