Formulation of Prices

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    Professor Herbener, I have been engaged in debate about the formulation of prices and I would appreciate some advice and insight on how to respond to some seemingly off-base allegations. The argument is that supply, demand and consumer preference do not really set prices, instead, most prices are formed using “mark up pricing” in which the prices are set by adding up the cost of inputs plus the company’s expected rate of return.

    As a source, this person linked me to a proposal written to Congress in 1933 or so bu the N.R.A. about industrial prices and their “relative inflexibility”. The argument was that supply and demand had worked over the previous century and prices reflected interactions between seller and buyer, but gradually more economic coordination was being accomplished administratively. In other words, it was argued that prices were being fixed by private businessmen in an administrative fashion and this was inflexible and unresponsive to supply and demand. Statements like this were made: “Prices in the depression were going down least where the drop in demand had been the greatest” and “In a large part of industry, the market is not equating supply and demand through a flexible price mechanism, but is brining an adjustment of production to demand at administratively determined prices.” They argued that a drop in demand, resulted not in lowering prices but in curtailment of production whle maintaining the price. One solution was to pulverize and break up industry and corporations.

    Further, the person who I am debating with argued that humans do not behave in a certain predictable way and there can be no laws of human action and that humans do not have known preferences therefore it is impossible to apply a law of supply and demand to prices. Ultimately, he denies the axiomatic Austrian approach about action and preferences, and he offered what he thought was evidence of prices being set administratively and not according to supply/demand via subjective consumer valuations.

    I’m sorry for the long winded and probably easily answerable question. This type of argument frustrates me and although I feel i know the answer, I’m not quite sure what approach or evidence to put forth. Thank you so much!


    Any and all action is taken by a person to obtain something the anticipate will be more valuable by foregoing an alternative considered less valuable. If two persons each anticipate a gain by exchanging what they have for what they want, then it’s in the interest of both of them to cooperate by finding a mutually agreeable price. The basic point of exchange between a buyer and a seller is for them to realize its mutual benefit. Sellers and buyers are free in a market economy to use whatever method they think best in formulating asking and offering prices. However, to make their trade and realize its mutual benefit, they must settle on prices that generate mutual benefit, i.e., prices above the minimum that the seller is willing to accept and below the maximum the buyer is willing to pay. The existence of billions of exchanges every day throughout the world illustrates the truth of this claim.

    Of course, government coercive force can attempt to impose legally mandated prices. The NRA cartelized various industries during the Great Depression. The point was not to make prices inflexible, but to raise them back to their pre-depression levels. By the time the NRA was in force in 1933, prices had already fallen dramatically. Price were clearly not rigid downward as they fell 30 percent from 1929 to 1933. Prices were not sticky downward during the depression. Moreover, the NRA was declared unconstitutional by the Supreme Court in 1935. So, at most, the NRA codes only administered prices for two years.

    As Joe Salerno has argued, the changeability of prices are one part of an entrepreneur’s strategy to cater to buyers. If buyers want prices that change rapidly in response to changes in demand, then entrepreneurs employ the technology to make this possible as in financial markets like the NYSE. If buyers want prices to change more gradually regardless of the moment to moment changes in demand, then entrepreneurs give buyers that result as in retail stores like Wal-Mart.

    The billions of successful exchanges that occur every day belie the claim that the behavior of person in unpredictable. Moreover, the laws of demand and supply do not refer to predicting people’s changing preferences over time. The laws take a person’s preference as it is demonstrated in action and conjecture at that moment what would be logical for the person to have done had the price been different than it was while every other relevant factor involve in the person’s behavior remained the same.


    Professor Herbener, thank you very much for the detailed and very helpful reply! Your response cleared up a lot of murky waters for me, and the links you provided were spot on. It’s amazing how much control the FDR and Progressive era intellectuals tried to exert over the market. The legacy of such short-sighted economic fallacies lives on to this day unfortunately, as you well know. Your class is helping me tremendously and I am very thankful!


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