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A Study Guide to Murray Rothbard's Man, Economy, and State, with Power and Market, by Robert P. Murphy (Hillsdale College)

CHAPTER 5: PRODUCTION: THE STRUCTURE (also in PDF)

Chapter Summary | Chapter Outline | Notable ContributionsTechnical Matters | Study Questions

CHAPTER SUMMARY

The evenly rotating economy (ERE) is an important tool in Misesian economics. The ERE is a fictitious construct where the future is certain, a world where economic activities repeat themselves indefinitely.

The ERE is primarily used to distinguish profit from interest. Entrepreneurs earn pure profits when they judge future conditions better than their rivals, while they suffer losses if they exercise poor foresight. In an uncertain world, a man may anticipate that consumer demand for a new product will be higher than others expect, and he will buy the factors necessary to produce the good and reap a much higher payment when he sells the finished product to consumers. This phenomenon is impossible in the ERE, because everyone knows exactly how much each good will fetch from consumers in the future. However, because capitalists advance present money to the owners of factors in order to sell goods to consumers in the future, the capitalists still earn more money from consumers than they had to pay to all of the factor owners who contributed to the production of the good. This excess would appear as a “profit” to an accountant, but not to an economist. It merely represents the interest earned by the capitalists on their invested funds. In the ERE the rate of return (per unit time) will be equal in all lines of production.

The difficult problem of analyzing the payments to various factors of production is broken down into simpler cases. In this chapter, we assume that all factors are completely specific, i.e. are useful only in the production of one good. We then deal with the case of joint ownership of the product by the factor owners; that is, the owners of land and labor each contribute their efforts to the maturing product, and then get paid their portion when the consumer purchases the finished good. The primary lesson from this analysis is that capitalists earn no independent return; ultimately all revenue from the sale to a consumer can be traced back to the owners of the original factors.

We later relax this assumption and allow for capitalists to pay the owners of land and labor upfront for their services, in exchange for relinquishing ownership over the maturing capital goods as they move through the production process. In this more realistic scenario, the capitalists do indeed retain a certain portion of the total revenue spent by consumers. However, this revenue is due to the fact that the capitalists paid the workers and landowners before their services yielded revenues from the consumers. It is the agio on present versus future goods (not exploitation or superior bargaining power) that explains the discounted payment to the original factor owners.

Cost is a subjective, ephemeral concept. The cost of an action is immediately borne by the actor, and is known only to him. The classical economists, as well as Alfred Marshall, were mistaken when they argued that prices are somehow influenced by the “costs of production.” The causality is completely the reverse: It is not the case that diamonds are expensive because they are costly to produce. On the contrary, diamond mines are expensive because consumers place a high marginal utility on diamonds. If one man takes ten hours to produce a good than another man can make in five hours, the first man cannot expect to earn a high price in the market because of his higher “costs.”


CHAPTER OUTLINE

1. Some Fundamental Principles of Action

A review of concepts discussed earlier.

2. The Evenly Rotating Economy

The evenly rotating economy (ERE) is an fictitious mental construction in which all economic activities repeat themselves in a perfectly predictable manner. The ERE is the final end state toward which the market would tend if all disturbing influences were held at bay.

There is no uncertainty in the ERE. The ERE allows the conceptual distinction between profit and interest: Because there is certainty, there can be no profits or losses in the ERE. However, there is still time preference, and hence interest.

3. The Structure of Production: A World of Specific Factors

This section analyzes a hypothetical world in which each good is produced by several completely specific factors; i.e. each factor of production is suited to produce only one good. There is thus no “economic problem” in deciding on the allocation of factors: Once consumers decide upon which goods they desire, it is a simple matter to employ the factors in the proper fashion.

It is clear that the total revenue obtained from consumers for a given good must be the total incomes paid to the factors used in its production. To analyze the distribution of this total income among the various complementary factors, Rothbard deals with two possible cases: joint ownership versus ownership by the capitalists (sections 4 and 6 below, respectively).

4. Joint Ownership of the Product by the Owners of the Factors

In this simple case, Rothbard assumes that the owners of the (completely specific) factors, which are used in the production of a given consumer good, maintain joint ownership of the goods-in-process as they “move down the pipeline” from the highest orders to the final consumer good. The main purpose of this analysis is to drive home the point that there can be no independent return to the owners of capital goods; all income received at the point of final sale (from the consumer) ultimately flows to the owners of the original factors, land and labor.

5. Cost

The marginal cost of an action is the value placed on the next-best alternative. This is clearly a subjective concept, since value is subjective. No outside observer can determine what the cost of someone’s decision. Moreover, cost is “ephemeral” in the sense that, once a man acts, the best alternative course is immediately rendered unattainable. (If it were not, then its value would not really be a cost of the original action. One cannot undo an action, he can at best perform another action.) Because action is forward-looking, the costs of production have no bearing on the sale price of a good.

