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Chapter 4 of 30 · Study Guide to Human Action: A Treatise on Economics by Robert P. Murphy

Part Three: Economic Calculation

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Part Three—Economic Calculation

CHAPTER XI

VALUATION WITHOUT CALCULATION

Chapter Summary

1. THE GRADATION OF THE MEANS

Acting man values means according to the valuation he places on the ends they can achieve. (An apple seed is valued through consideration of the future apples it can produce for consumption.) The totality of means needed for a given end would possess the same value as the end, except for the discount due to the waiting time involved. (The concept of time preference will be discussed in a later chapter.)

Often actors must choose between various outcomes that all consist of countable supplies of different goods. Even so, the fundamental act of choice always involves a purely ordinal value judgment, not a quantitative “measurement” of subjective value. If a person, in one fell swoop, trades away five oranges in exchange for eight apples, all we can conclude is that he derived more satisfaction from “eight apples” than from “five oranges.” The units involved allow us to go no further than if he had traded away one baseball card for one lollipop.

2. THE BARTER-FICTION OF THE ELEMENTARY THEORY OF VALUE AND PRICES

The modern theory of economic value traces back the objective, quantitative prices in a market economy to the subjective, ordinal rankings of individual actors. In such an exposition “imaginary constructions” are needed, i.e., the economist must rely on simplifications in order to analyze one part of the economy, even though in the real world such a simplification would disrupt the very element being analyzed.

In this chapter, Mises discusses the imaginary construction of the barter economy, i.e., the tentative (and false) assumption that all exchange ratios emerge with goods being traded directly against each other, with no use for a medium of exchange (i.e., money) at all.

This assumption is necessary to understand the actual role of money. However, historically it led many economists into two great errors. First, many economists believed that money was neutral and served only to facilitate the “real” transactions that had been studied in the imagined state of barter. So if, say, the economist concluded that, in barter, one apple traded for two oranges, then it was a mere afterthought to add in money and conclude that (say) one apple traded for $1 and one orange traded for 50 cents.

The second great error of many economists was to suppose that items exchanged in a market were of equal value. Even the great classical economists thought that long-run prices were due to the quantity of labor needed to produce the goods in question. The modern subjective theory of value starts with the realization that people trade goods precisely because they value them differently. When Joe gives up his apple for Mary’s orange, this doesn’t prove that each fruit has equal value. On the contrary, it shows that Joe values the orange more than the apple, while Mary values the apple more than the orange.

The Theory of Value and Socialism

The socialists, Institutionalists, and Historical School attack the economists’ attention to the problems of the isolated individual, commonly referred to as “Crusoe economics.” Although it is necessary to first understand autarkic exchange before proceeding to interpersonal exchange, nonetheless there is some validity in the charge. Ironically, the Crusoe approach is inadequate because it cannot illustrate economic calculation, which is what vitiates the entire program of the socialists and other critics of the economists.

3. THE PROBLEM OF ECONOMIC CALCULATION

Technology is quantitative; it tells actors how many units of various inputs are necessary in order to yield a definite quantity of output. However, this type of knowledge (of technical recipes) would solve the problem of economic calculation only in the artificial world where either (a) all means of production could be perfectly substituted for each other in definite ratios or (b) each means of production were suitable for one end only.

But in the real world, neither (a) nor (b) is true. Instead, each means of production is more or less suitable for a wide range of ends, and thus each means is substitutable for others but to varying degrees, depending on the task. This fact makes the problem of economic calculation too complex to be solved through engineering knowledge alone. Technology can tell us how many inputs of various kinds will yield a certain output. It cannot tell us which of several possible combinations of inputs is the most “economical” to use when producing a good.

Only money prices can solve the problem of economic calculation. With the use of money, every transaction has one particular good—the universally accepted medium of exchange—on one side, and this gives a common denominator to aid actors in their conduct. A man can look at the infinity of possible ways of taking various combinations of inputs to yield a given output, and he can determine which method is the cheapest. The natural sciences alone cannot provide this type of information.

