Production: General Pricing of the Factors

0:00Thank you. I'm going to try and experiment here and go without the podium to have a little bit of a less formal environment. Although I did bring my powdered wig and my black gown that I used to teach back at home just in case it becomes appropriate to use it. I do feel a little bit odd. Chad told me because of the camera I had to sit in the high chair. And I've been told on many occasions that I belong in a high chair, but I don't know if this is exactly what they had in mind. what they had in mind but I do feel a little bit like I'm on like I'm on MTV unplugged like I should have an acoustic guitar so I feel like breaking out into song you'll know why it's interesting to begin by thinking about you know where this material fits in with the overall structure of the book and just to remind you that there's a five chapter section on production theory of which this is

0:57is the middle, right? Two chapters we've done already today. We'll talk about Chapter 7 just now on general principles of factor pricing. It's a chapter on entrepreneurship that we'll do this afternoon and then tomorrow morning another chapter on some more specific details about factor pricing. But apparently from what we know from Rothbard's correspondence when he was working on the book, originally he planned just a single chapter on production theory. And if you think about the typical undergraduate level or even graduate level textbook in economics, often one or maybe two chapters on production theory is about all you get. But the more he got into the material, it began to expand. He ended up with five chapters on production theory, which is unusual.

1:45It's also unusual compared to other treatises in Austrian economics. Rothbard goes into far more detail, for example, on factor pricing, even than Mises does in Human Action. And if you look at some of the contemporary works in Austrian economics, particularly works that came out in the 80s, the early 90s, where lots of attention was placed on the role of the equilibrium construct and expectations and uncertainty and the market process in spontaneous order and so on, there's relatively little discussion of, you know, What you might consider the mundane details of economic analysis such as production theory and factor pricing. So it's interesting that he gives so much attention to it. I mean also the fact that there's an entrepreneurship chapter in here is quite unusual, right?

2:36We noted yesterday that Rothbard's inclusion of a chapter on money right at the very beginning of an economic principles textbook is highly unusual. It's also unusual to have a chapter on entrepreneurship right in the middle of production theory. You don't get that in any of the contemporary textbooks and you really don't get this kind of integration between entrepreneurship and the rest of micro theory or price theory even in some contemporary Austrian works. So just as money for Rothbard is not a peripheral topic that you sort of stick on at the end after you've done basic economics, likewise entrepreneurship is not a self-contained topic but rather it's an integrated, an integral part of the basic analysis of market exchange, production and so on.

3:24Now you guys have, you've read the chapter. Hopefully you've read the study guide and read through the text of the chapter at least once. You know, one of the things that's significant about the chapter, again, is not simply the volume of material The volume of material, but the way in which Rothbard develops this gradual incremental step-by-step treatment of all the relevant aspects of production theory in great detail. His predecessors from Menger to Boehm-Bawerk to Mises did not do it exactly in the same way, did not provide as much detail, and were not as systematic in how they did it. The general principles of imputation are present in Menger's 1871 book, Principles, The Principles, but only in a very sketchy way, in a very sort of preliminary treatment.

4:17And perhaps he would have gone into more detail if he had ever written the rest of his Grand Treatise. The Principles was supposed to be an introduction to a large, multi-volume work on economic theory that never got written. Boehm-Bawerk has lots of material about factor pricing, but it's not very systematic. It isn't given the same kind of treatment as Rothbard. And again, Mises brings up particular topics here and there but doesn't provide this kind of treatment. How many of you have had, raise your hand if you've had either an advanced undergraduate or a graduate level course in microeconomics? So most people have, right, not you guys. So you have some exposure to, let's call it the standard approach, the mainstream approach, to the neoclassical approach, whatever is the appropriate term, to the production function, and if you're really fancy, maybe isoquants and iso-costs and average cost curves and marginal cost curves and profit maximization, etc.

5:23This is different. As you read it, what were some things that struck you about how Rothbard's treatment of these issues is different from the treatment that you get in the standard textbooks. Just it could be anything from technical matters to general style and sort of look and feel. What are some things that strike you as you look at it? I think for me, it goes through the entire book, but it's structure as a whole, so it's gradually built up. Whereas in my economic course, they have basically one model, which they apply to different studies, and that's pretty much it.

6:10And if you don't get a sense of the bigger picture, or how they're interrelated, then you seem like arbitrary and show some scenarios that explain it somehow. Okay, good, so you get a sense that not only is it sort of very comprehensive, covers all the relevant topics step-by-step, but it's not just an isolated, it's not there's a consumer theory part and a producer theory part, and then you stick them together in another part, and these don't really fit. It seems like it's part of an overall, a structure, an edifice, right, was the term that he used in his, in his preface. Okay, what are some other things? What's different about it? Say, his emphasis on the time factor. Okay. I think that's an extremely important point.

7:10Like with money, as we discussed yesterday, Just yesterday, the typical mainstream treatment of value theory and exchange and pricing is all in barter terms. And then, you know, Chapter 23 of the textbook talks about money. And it really doesn't have anything to do with the rest of the analysis. It's neutral, but it doesn't have any effect on sort of the substantive conclusions. Same thing with time, right? Most microeconomics textbooks don't, I mean, maybe if they're really advanced, they might might have a production function with a two-period model, but you could go through the entire microeconomics course without having any notion of the passage of time, calendar time as we experience it.

