 It's a great thrill to be speaking at Mises University 2013. This is the highlight of the academic year for me. I attended my first Mises University as a student back in 1988. We didn't call it Mises University back then, but several of those who are here with us this week were also present at that conference. And I wanna echo some things that Tom Woods said in his opening talk about how, that was a life-changing event for me. And it's been fantastic to attend Mises University, well, to have attended Mises University every year since 1988, either as a student or since 1994 as a faculty member, as a speaker. So I don't know how many years that is. Austrians aren't good at math, so I won't try to give you the number, but I've been listening to these lectures and giving these lectures and really thinking about the Austrian tradition for those many, many years. And I think I'm finally starting to get it. So it all makes sense to me now, but it took 20 or 25 years because I'm a little bit slow. But as Tom said, people who are graduates of Mises University and other Mises Institute programs have gone on to do fantastic things in many different walks of life, including in academia, in writing, in teaching, other forms of scholarship. And so those of us on the faculty of MisesU who have been through MisesU programs as a student really have a great perspective on how this event can really change your thinking. And so I'd be delighted to talk to any of you privately during the week if you wanna talk about sort of career issues and where you might go after taking Mises University courses, going through Mises Institute programs and so on. It really has been a fantastic event, very important event for me. We're in the second day of our Core Topic series and we've been through many of the fundamentals of the Austrian tradition and we have a couple more to go. Today's lecture is on the Austrian approach to production and the business firm. Now I have to say that compared to some other topics that you'll see on the schedule for MisesU like drug policy or the economics of Bitcoin or whatever thing might sort of float your boat these days, production theory seems kind of boring. Right, this seems kind of ordinary and mundane. And gee, why do we have to spend a lot of time on the production function and inputs and outputs? Don't we already know that stuff from mainstream theories? Aren't the Austrians basically saying the same thing on production theory as mainstream economists just without the math and without the graphs? I wanna challenge you this morning to think of production theory in a different way. It's not at all the case that Austrian production theory is just like mainstream production theory but in a different form. In fact, it's quite original, it's unique and it really is foundational to everything else that we do almost everything else that we do as part of Austrian economic analysis, right? Goods and services don't magically come into existence by themselves, right? They have to be created. They have to be transformed through the purpose of acts of individuals and that's what production is really all about. Let's just start with some definitions, right? What is production from an Austrian point of view? Here's a great statement from man economy and state. Production is the use by man of available elements of this environment as indirect means as cooperating factors with human labor to arrive eventually at a consumer's good that he can use directly to arrive at his end. The use by man of available elements of the environment, right, so that includes what we might call nature-given elements of the environment, raw materials, you know, trees, rocks, natural resources and so forth, animals and also man-made factors of production, tools, machines, equipment and so forth that are used in cooperation with each other and with human initiative right to produce goods and services that we ultimately want to consume that satisfy our ultimate ends. So the central idea of production is this notion of transformation, right? Of resources or factors or inputs that we find available to us into other things that can directly or indirectly satisfy our most urgent needs, okay? As Rothbard emphasizes in this quotation, factors of production do not automatically assemble themselves into consumer goods that we would like to obtain, right? It takes an act of will, it takes purposeful human behavior, right? Austrian economics starts with the choosing individual. Austrian economics is about human action, gee, wouldn't that make a good title for a book? It doesn't happen automatically. One of the main problems with conventional approaches to production that you get in economics textbooks and in some business schools is that it comes across as a very sort of mechanistic thing, right, that, you know, just as a plant grows and yields fruit. I mean, a banana tree or a coconut tree on a deserted island just springs up, it grows and coconuts just appear on the limbs and we can sort of pick them and eat them or drink them or whatever. Gee, isn't that nice? People have been misled into thinking that production processes in an industrial economy are like that coconut tree or the banana tree, right? Once factories are in place, the wheels turn and stuff comes out, right? And rich people make a lot of money off of that. I mean, the whole notion that you find in most, the sort of tax jargon of earned income versus unearned income, right? If you're paid wages for working a job, especially one where you work with your hands, right? That income is earned for tax purposes. Income that is the result of entrepreneurial activity and capitalist activity is often classified by the tax authorities as unearned. The idea is, well, I mean, it just kind of comes to you. If you've got factories, if you