4. ECONOMIC CALCULATION AND THE MARKET

The money prices established in a market are not measurements of value. They are historical facts, recording the ratio at which two items (the money good and some other good or service) exchanged in the past. Even though they are malleable (unlike, say, a chemist’s belief in the fixed nature of the charge of an electron), market prices still provide a guide to future action. Without them, all of the subsidiary concepts in accounting (capital and income, profit and loss, spending and saving, cost and yield) would be metaphorical.

Why It Matters

The issue of economic calculation is one of the central themes of the entire book, and Mises breaks up the discussion over several chapters. In this chapter, he focuses on what economic calculation is not—that is, he shows how there are quantitative relationships (in the natural sciences and in our technological know-how) that intersect “economic life,” but that these pieces of information alone do not suffice to solve the central problem of economic calculation. Mises briefly states that the solution is money prices, but he doesn’t elaborate in this chapter.

Technical Notes

  1. Mises singles out the varying specificity of factors of production as the key issue in economic calculation (pp. 207–08). For example, if a particular output good could always be produced by either n units of a, or 2n units of b, or 3n units of c, etc., and moreover this pattern were true of all output goods (with possibly different values of n for each consumer good), then it would be easy enough to value the factors of production. One unit of factor a would have the value of 2 units of b and of 3 units of c, and so forth. And we also know that a would have the same value (disregarding the time lag needed for production) as 1/n units of this particular consumer good. Thus, starting with the valuation placed on the final consumer goods, the completely nonspecific factors of production could be valued quite easily.

    On the other hand, if all factors were completely specific—meaning that factors a1 and a2 could only be used to produce consumer good A, higher-order goods b1, b2, and b3 could only produce consumer good B, and so forth—then it would be easy enough to value the factors: disregarding the time lag involved, a1 and a2 would be valued as much as A; b1, b2, and b3 would be valued as much as B, and so forth. But things are not so simple when the factors can be used in varying combinations to yield many different types of consumer goods.

  2. On pages 210–11 Mises alludes to the fact that even the physicists may have to drop the idea of a fixed standard against which to measure absolute quantities. For example, the famous Heisenberg uncertainty principle states that it is impossible to pin down the position and momentum of a subatomic particle beyond a certain degree of accuracy; the very attempt to determine the position of an electron (by firing light at it) will itself change its momentum.

    Even so, Mises says that on a macroscopic scale, natural scientists can certainly continue to believe that it makes sense to talk of length, without worrying that meter sticks themselves might change their size unpredictably. Yet this is precisely the problem with economic calculation. Money prices aren’t a measurement of subjective value, because money itself is an economic good, subject to changing preferences and diminishing marginal utility as one acquires more units of it.

Study Questions

  1. THE GRADATION OF THE MEANS
    • How is the gradation of the means similar to that of the ends?
  2. THE BARTER-FICTION OF THE ELEMENTARY THEORY OF VALUE AND PRICES
    • Why is it necessary to use money prices in order to engage in economic calculation?
    • Why does the economist need to first explain the direct barter economy before analyzing the monetary economy?
    • What are two principal errors that emerged from the unsatisfactory examination of direct exchange? What were the consequences for the understanding of money and its influence on exchange?
    • Is money neutral?
    • Does exchange imply that the goods or services involved have equal value?
    • Can we measure value?
    • What can we say about the valuations of units of a homogeneous supply?
    • In what way did the classical doctrines provide a basis for Marxian theories?
  3. THE PROBLEM OF ECONOMIC CALCULATION
    • Why are money prices necessary for evaluating and comparing the different alternatives and plans that serve at removing uneasiness for the acting man?
    • Do economic quantities imply money prices?
  4. ECONOMIC CALCULATION AND THE MARKET

    Comment: “The distinctive mark of economic calculation is that it is neither based upon nor related to anything which could be characterized as measurement.”

    • Why do exchange ratios permanently fluctuate?
    • Why do economic calculation and the estimation of the expected outcome of future action go hand in hand?
    • What is the meaning of economic calculation for human action? How is the concept of economic calculation related to “quantitative sciences of economics”?

