Reply To: High demand causes entrepreneurs to…


Your list is not quite right.
1. Demand for a consumer good increases.
2. Price of consumer good rises.
3. Profit for production of such consumer goods increases.
4. Entrepreneurs produce more of such consumer goods, which has two effects:
a. As they increase their supply of such consumer goods, the market-clearing price declines, which
reduces the profit from even more additional production.
b. As they increase their demand for the inputs used to produce such consumer goods, their market-
clearing prices rise, which also reduces the profit from even more additional production.

If your friend is a neoclassical economist, what is probably tripping you up (and it appears in your item no. 6) is that supply in the Austrian view is not based on costs of production. Production decisions are made based on costs of production, but selling decisions are based on the opportunity cost of selling the output, not the opportunity costs of producing it. Only in neoclassical models are selling decisions and production decisions synchronous. In reality entrepreneurs made production decisions and incur production costs before they made selling decisions and receive revenues. Once a good is produced, then production costs are sunk and are no longer opportunity costs of using or selling the good. But in order to sell the good and receive the revenue from the consumer, the good must have already been produced and therefore, production costs aren’t relevant for making the decision to sell or not to sell to the consumer.

If these points aren’t clear from the Austrian Economics lectures, take a look chapter 11 in Bob Murphy’s book, Lessons for the Young Economist: