In his 1963 presidential address to the Southern Economic Association, later published as “What Should Economists Do?”, James Buchanan called on “economists to change their thought processes, to look at the same phenomena through ‘another window’, to use Nietzsche’s apt metaphor. I want them to focus on ‘exchange’ rather than ‘choice’” (1964, p. 217). The idea that economic theory is a “window” is a very apt metaphor, especially when economists come to different conclusions observing the same phenomenon. Thus, alternative conceptualizations of economic theory serve as different “windows” from which economists draw different conclusions about the world, especially about the functioning of markets.
Just as Buchanan often used this metaphor of Nietzsche, I want to adopt it here to make an important distinction between “price theory” and “price theory”.microeconomicswhich are often confused. Although the distinction may appear to be a semantic distinction, in these articles I will explain and illustrate the subtle differences between the two that have important implications for what we “see” when markets operate, and the extent to which we conclude whether the markets “work”. or “fail”. Just as the same individual will observe different aspects of the same car traffic from different windows of a building, we will draw different conclusions about a particular market simply depending on whether we are looking from the window of “price theory” or from ” microeconomics”.
What is the difference between both ? As Buchanan suggested above, “price theory” is primarily concerned with the study of how individuals pursue their distinct goals through exchange, which in turn creates exchange rates ( i.e. market prices) as by-products of their purposive behavior. These market prices, in turn, guide individuals in their consumption and production decisions. Human choice is not absent from price theory; rather, it is a necessary, though insufficient, subset of price theory for understanding the unseen manual processes that generate social order. Nor does price theory imply that markets instantaneously allocate resources according to omniscient human actors. On the contrary, a price-theoretic approach to economic theory is an approach in which there is a indirect link between a human agent and the tendency to equilibrium, a tendency in which market outcomes are not directly reducible to the individuals who constitute a market.
In other words, prices emerge from the act of exchange between individuals engaging in open choice in a world of uncertainty, but not of human design. However, once they appear, the prices become guides for future action. Thus, whether markets “work” or “fail” does not depend on the behavioral characteristics of individuals, but on whether institutions secure and reinforce individuals’ ability to trade (i.e. private property) . A “market failure” in this respect is not a failure of markets to “work” but a failure to establish the conditions for a market to exist, releasing future profit opportunities to establish those conditions.
Moreover, it is not enough that the prices reflect complete and available information. quickly, as suggested by the efficient market hypothesis; real world market prices are not sufficient statistics to approximate an allocation of resources compatible with equilibrium. Rather, market prices must translate the tacit and dispersed knowledge of millions into publicly held information. properly (see Boettke 2012, 2018).
As noted value investor Howard Marks points out, market prices are “efficient” in the sense of “quick and quick information to incorporate” not “correct”. (2011, p. 8). Thus, although not immediately obvious by its epithet, price theory depends crucially on the study of non-price competition. As Harold Demsetz argue, “[m]market processes do not operate instantly or knowingly, so perfect competition barely exhausts the many ways in which self-interest is pursued. Competition through product quality, contractual arrangements, and institutional innovation, along with tactical speed and vigilance, all become meaningful” (1982, p. 18). Price theory, properly understood, is a window from which to understand how individuals can learn to cooperate with each other without command within the framework of a division of labor. Such counter-intuitive “cooperation” manifests itself in a form of peaceful and cooperative cooperation: productive specialization And exchange.
Tomorrow I will examine how this theoretical “window” compares to microeconomics.
Rosolino Candela is a Senior Fellow in the FA Hayek Program for Advanced Studies in Philosophy, Politics, and Economics, and Program Director of Academic and Student Programs at the Mercatus Center at George Mason University.