Notice that in the special case of completely specific factors, there is no cost to production. If a factor is suitable for the production of only one type of good, then its use for this end entails no foregone alternative. Where this is obviously not the case—such as a wooded area being inherently beautiful if not used for erecting a shopping mall, or labor hours being used for leisure if not devoted to a productive end—simply proves that in the real world, factors of production are not completely specific; they must be allocated among competing ends.

6. Ownership of the Product by Capitalists: Amalgamated Stages

In this section Rothbard makes the more realistic assumption that, rather than the owners of land and labor waiting for their joint product to “ripen” into a final consumer good before receiving any income, instead the capitalists pay the owners of original factors at each stage of production. It is then the capitalists who retain ownership of the goods-in-process as they move down the pipeline from the highest order to the final consumer good. If there are no entrepreneurial errors, the capitalists will always receive more from the consumer than the sum total in payments made to the original factor owners.

This apparent change (from section 4, where the factor owners maintained joint ownership of the maturing product) is not due to “exploitation,” and it does not indicate a separate return to the capitalists as such. In section 4, the factor owners had to wait until the final sale to the consumer before receiving any payment. For example, laborers in coal mines would have to wait years before receiving any income from their efforts. But the capitalists offer to pay workers (and land owners) immediately for services that will not yield finished consumer goods until the future. Thus, the capitalists are exchanging a present good (money) for a future good (the marginal product, in terms of the final consumer good, of the factor in question). The excess of the capitalists’ income from consumers, over the sum of payments they make to the owners of original factors, is due to interest (i.e. time preference), and not to any bargaining power or other “contribution” of the capitalists.

7. Present and Future Goods: The Pure Rate of Interest

In the ERE there are no pure profits or losses. (Profits accrue to those who anticipate future conditions better than other actors, but in the ERE there is no uncertainty.) However, present goods still exchange at a premium against future goods, and thus capitalists can still earn interest. In the ERE, the rate of return in all lines must be equal; if capitalists earned 5% in one line and 3% in another, then they would shift out of the latter and into the former until the rates were equal. The precise determination of the interest rate will be discussed in the following chapter.

The classical economists (as well as today’s layman) thought that labor earned wages, land earned rent, and capital earned interest. This tripartite division is completely fallacious. All productive factors earn a (gross) rent or “hire price” per unit time in accordance with their marginal productivity, whether the factor is labor, a piece of land, or a machine. Those who buy

8. Money Costs, Prices, and Alfred Marshall

The classical economists tended to think that prices were determined by the “costs of production” (at least in the long-run and for reproducible goods). After the marginal (or subjective) revolution in the 1870s, many economists (including the Austrians) stressed the primacy of utility in the determination of price. Alfred Marshall famously argued that cost (supply) and utility (demand) determined price together, and that to ask which cause dominated would be akin to asking which blade of a scissors did the cutting. The Austrian response to Marshall is that even supply curves are ultimately determined by marginal utility. There is no “real cost” (in an objective, technological sense) to anything; all actions, including decisions to produce, are accompanied by a marginal cost that itself flows from a subjective valuation.

It is true that in the ERE, money prices for consumer goods tend to equal money prices for factor payments (due account being made for interest). But this does not mean that money costs determine money prices. The consumer of a good does not care how much money a producer spent in its production; the price of a good is determined by its marginal utility to the consumer. If the utility of a certain consumer good is so low that a producer cannot afford to purchase the factors necessary for its construction, the producer will hire fewer of the factors and produce less of the good. This will tend to lower the rents (i.e. prices) earned by the factors, and the reduced supply of the good will raise its marginal utility to consumers. The process will continue until the sum total of factor payments (including interest) equals the sale price of the consumer good. This process explains the tendency that “price equals cost.”

9. Pricing and the Theory of Bargaining

Because the analysis to this point has assumed completely specific factors of production, economics can say very little about the distribution of the income earned at each stage among the complementary factor owners. (We do know that the total income earned in a given stage must be discounted at the prevailing rate of interest.) Any voluntary agreement among the factor owners will leave them all better than if they did not produce at all, but we cannot predict what the actual agreement will be because of “zones of indeterminacy.”

At the very end of the section Rothbard explicitly introduces the assumption that labor is scarcer than land. There are always uses to which labor may be devoted to increase human happiness—if only to be consumed as leisure by the laborer himself. In contrast, at any given time there are always “submarginal” plots of land and other natural resources. It simply does not pay to incorporate them into a production process. Note that this assumption is not an a priori truth, but an empirical observation.


NOTABLE CONTRIBUTIONS


TECHNICAL MATTERS


STUDY QUESTIONS

Technical point: psychic revenue vs. profit

Study questions: fortune teller providing a service?


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