7:56Time is covered in some parts of macro theory and maybe some parts of growth theory, but it isn't integrated in any way with basic micro or price theory. So his treatment of time and discounting is extremely important as well, and is unique. It's not based on math, it seems you're not supposed to plug in numbers to a bunch of other equations and solve for the edge worth of class or something. Yeah, I mean, there's, I won't say no, there's little math, few diagrams. I mean, come on, if you take an intermediate or advanced micro theory course in a typical university, what is it? What is it? It's all equations and graphs, right? I mean, Ruppert does have a little bit of algebra.

8:41He has some arithmetic and occasional algebra. He does have some diagrams, but, you know, the arithmetic content, the mathematical content is pretty low compared to the typical treatment. What – I mean, there's one diagram in particular that dominates sort of the mainstream treatment of production cost. What particular diagram or family of curves do you see over and over and over again in the standard treatment? You have one set, if you're advanced, you have these isoquants with marginal rates of substitution Institution, and in a more basic course you have, what other curves? Cost curves, yeah.

9:34You know, the marginal cost curve and the average cost curve and the long run average cost curve and the short run average cost curve and average variable cost and average fixed cost and lots and lots of these diagrams. That's absent from this chapter. Okay? So we don't see all the cost curve diagrams that are normally included in these treatments. and that's something that should strike us as interesting or unusual. He doesn't elaborate on that. You read that pretty straightforward. Yeah, I mean, the fact that the standard treatment is basically about that and nothing else and plays a much, much, a very different role in Rothbard's analysis. Okay, say that again. I think I know what you're getting at, but in the mainstream analysis.

10:32Right, that is a good point. When Rothbard talks about capital, right, he doesn't use Well, and labor and land, right, he's not, this chapter is not about some aggregate notion of capital in the abstract, or labor in the abstract, but he's, right, when we talk about prices, factor prices, he's talking about the prices of specific factors of production, right, actual capital goods, or actual units of labor, okay, so maybe we could call this, you know, an emphasis on discrete factors In the typical mainstream analysis, a firm produces output with two inputs, K and L.

11:22What exactly is the K, what exactly is the L, well, Rothbard is explicitly allowing for heterogeneous capital goods, units of labor, units of land that are used in discrete quantities. Remember the term that Professor Salerno used in his opening lecture about, you know, the way that we characterize Rothbard's analysis as part of this grander tradition that goes back to Menger. Remember he used the term causal realist. Spell that right. Causal realist, like this is – Rothbard is presenting an analysis, in this case, of The Pricing of Factors of Production, the Use of Factors of Production, that is causal, based on principles of cause and effect, as opposed to what would be, I mean, what does causal mean in contrast to what? What's non-causal?

12:19Yeah, exactly, simultaneous determination, right? This standard micro theory, mainstream and Micro-Theory doesn't have any notion of causality, right? That's considered unscientific, right? How would you describe it? That's, you know, Aristotelian, that's pre-scientific, scholastic, right? Real science, hard science has dispensed the notion of causality, we're told, and instead uses the principle of simultaneous determination, right? All these different variables in the economic system are equally determinate, right? One can be described as the cause of another, that's too sort of humanistic. So here we have an explicitly causal treatment, and it's also a realistic treatment, meaning it's designed to explain actual prices.

13:12The actual prices that are paid for factors of production, not some kind of abstract or long run equilibrium prices. Joe talked about going to Wal-Mart and buying his Def Leppard CD for $12.95 or whatever Rothbard's analysis is meant to explain why this local construction company paid so many dollars for a particular quantity of steel at a particular moment in historical time. You're trying to explain the real world using causal analysis. Anything else strike you as being unusual or different about your reading in this chapter? Chapter, right, absolutely, so the role that entrepreneurship plays is central and I think Bob Murphy I think has the section on entrepreneurship after this one, so I'll leave the details to him but also notice that I like to use the word mundane as a sort of a mundane treatment of the entrepreneur. Mundane not meaning unimportant but meaning kind of everyday, right? That the entrepreneur is portrayed in Rothbard's chapter 8 is not, you know, this sort of heroic romantic

14:39you know, sort of dashing figure which is the notion that you get in Joseph Schimpfhater's treatment of the entrepreneur but is, you know, an everyday business person who you that you don't see, isn't necessarily in front of the cameras, but is out there doing his or her thing, adjusting the structure of production to satisfy consumer wants. Okay, so we'll get into more details later this afternoon, but the role that the entrepreneur plays in this section is certainly extremely important. Okay, I'll say the analytical tools here are not arbitrary.

15:33I mean, I think Joe said in his last lecture, you know, this idea of the proof of the pudding is in the eating, and you don't get that strong sense in a lot of the standard treatments that well, here's a convenient way to represent production, we use a production function and and off we go, you know, how, what insight do you get out of that that you wouldn't get out of an alternative means or how do you compare those insights to what you would get from some other method of analysis, you don't really get that, that's too philosophical, too meta for the typical treatment, typical textbook.

16:18Anything else strike you as interesting or unusual? I was just going to say that a lot of times, like in the classical, he made it really important to say that they just focus on a firm, where it doesn't have an effect, it's too small to have an effect on it overall, so the price they just treat it as giving, so they kind of give up on it, they're not explaining the prices, what he's trying to figure out on the whole of the economy, on the finances. Yeah, that's an extremely important point. There's no assumption of price-taking behavior, so absence of perfect competition. So we don't assume that every firm, every producer is sufficiently small, that their actions have no effect on the market and so on.

17:09Again, this goes back to the notion of causal realism, that we're not trying to explain explain the behavior and characteristics of a hypothetical infinitesimally small firms because they don't exist, right, but rather we're trying to explain the behavior of actual firms in the real world which are not price takers in those sort of Volrasian sense of price taking behavior. He mentions that explicitly in one or two places, I think it's towards the end where he is talking about the relationship, it's in the appendix actually where he talks about about the relationship between the, talks about the shape of the marginal product curve compared to the marginal value product or marginal revenue product curves. And he notes that as the firm expands production, sorry, as the firm, as the entrepreneur begins to use more and more units of a factor, not only does the marginal physical product of that factor fall, but the price of that factor will be bid up as the entrepreneur seeks additional

18:08units in the market for the factor. So there's an explicit assumption that the entrepreneur is not a so-called price taker, right? But rather that the demand curves or factors are downward sloping, that the entrepreneur's actions in the factor market have an effect on the factor price. We'll come back to this point about mutual determination and circularity a little bit later. Right? And through the standard mainstream approach, all that the standard model does is kind of describe a state of affairs in which variables have particular relationships to each other, right? But it seems very odd if you start with the assumption that firms are price takers and then try to derive factor demand curves from them and use them to explain factor prices.

19:01But we started with the assumption that firms are price takers in the factor market. So where do factor prices actually come from? If everyone's a price taker, where do the prices come from? Okay, there's some circularity involved in the way – in sort of the standard treatment of marginal productivity, but we'll come back to that point a little bit later. You know, important term – one of the most important terms to get out of the chapter Manger is this word imputation, imputation. The concept is in Menger's treatment and the principles, though not the term. The term of the German equivalent of this term was introduced by Wieser, but has become, became a standard part of the Austrian literature, the pre-war Austrian literature.

19:52What is imputation? The value of the factors, or the prices that people are willing to pay for factors. The value of the factors is imputed from or determined by the value of the final goods that they're used to produce. Right, this is just an extension of Menger's analysis of the value of consumer goods, right? The demand for consumer goods, and hence the prices of consumer goods, the final goods and services in the market are determined by their ability to satisfy human wants. The theory of imputation is an extension of that principle, right, to explain the values and prices of intermediate goods, the factors of production, the goods that are used to to Produce the Consumer Goods, okay?

20:52And Menger introduces this concept in a general way. This quotation, I don't know if you can read it. This is in The Principles, this example of tobacco. He says, Menger says, he says, if as the result of a change in tastes, the need for tobacco should disappear completely, so you can say change in taste or change in fascist regulation, As Menger writing in 1871, if the need for tobacco should disappear completely, the first consequence would be that all stocks of finished tobacco products on hand would be deprived of their goods character. Okay, so the cigarettes, cigars, chewing tobacco, pipe tobacco, whatever, would no longer have the characteristic of an economic good because it is not available as a means to satisfy a human want.

21:40Okay, so tobacco would no longer be an economic good. And here's the point about imputation. A further consequence would be that the raw tobacco leaves, the machines, tools and implements applicable exclusively to the processing of tobacco products. So specific factors of production, the use of which, whose use can only be used to produce tobacco products, all of these would lose their goods character as well. In the case of the factors of production, the specific factors used to make tobacco would also no longer have the characteristics of economic goods because they can no longer be used indirectly as a means to satisfy human wants. The services presently so well paid of the agents who have so much skill in the grading and merchandising of tobaccos in such places as Cuba, Manila, Puerto Rico and Havana, as well as the specialized labor services of the many people both in Europe and in those Most distant countries, uncivilized countries like the US, who are employed in the manufacture

22:41of cigars, would cease to be goods. Even tobacco boxes, humidors, all kinds of tobacco pipes, pipe stems, Menger was obviously a tobacco enthusiast, would lose their goods character, and here's the point. This apparently very complex phenomenon is explained by the fact that all of the goods enumerated above, all these factors, right, derive their goods character from their causal All connection with the satisfaction of the human need for tobacco. With the disappearance of this need, one of the foundations underlying their goods character is destroyed. Okay? So one is you can imagine some kind of tobacco cigarette rolling machine that's an extremely impressive and technologically advanced piece of machinery, right, and we think, wow, this thing must be really expensive, must be really valuable in the market, right?

23:29Right? Well, it's valuable solely in its ability to produce tobacco that satisfies human desires. Okay? So if tobacco were overnight to become, you know, completely unpopular, were to lose its goods character in Menger's term, then this elaborate tobacco machine would be almost useless. But it might have some salvage value. You can melt it down for scrap. You can use it as a doorstopper or something like that. Right? But most of its value would be lost because its value is imputed from the value of the goods and services that it is able to produce. I mean, it's an important distinction when we think about the demand for consumer goods and the demand for producer's goods, right? Consumer's goods are demanded directly because of the satisfaction that they provide, whereas producer's goods are demanded, in a sense, indirectly, right?

24:22Entrepreneurs have a demand for producer goods or intermediate goods or factors, not because Because they get utility out of employing those factors, but because they can use those factors to produce consumer goods and services that they can then sell for money. So it's indirect step that we sometimes use the term that the demand for factors of production is derived, to derive demand curve, it's derived from the demand for the consumer goods that they're used to produce. Like if I own a restaurant and I hire Professor Salerno as one of my, you know, as my head I'm a waiter. I may demand bananas because I like to eat bananas and I get a lot of satisfaction out of them. I wouldn't demand his labor because I get a warm fuzzy feeling every time he's in the room.

25:10Quite the contrary. I would demand his services only to the extent that they're valuable to me in producing meals that I can then sell to people for money. There's another quote too. Menger also hints at, so here's the general idea, right, that the value of factors is imputed from the value of the consumer goods they produce. Menger goes into a little bit more detail about how one might come up with an actual unit, a specific valuation on a particular unit of a factor. And he does it this way, it's analogous to Menger's concept of marginal utility for consumer goods. So when, as we discussed yesterday, the marginal utility of a particular consumer good, of a discrete unit of a consumer good, is given by the ability of that marginal unit to satisfy a particular incremental use or want.

26:11Right, so we think, what need or want or satisfaction would the consumer be unable to achieve if a marginal unit of that good or service were taken away? Well, it's the same sort of principle here. Right, Menger says, this, what he's talking about in this section, general law, this is a general law of the determination of the value of a concrete quantity of a good of higher order. Assuming in each instance that all available goods of higher order are employed in the most economic fashion, the value of a concrete quantity of a good of higher order is equal to the difference in importance between the satisfactions that can be attained when we have command of the given quantity of the good of higher order, whose value we wish to determine, and the satisfactions that would be attained if we did not have this quantity at our command.

27:02This law corresponds exactly to the general law of value determination. So the value of a specific unit of a factor of production is determined by the amount of consumer want satisfaction we would not be able to achieve if that particular unit of the factor were taken away. Right? We're abstracting in this discussion from the element of discounting, the time discounting, which we'll get to in just a moment. Okay? An important thing to keep in mind here is, you know, there's a subjectivity. There's an important kind of subjectivity here. Let me try again. Here we go.

27:50Red works. Better red than the dead pen, better red than dead. is an important subjectivity in the sense that, you know, what makes something a producer's good, a higher-order good, or a consumer good, a lower-order good, is it's not determined by the intrinsic characteristics of the good, not determined by its technological properties or its chemical properties or whatever, but, right, it depends on the intentions of the human actors who are involved in the process. Right? So, I mean, Joe Salerno's company could be a consumer good, hypothetically. You know, he could be employed by a mail escort service, let's say. No, it's not an example.

28:36I mean, in principle, people could get utility out of Joe, right? Or, he could be a laborer and people get utility out of the things that he produces. It's the exact same Joe, right? I like to, it's one of my strange quirks, I like to make my own croutons. Some people think that's weird, but, right, I mean, so, if I'm making my own croutons, then bread is not a consumer good for me, but it's a factory production, right, because you take bread and you leave it out and let it get a little stale and you cut it into croutons and you toast them in the oven, you put some herbs on them, very good. The exact same loaf of bread can be a consumer good or a factory production, depending on and How I Intend to Use it, okay? So this is important. Something else that's critical to Rothbard's presentation in this chapter is that he's interested in the economic aspects of production, not the purely technological aspects of production.

29:35I mean, some standard treatments of production theory are all about the physical technology of production, right? I mean, how many kilowatt hours of electricity compared to how many man hours of labor, compared to how many units of steel do you have to stick into this process to get certain quantities of automobiles or whatever? The purely economic aspect, the valuation aspect is either absent or sort of brought in later. All the technical aspects of production are treated first and then, oh yeah, by the way, we need to introduce prices somehow. Rothbard is a very integrative treatment, as someone pointed out earlier. Okay, this sort of basic Mengerian insight, as elaborated by the later Austrians, von Boehm-Bawerk, Mises, Rothbard, it seems pretty obvious, right, that my example of the cigarette The early machine, you know, in a world where tobacco is forbidden or is unpopular, right?

30:43It's pretty obvious that machine wouldn't be all that valuable. But of course, when the theory of imputation was introduced, it was a radical departure from some of the theories of the day, right? You know, the idea of the classical economists, which was mentioned earlier today, that cost is the determinant of price. In other words, the costs of factors of production determine the prices of consumer goods, right? You see that, for example, in the labor theory of value in the classical economists and picked up by Karl Marx, right? That the value of particular goods and services, not all, but some goods and services, reproducible goods and services, is determined by the quantity of labor that went into their production, okay?

31:28Mises uses the example of champagne, right? Right, he says the classical economist believed that champagne that we drink, right, sparkling wine, whatever, the reason it's so expensive is because the land used to grow champagne grapes in France, the land in the Champagne region of France, is very, very expensive land. Right, Mises pointed out, no, that's the, that explanation has the cause and effect reversed. The reason the land in champagne is so valuable is precisely because people have a very high willingness to pay for the drink that you make out of the champagne, okay? So it's the valuation for the champagne beverage that gives the land in champagne its value, not the other way around, okay?

32:19I mean, now, this is not to deny that entrepreneurs, in making their, Joe, you call it, their sticker pricing decisions, that they deny that they may use rules of thumb, right, based on market prices of particular inputs that they purchase. You go to business school and you learn about these, you know, sort of optimal markup rules, and a lot of people believe that that's the way entrepreneurs operate, right, that you You go out and you buy the factors that you need and you add 20% and you sell it, right? So if factors get more expensive, well of course, final goods prices are going to get more expensive. Okay, but the prices that consumers pay for goods in the marketplace, right, is constrained by the demand, their willingness to pay for the services of those consumer goods, right?

33:06Doesn't matter what the factor prices were, it doesn't matter how expensive, doesn't matter how much the entrepreneur had to pay, right? That doesn't mean that consumers are going to be willing to pay that much for the final We'll talk a little bit about differences between Rothbard's approach and the neoclassical approach in just a moment. I've already mentioned this inherent circularity in the mainstream approach, but I actually added some diagrams to this, we'll come talk about that a little bit later. A couple more things to sort of walk us through, the way Rothbard goes about it, right, his presentation of the imputation theory, and I think this is all nicely explained in the study guide.

33:54I mean, everything in the study guide, it's wonderful of course, but let me clarify. So Rothbard uses the term DMVP, discounted marginal value product, you may be more used to the term discounted marginal revenue product or just marginal revenue product and as far as I'm concerned those are synonymous. You can use MVP or MRP if you like. So what was the definition? The discounted marginal value product or marginal revenue product is the monetary revenue attributed or imputed to one service unit of a factor, right? One discreet Unit however that's perceived by the entrepreneur discounted by the social rate of time preference or the pure rate of interest that we were talking about before. That DMVP or DMRP establishes the most that an entrepreneur would pay for one service unit of that factor. An entrepreneur would never pay more than in the ERE and long run equilibrium, no one would pay more than and the DMVP or DMRP of the factor because then you'd be paying, your outlays would

35:13be greater than your receipts from employing that factor in production. How do we know what the DMVP or the DMRP is? Well we have to be able to discount of course. But Rothbard adds some clarification or qualification describing specific cases in which the The MVP or MRP can be calculated in a way that is useful for explaining factor prices. And here's where he's a little bit different from the standard sort of mainstream treatment that talks about fixed proportions and variable proportions, perfectly substitutable inputs versus imperfectly substitutable inputs. Rothbard emphasizes that what's critical here is not Not variable proportions, per se, but the fact, what's necessary to use the marginal productivity account explanation for factor prices is that the factor be what he calls isolable.

36:12That the value of that factor be isolable, meaning you can independently identify the contribution of that factor from the other factors that are also used in the same production process. Okay, to be isolable, there are two conditions that have to be met, right? The factor must be used in variable proportions, right? What does variable proportions mean, as opposed to fixed proportions? We could change it by a little bit, it's going to be awkward. Yeah, like, that's right, I mean, you can, if there's more than one way to skin a cat, Right, you can add a little bit more labor, a little bit more of this factor and still get a cat, right, then you have variable proportions, then the inputs can be used in variable proportions.

37:04If you think of an automobile and you just define the inputs as, you know, steering wheels, you know, brakes and engines, right, it isn't the case that you can say, well, we just won't have brakes but we'll have two steering wheels and the car will be just as good. But that's a case where the factors have to be used in particular combinations, right? Adding it, you've got one engine, one set of brakes and one steering wheel, adding another steering wheel doesn't give you anything that's any more valuable than what you had before. It doesn't give you any more car, okay? So that's a case where the inputs have to be used in particular fixed proportions, right? And as we'll see with some examples, we cannot use the marginal productivity theory in the and the same way to explain factor prices when you have fixed proportions.

37:52But Rothbard points out also that the specificity of the factor as used in production matters, right? So a specific factor is a factor that can only be used to do one thing, okay? This, you know, cigarette rolling machine that I described, let's assume it can only be used to make cigarettes and, you know, as a door stopper, okay? A nonspecific factor would be something that can be used in multiple production processes. A truck, for example, is a nonspecific factor of production in that, you know, it can be used to transport different kinds of goods and services to different kinds of end users. Labor is a fairly nonspecific factor of production, though, again, that, you know, depends on the case.

38:39Maybe, you know, Mozart may have been completely useless at doing anything other than composing and Music, in which case his labor would be fairly specific. You couldn't employ him as a weaver or a horseman or whatever. But for most people, there's at least some specific, some, there's more than one use to which their labor can be put, okay? Let's look at some examples, get you to crank through these. These are not hard, okay? So, what's the DMRP and what's the ERE price in these particular cases? Well, just to keep things simple, let's ignore the D. Okay, so ignore discounting for a moment. If we include the discounting, it just means we have to do another algebraic step, it doesn't change anything.