CHAPTER XII

THE SPHERE OF ECONOMIC CALCULATION

Chapter Summary

1. THE CHARACTER OF MONETARY ENTRIES

Economic calculation encompasses everything that trades against money. Despite their apparent precision, most of the entries on balance sheets reflect the speculative anticipation of owners regarding future market conditions. Therefore, there is nothing “objective” about them. Even so, economic calculation is as effective as it could be. It cannot give a perfect guide to the future, because the future is inherently uncertain.

2. THE LIMITS OF ECONOMIC CALCULATION

Economic calculation can’t account for things that do not exchange for money. Even so, by reducing all other items to a common denominator, economic calculation makes decisions easier for “noneconomic” items. For example, if a financial wizard is choosing between a stressful job at a hedge fund that pays $350,000 per year versus a relaxed life in academia that pays $150,000, economic calculation allows him to boil down the decision to, “If I started in the academic spot, would I prefer to give up the relative peace for an additional $200,000 per year?” The fact that money prices do not eliminate all other judgments is surely not a strike against the conveniences that they do render.

Economic calculation only “works” in the setting of acting men in a market economy, making actual decisions. It makes no sense to discuss the “social value” of a particular policy, as if central planners could perform such computations outside of the haggling on real markets. It also makes no sense to compute the “total income” or wealth of an entire nation. When a firm’s capitalization is $1 million, that means (in principle) that if one sold all the assets and paid off all of the liabilities, there would remain $1 million. But this obviously can’t be done for the entire wealth of a large nation, let alone for the world as a whole.

3. THE CHANGEABILITY OF PRICES

Prices are in constant flux because their underlying determinants—ultimately the subjective valuations of individuals—are always changing. The popular clamoring for stable prices is due to the lamentable desire to pattern economics after the natural sciences.

4. STABILIZATION

It is understandable why people long for a money with “stable” purchasing power—the terrible experience with government inflation has led to this desire. Nonetheless, the numerous proposals (of various commodity baskets, etc.) for a stable money suffer from insuperable difficulties. These are some of the more important ones:

(1) Prices are not measured in money; they consist in money. There is no immutable unit of “value” that (even in principle) could be used to define the purchasing power of money.

(2) The components of a price index change in quality over time; a television set today is not the same thing as a television set in 1950, and thus comparing a dollar today to one in 1950 is arbitrary.

(3) The relative importance of the components of a price index can change over time, and there is no nonarbitrary way of gauging this effect. For example, if most people became vegan, then the price of milk and eggs should obviously carry a smaller weight in the commodity basket.

5. THE ROOT OF THE STABILIZATION IDEA

Historically, moneys that originated on the market (such as gold and silver) were adequate for economic calculation, even though they did not possess an eternally fixed “stable” purchasing power. Government inflations changed this and made it imperative for businesspeople to take into account changes in the value of money in their planning and long-term contracts.

Another factor in the popularity of the stabilization idea was the desire for a secure arena outside the uncertainty of the market. People thought the state (with its tremendous might, consuls, and so forth) could provide a shelter for wealth outside the vicissitudes of pleasing the consumers afresh every day.

Why It Matters

In this chapter, Mises lays out the boundaries of economic calculation and explains that, within their sphere, market prices render all the services needed of them. The tools of economic calculation are inappropriate, though, when people extrapolate into areas outside of the actual market. In particular, economic calculation cannot provide a measure of immutable value, because no such thing exists. The efforts to devise a stable money and to provide a flow of guaranteed income are futile.

Technical Notes

  1. Mises writes (p. 223) that the term “price level” is misleading. It suggests that changes originating on the “money side” could affect all prices proportionally, but (as we will see in later chapters) this is impossible. Money isn’t neutral, and changes in the supply of money will necessarily cause “real” disturbances, not just nominal ones.
  2. On page 228, Mises critiques the popular claim that war bonds allow the costs of a war to be shunted onto future generations. This is silly because all of the tanks, bombers, etc. consumed by the war effort obviously come out of current production. Of course, a war impoverishes future generations, but only because they inherit a smaller stockpile of capital goods than they otherwise would have.