own factories, money just flows in. All you gotta do is kick back and cash the checks. But stuff doesn't come into existence that way. Now even just from this simple statement by Rothbard, there's some other important implications too, such as the passage of time, right? Rothbard says that these factors of production are combined to arrive eventually at a consumer's good that can be used. So it's not instantaneous, right? There's some passage of time between the activities that take hold of and combine and transform these inputs and the realization of the final outputs that can be used to satisfy ends. That takes time. And with time, of course, comes uncertainty, right? So nothing about the production process is automatic. As I mentioned before, factors of production, some of them are nature-given and some of them are themselves produced by human initiative and the use of other factors of production, right? We've already talked about this week, the Austrian notion of the structure of production and in a modern, advanced industrial economy, right, that structure of production, that chain of production is very lengthy indeed. I mean, you all know the I-Pencil story, Tom Woods mentioned it the other night. I mean, we could pick up any sort of tool or piece of equipment that you guys are currently using. I mean, some of you have, I don't see anybody with a pencil, like a pencil. Okay, there's a couple of pencils. All right, we got some retro old school folks in the room. But most of you are typing on a computer, a tablet or your phone or whatever. I mean, if we took your iPhone and we traced it back in time to the original factors of production, human labor and silicon, well, not even plastics. You know, the sand, right? I mean, the really nature-given factors through all of the different stages you have to go through, transforming one thing into another, transforming sand into silicon and other materials into plastics and sub-assemblies and so forth until you get to the final iPhone. I mean, that's an amazingly lengthy production process. I don't mean necessarily lengthy in calendar days, though it does take a number of calendar days, but just in terms of complexity, right? How important is production theory? Well, if you take a classic Austrian theory text, like Rothbard's Manneconomy and State, it's a lengthy book, as you know, over a thousand pages, a huge chunk of Manneconomy and State is dedicated to precisely the theory of production. Five full chapters of this lengthy book, many hundreds of pages, are devoted to the theory of production, the theory of the firm, and the theory of the entrepreneur who will come into our story in just a moment. That suggests that Rothbard certainly didn't think it was a minor or trivial part of economic analysis, nor did he think he could simply refer the readers to established textbook theories of production and add an Austrian gloss and go on to the next thing. That's production. What's the firm? What do I mean by the business firm? In this context, you can think of the firm as the locus of productive activity, right? So the firm is an institution in which production takes place. The firm and production, the theory of the firm and the theory of production are intimately intertwined, though they focus on slightly different aspects of this process of transforming inputs into outputs. When we, in the theory of the firm and the analysis of the firm, we're particularly interested in the role of the entrepreneur, the primary causal agent in this process of production. So the theory of the firm is essentially the theory of the entrepreneur and those factors of production that the entrepreneur takes hold of, acquires, transforms, and has ultimate responsibility for. And we'll see some more details in that in just a moment. Okay, so a little bit about the basics of Austrian production theory. A lot of this is in Karl Manger as Joe Salerno explained in his lecture, opening lecture yesterday morning. And probably the central figure in elaborating on the details is Manger's student and Mies' teacher, Eugen von Bumbavirk. By the way, Bumbavirk is worth having in your collection because he's a 19th century German guy with a funny name, you might, and not to mention kind of a funny look, you might think, okay, that's nice, but I'll stick to Rothbard or something that's easier or something that's easier to read. Actually, Bumbavirk is remarkably easy to read as is Manger. Of course, most of us will be reading him in English translation. He did write a couple of articles in English but mostly wrote in German. But he's very clear writers, very lucid, easy to understand, and I certainly recommend having some of Bumbavirk on your bookshelf. The basic elements that Bumbavirk used in developing his theory of production are inputs and outputs, right? It's fine to distinguish inputs into categories such as land, labor, and capital. What Austrians mean here by land is not just dirt, not just real estate, but any factor of production that is given by nature. You don't have to do anything, you don't have to produce it, it's just there. Now, human labor has to be applied to it and machines and other things may have to be applied to it to make it usable, right? So it has to be combined with labor and with capital goods, but you don't have to produce the raw material, you don't have to produce the physical land itself, it's given by nature. Labor, of course, human labor is another kind of factor of production. I would, my labor would mean productive effort, labor effort expended by people. It could be toil in a sense of working in the factory or out in the fields, bailing hay or whatever, but of course we don't just mean backbreaking physical labor, mental labor, intellectual labor is labor too, right? So if you work in an office or you're