39:27So forget about discounting for a moment. Suppose you have a production process with three factors of production, column A, B and C. And if you use four units of factor A, ten units of factor B, and two units of factor C, you can produce output that you can sell on the market for 100 bucks. And suppose it takes place instantaneously, no passage of time, so we don't have to worry about discounting. However, if you took away a unit of factor A, so you only have three units of A, ten units of B, and two units of C, you can sort of produce something. It's not like the car In the car case with the brakes and the engine, right, you still have something, it's just not quite as valuable, the output is only worth $80, okay? What's the marginal value product or marginal revenue product of a unit of factor A, you know, with these levels of use?

40:21$20, yeah, I mean, easy, right? In other words, if I took away a unit of A, I would lose $20 worth of final output. So the marginal value product or marginal revenue product of A in this case is 20 bucks, right? So entrepreneurs are out there bidding for the use of units of factor A, right? And competitive bidding among entrepreneurs will tend to push that price up towards its DMVP or DMRP. And so in the long-run equilibrium construct we talked about this morning and the evenly rotating economy, No uncertainty, the price of a unit of factor A would be 20 bucks. Okay? Suppose, oh, so again, and remember that A has to be nonspecific, meaning it's not just variable proportions that we need.

41:16We also need to assume that A couldn't be used in some other production process. Okay? It's not specific to producing this particular output. Okay, suppose you have a case of fixed proportions, right? And maybe the units can be divided in various ways. Can you guys see this in the back? Okay. Right, so if you have 4A, 10B and 2C, same thing we started with before, you get a hundred bucks worth of output. If we take away a unit of factor A, we also have to take away in proportion, you know, 25% of factor B and 25% of factor C. We get something that's worth 75 bucks. Right, in other words, suppose it's the case that if you only have three units of A, having anything more than 7.5 units of B does you no good.

42:06Okay, and having anything more than one and a half units of C adds no additional product. So this is a case where the factors have to be used in the same, in a constant proportion. Okay? Well, what's the marginal revenue product or marginal value product of factor A in this case?

42:34Okay. Well, what's the definition of marginal value product, marginal revenue product? How much what? Help them out. Or in reverse, how much revenue do you lose when you take away a unit of the factor? We take away a unit of factor A, how much revenue did we lose? Twenty-five bucks. The fact that the other factors can only be used in fixed proportions doesn't change the fact that, lo and behold, when we took away a unit of factor A, we ended up with something that was worth twenty-five dollars less. Well, wait a minute. But then, isn't it also the case that the marginal revenue product of, you know, 2.5 units of B is also 25 bucks?

43:26And the MRP of, you know, a half unit of C is also 25 bucks? The answer is yes. That's exactly right. Okay, notice there's no requirement that if we take the MRP of factor A and add it to the MRP of factor B and add it to the MRP of factor C that we have to get the total change in output or something like that. Okay? There's no requirement that the value of the marginal products has to sum up to the value of the total product. Okay? Not in a case where we have factors that are not isolable. What's meant by not isolable here, right, is that it's impossible to isolate the contribution of factor A from the contributions of the other factors.

44:14Because you can only use them in particular combinations. Okay, so we can attribute an increase, a change in value of 25 bucks to this change in the use of A, B and C combined in a certain way. But we can't attribute that individually to it, to, we can attribute it only to the bundle, not to the factors themselves. What does this mean? Well, it means no entrepreneur would pay more than 25 bucks for a unit of A, okay? But an entrepreneur might pay, might only have to pay, you know, five bucks or ten bucks. I think somebody said this earlier, right? The price, price of factor A would be no more than 25 bucks, but it's an indeterminate, And it would be somewhere in an indeterminate range, right bounded by 0 and by 25, depends on the bargaining position of the whoever owns units of factor A, and the bargaining strength of the potential users of factor A, competitive conditions and so on, okay?

45:11But even a more interesting case is if you have an indispensable factor, okay, so indispensable The definition of a car, suppose you have a unit of A, two units of B, three units of C, you get something worth 200 bucks, if you take away A, but you still have two units of B and three units of C, you get something worth zero. Okay, so this factor is indispensable to the production of this final good. Well, again, it's, this factor is not isolable, okay, you can't evaluate its contribution independent of the contributions of the other factors.

46:05According to our definition of marginal revenue product or marginal value product, what's the MRP of factor A in this case? $200. Okay. Does that mean that factor A will trade at a price of $200 in the market? Not necessarily. Nobody would pay more than $200 for it, but they might pay substantially less than $200. Depending on the specificity of the factor, what other uses in the production What kind of process can that factor be put? What quantity of that factor is available and so on? Right? So, we talked about the adding up, what they call the adding up problem. It bothered Wieser, but did not bother von Boehm-Bawerk, and it doesn't bother Rothbard.

46:55Right? People object, and I think somebody mentioned this, maybe it's in the study guide, Bob mentioned it that, you know, some people object and say, well, but how can you say that the marginal revenue product of the factor is equal to the value of the whole output? Well, I mean, in this sort of unusual case where you have an indispensable factor, that's exactly the case. This is a case where the marginal productivity theory of distribution does not help you very much in explaining the price of the factor. For this is Riesman's carburetor problem. Some of you know the economist George Riesman, who's a student of Mises, highly influenced by Mises but also by Ricardo and the classical economists, Rejects entirely the Austrian account of factor pricing, the Mangerian account in which the prices of factors are explained in terms of the marginal utilities of the final goods they produce.