Study Questions

  1. THE CHARACTER OF MONETARY ENTRIES
    • Can we anticipate future prices by looking at prices of the past?
    • Why do we have to distinguish between economic calculation as it is practiced by businessmen planning future transactions and those computations of business facts that serve other purposes?
    • Can economic calculation expand our information about the future?
  2. THE LIMITS OF ECONOMIC CALCULATION
    • What are the requirements for economic calculation?
    • How can things that don’t enter into the items of accountancy and calculation be evaluated and be taken into consideration?
    • Why is it nonsensical to compute national income or national wealth?

    Comment: “[P]rices are not measured in money; they consist in money.”

  3. THE CHANGEABILITY OF PRICES

    Comment: “The popular notions about money and money prices are not derived from ideas formed in the past. It would be wrong to interpret them as atavistic remnants.”

    • Why are the ideas of price stability fallacious? Why are they so popular?
  4. STABILIZATION
    • Why is the conception of stabilization useless in a world of perpetual change?
    • Why is it nonsensical to compare baskets of commodities over time in order to define index-number methods? What are the obstacles in regard to technological features of the commodities? Would it be possible to realize it if there weren’t these obstacles?
    • Why can’t other things remain equal if the purchasing power of money changes?
    • Does human action imply change? Why?
  5. THE ROOT OF THE STABILIZATION IDEA
    • What is meant by, “What economic calculation requires is a monetary system whose functioning is not sabotaged by government interference”?
    • What are the problems of government bonds?
    • How is the interest for government bonds financed?

    Comment: “Financing a war through loans does not shift the burden to the sons and grandsons. It is merely a method of distributing the burden among the citizens.”

CHAPTER XIII

MONETARY CALCULATION AS A TOOL OF ACTION

Chapter Summary

1. MONETARY CALCULATION AS A METHOD OF THINKING

Monetary calculation is the guiding principle of action in any society with a division of labor. It transforms the very thought process of anyone considering action that involves the property of others. Potential actions are evaluated on the basis of expected costs and revenues, while past actions are evaluated with the accounting of profit and loss.

Monetary calculation is not simply an outgrowth of action, however. Besides purposeful behavior, monetary calculation requires the institution of private property in the means of production, as well as a universally accepted medium of exchange (i.e., money).

Capitalism was originally a smear term for the system of free enterprise, meant to imply that this system only serves the narrow interests of the capitalists. However, the term is a good one, for the very notion of capital—of summing the market prices of the resources available for a project—is inextricably linked to monetary calculation, which itself can only occur in a capitalist society.

2. ECONOMIC CALCULATION AND THE SCIENCE OF HUMAN ACTION

Praxeology and economics would never have been developed were it not for the historical evolution of economic calculation. Only with money prices and the related concepts of capital, profit, and loss could the early writers have noticed patterns in commercial activity.

Why It Matters

In this very short chapter, Mises stresses the tremendous significance of economic calculation. It is not simply a habit of businesspeople, but rather a distinct mode of thinking. It is necessary for modern civilization, and is the reason for the usefulness of quantitative science. However, Mises underscores the fact that calculation can only work where there is money and where goods of all orders are owned privately.

Technical Notes

  1. Mises claims that monetary calculation is the “guiding star of action” (p. 230). However, action alone does not allow for calculation. In a socialist society or one with only barter, there would still be action—people would still adopt means to achieve ends—but there would be no true economic calculation.
  2. Mises writes that the “measurements of physics and chemistry make sense for practical action only because there is economic calculation” (p. 231). What he means is that the knowledge of the natural sciences alone is not enough to steer the use of scarce resources. Technology may dictate several ways of using resources to yield a desired outcome, but only with money prices can the actor determine which method is “best.”
  3. One could, in principle, develop all of the theorems of praxeology without experiencing firsthand a society based on the division of labor and money prices. After all, praxeological results are true a priori. However, in practice, no intellectual would have even thought along these lines had he not grown up in a capitalist society.

Study Questions

  1. MONETARY CALCULATION AS A METHOD OF THINKING

    Comment: “Monetary calculation is the guiding star of action under the social system of division of labor.”

    Comment: “Monetary calculation is entirely inapplicable and useless for any consideration which does not look at things from the point of view of individuals.”

    • Can economic calculation expand our information about the future?
  2. ECONOMIC CALCULATION AND THE SCIENCE OF HUMAN ACTION
    • What is Gresham’s law?
    • What is the quantity theory?

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