47:49And one of his reasons for rejection is to use this sort of counter example. I don't know if you guys know what a carburetor is. The young people may not know, but it's the thing that you used to have to have in your car before fuel injection to make it run. And he says, well, you know, suppose you have a car that's worth $10,000, but without the carburetor, it doesn't run, and it's worth zero. So, according to Riesman, marginal productivity theory implies that the price of a carburetor should be $10,000. And that's absurd. Therefore, the marginal productivity theory must not be able to explain factor pricing. My response to that is that no, this is just an unusual case in which the price of the factor is not explained by the marginal revenue product of the factor.

48:38The marginal revenue product of the carburetor in that case is 10,000 bucks or whatever the value of the car is. That doesn't mean that carburetors trade for 10,000 bucks apiece, right? We need to include other factors to explain the price of carburetors. Namely, what are the alternative uses to which the things that go into a carburetor can be put elsewhere in the economy and so on. Okay, so this is not a problem for marginal productivity theory, it's just a case where it doesn't apply. I have some diagrams about the neoclassical approach, but we'll skip it unless you guys want to talk about it later. And just to point out that, as I said before, in the standard approach, you start with price-taking firms, Right? Prices are given exogenously and then you move the prices around and show how firms would use different combinations of factors, use that to derive factor demand curves, which you then use to explain the prices of the factors, which is what you started with, which you initially assumed to be

49:41exogenous, assumed to be exogenous. So it's circular. Okay, there's some discussion in the end of the chapter about differences between land, labor and and Capital. Okay, what are they? What's the difference between land, labor, and capital, according to Rothbard? I'm sorry? What do you mean? Explain. Well, I mean, look, can you purchase units of labor in the market? Yeah, you can purchase labor services, right, not laborers, unless you have slavery, right?

50:29So in the absence of slavery, you can buy labor services. Can you buy the services of land? Yeah, sure. Right, I mean you can, a farmer can rent land to grow crops, you can rent an apartment, You can rent the services of the land on which an apartment house is built. So can you rent the use of a machine? Well, I mean, can you rent a car? One, I thought that the only one on our points was that it's imputed back to just land and labor. Ah, okay.

51:15No, that's a good point. You're one step ahead of the game. And you're distinguishing between, you're referring to the distinction between gross and net rents, right? So what I'm talking here about just gross rents, I mean, can you go to a store, can you find somebody who owns a capital good and say, hey, can I use this capital good for three hours and here's $25? Yeah, sure you can. You can go to the rental center and you can rent a weed whacker or something. If you don't have a weed whacker, you can rent a car, you can rent the services of the building and so on. Obviously you can rent labor services, that's what we do when we hire labor, right? So one difference between land, labor and capital that we just alluded to is that you can not only rent a car, but you can buy a car outright, okay? You can rent a weed whacker by the hour, or you can buy your own weed whacker, okay?

52:06This is on my mind because I don't actually own a weed whacker, but I have some need of a weed whacker in my backyard. I'm trying to borrow my neighbor's weed whacker, but he doesn't want me to have it.

52:19Unless we have a slave economy, you can't buy a laborer. Now Walter Block probably has some ideas about indentured servitude and whether you can sell yourself into slavery and all that, but let's leave that for discussion over dinner. What determines, according to Rothbard, the purchase prices of the things that you can buy, of capital goods, of pieces of land, and so on. How are those purchase prices related to the rental prices? Yeah, the price of the weed whacker in the ERE is equal to the present discounted value of these, you know, the stream of future rental prices.

53:08Okay, where do those come from? Well, with the exception of the cases we discussed earlier, from the DMRP. Okay, so I have the DMRP or DMVP of weed whacker services that I could use over the life of the weed whacker. Okay, and I add those up and that gives me the price of the weed whacker. So either I can add up the MRPs and discount them back to the present or I can add up the discounted MRPs and take that sum. That tells me how much I would be willing to pay for a weed whacker if it lasts 10 years. Well, then that's 10 years. I don't have to rent it by the hour or borrow it from my neighbor or whatever. Okay. So that's the difference between labor and the other two factors, right, that labor can't be bought and sold.

53:53But now, this, I can't see your name tag. Yeah, Ed, we've heard this assumption, gross and net rent, okay? How does, how do capital goods, let's get there step by step. How do capital goods differ from land and labor? There's sort of a standard mainstream answer to that question. And then Rothbard gives a slightly different answer. It's highlighted by our distinguished study guide, author, you might recall. Let me just think about it.

54:41Why? Yes, that's right, but why?

54:50Yeah, that's nearly right. I mean machines are produced by something else, right? So the kind of a standard way that economists think about this is a mainstream way is to distinguish between sort of, you know, nature-given and man-made factors, right? That land and labor are given by nature, whereas capital goods have to be manufactured, have to be made, okay? So right away that tells us that well, I mean, you know, I don't have to pay to create labor services, right? I mean, I have labor services. They're given to my, my labor is a free gift that I've received. Likewise, if I discover an unused piece of land, right, I don't have to use factors of production to produce the land, whereas to To make a machine, to make a capital good, I do have to employ land and labor, right?

55:48So Ed's point is, you know, in the ERE, right, you can buy capital goods, you can buy machines in the ERE, right, but to produce a machine, you have to buy land and labor, right? And leaving discounting aside for the moment, right, the price of the factors that are used is to produce the machine will be bid up to the point where they equal the value of the machine which is determined by the prices of the final goods and services that machine can be used to produce, right? So just as the value of tobacco is imputed back to the value of the cigarette rolling machine, right? The value of the cigarette rolling machine is imputed back to the machine that made it and then back to the machine that made it and then back eventually to land and labor.

56:40In the ERE, in the absence of uncertainty, those prices will be bid up to the point where there's nothing left over for the owner of the machine. In other words, in the ERE, capital goods do not get what Rothbard calls a rent. They don't earn a rent the way land and labor do. In the ERE, capital gets an interest return based on time preference and discounting, and Accounting, but does not earn a rent. Again, it's important here to notice that Rothbard uses the term rent in a different way than it's often used. What are some ways in which the term... I mean, we all know a common sense use of the term rent, right?

57:26Because a lot of you have rented a car before, okay? Most of you have probably rented an apartment. I should probably go out to the video store and rent a DVD. What does the word rent mean in that common sense everyday context?

57:49That's how much you pay per unit of time to use something. So many dollars an hour, or so many dollars per week to rent an apartment. That's the way in which the term rent is used by Frank Fetter, and that's the terminology that Rothbard adopts. The term rent is used a different way by Marshall, a different way by Ricardo. If you read the modern textbooks, there's all sorts of different notions of a rent. For Ricardo, rent is a payment to a factor of production over and beyond So a rent is like an extra payment that you get above and beyond the payment that would be required to get you to do the thing.

58:40But in the Federal terminology, no, the entire payment per period of time that a factor receives is the rent going to that factor. So if you don't like, you know, use, instead of rent, use rental price, okay? A wage is the rental price of labor. The money you pay at Blockbuster is the rental price of a DVD, okay? So the point is that the rental prices of capital goods in the ERE would be bid up to the point where, you know, you, sorry, the rental prices of the factors that are used to produce capital goods will bid up to the point where there's nothing left over for you once you buy the capital good.

59:26So the owners of the capital goods will get an interest return as a reward for deferred consumption. Okay, but they don't earn a rent because the rent going to those capital goods is imputed back to the original factors of production they're used to produce it. Okay, what are some other issues and questions that you have that we haven't covered yet? Yes? I'm sorry? Mr. Moderator, is that permitted? Okay.

1:00:18Q. Doesn't this only come for situations in which the other factors that you hold constant are still advisable?

1:00:48Is it the case that diminishing marginal value product applies only in cases where, I'm sorry, could you repeat the second part?

1:01:18You never use it in a region where it is decreasing, because the other factors that you are holding constant would then have a negative marginal value part. And I understand that. Isn't that only the case if those other factors that you hold constant are still divisible? are still divisible.

1:02:14I want to hold off on answering that and maybe come back to it later. I think that is already incorporated in the marginal value product of the factor that you're talking about. We don't need to add additional restrictions on the divisibility of the other factors, because that affects the marginal value product of the factor that you're talking about. I think that would already be folded in, but, yeah, let's, yeah, this one, right, that's That's the assumption of fixed proportions.

1:03:16Did you want to add something on that point specifically? In the second example, in which the facts are in fixed proportion, Mises gives an example of a purple shirt with a certain sherry shape. Oh yeah, yeah. But what he says is, that's fixed. The question is, is there a price, a warrant, sure, let's say, a certain amount of law and a certain amount of dine, right? But if they're not specific, even if it's a fixed proportion, then they both can be priced according to one or more activities, right? That's right. Or a fixed proportion and specifically two different influences. And then the third one is, I think the way we illustrate that is the diamond mining, right?

1:04:02So the diamond mining is indispensable to the production of mines. You might think, wow, the owner of the mine is going to get a lion's share of revenue. That's not true, of course. Because if the equipment and the laborers are not specific, all the diamond miners is a residual. And if it's sort of a diamond miner on the market, it may be very, very little. It's very hard to work and it's, you know, very productive. Right, so again, the question is specificity as well as different orders or inspecibility. That's right, and you're right, and the emphasis, I was trying to say earlier this, the emphasis on specificity as a separate set of conditions is something that's quite different from the standard treatment in which variability is the only thing that matters.

1:04:53Mark? All you've got that in an umpire is a good example of the indispensable factor would be an example of a professional baseball team where you have one umpire in the group, two baseball teams, and three work crews, a ground crew, a concession crew, and a ticket crew. If you take the umpires, they don't show up for a game. You can't have a game. Basically, there's no way to hold a professional baseball team. And so you lose all 200 whatever. And obviously the price of a product on higher fees is not going to be related to that, but the marginal revenue product is related to that.

1:05:43I was just wondering why...