a professional or an opera singer or whatever and you get paid for your services, right? You're also earning labor, you're earning wages and that work that you perform is also labor, right? By capital, we mean capital goods. We mean tools, machines, implements, right? Intermediate goods, goods that are not themselves consumed directly but are used to make other things that eventually, eventually leading to things we consume directly that are themselves produced, okay? So tools and machines and gadgets, right? They are themselves the result of some previous production process, some mixing of land, labor, maybe earlier stage capital goods, right? But all goods and services can ultimately be traced back to these original factors or originary factors, land and labor but in a modern industrial economy, there's very little that is produced only with land and labor, right? We're always using tools and equipment and machinery and of course, as I'm sure you all know, that is why we are vastly more productive than our ancestors, right? The reason that even workers engaged in, you know, non-glamorous activities, you know, trash collection, trash collectors earn much higher real wages today than trash collectors would in ancient societies, not because they're that much smarter, not because they put in more hours during the day, not because their backs are stronger, right? But because they have machines, they have garbage trucks and garbage cans and trash compactors and so forth, right? They have tools and equipment that allow the labor to be much more productive than it would without those tools and equipment, okay? But remember, production is an economic concept and in a monetary economy, it's what Mises would call a catalactic concept. So we're not only thinking of sort of physical units of inputs and outputs, but we're thinking in terms of economic value, which as you know from Joe Salerno's previous lecture, right, can only be ascertained, can only be measured in an economy with money where actors can engage in economic calculation, right? So in a market economy, all resources, land, labor and capital are privately owned. They're owned by individuals who have exercising property rights and these inputs can be traded in markets, they can be exchanged, right? So there are market prices for labor services, there are market prices for raw materials, there are market prices for intermediate goods, for capital goods, okay? Now those markets may not be markets, they may not be consumer markets in the sense that you think of a farmer's market or going to Walmart or whatever, they may be, those markets may be restricted only to entrepreneurs and factor owners who participate, but I mean as you know, if you've ever tried to fix your iPhone or fix your computer by getting spare parts on eBay, I mean nowadays almost anybody can have access to factor markets for almost any kind of input, right? Now whether you know what to do with the little piece of metal once it arrives in the mail is a different story, right? But it has a price, inputs have a price, raw materials have a price, intermediate goods have a price as long as there is private property and the price mechanism is allowed to work, as you know. When we have prices, then in the production process we can also measure gains and losses, right? As money profit and money loss, right? So we can think of success and failure in the more general sense that we've already talked about it this week, right? Did a particular human action arrive at the end that was intended by the actor or not? You know, Salerno gave the great example, elaborate, you know, riffing on Manger right of how you can make mistakes, you could pick up the New York Times thinking you're gonna get valuable information and you'd find of course that you're not. In a production process in a monetary economy, right? The success or failure of the entrepreneur at achieving the ends aimed at can be measured with more precision, right? In terms of money. So you have, you know, there are cash outlays for the inputs and there are cash receipts from the sale of the output and the entrepreneur can balance those receipts against those costs, taking into account, discounting associated with time preference and so forth and determine whether the action was successful. Did the gains exceed the losses? Right, you can do that in a quantitative sense in a monetary economy because you have, you know, accounting data and financial data that tell you whether you made money or not, right? So the producer, right, the entrepreneur engaged in productive activity is not aiming at satisfying, you know, his or her highest ranked end in the sense that a consumer is trying to satisfy his or her, achieve his or her highest ranked end, measured in a purely subjective way and so forth, right? Here we're talking about something different. The entrepreneur has a more explicit goal of making money, right, of taking more in and revenues than you spent in expenditures. You know, you want the biggest possible gap that you have. You want to get the highest possible money profit from your actions, okay? Again, so all of that, what I've said so far, this is pretty much accepted by any economic approach to production, maybe not phrased exactly the way I phrased it. What's a little bit more unique to the mangarian approach as elaborated by Bumbavark and Mises and Rothbard and so on are notions like time and uncertainty and the explicit role given to the entrepreneur, right? So the fact that this process of transformation takes place through time and that the future is uncertain, right, we know some things about the future but not all things and we cannot be certain that the results of our actions will bring about the desired ends. So just as the reader of the New York Times can be frustrated, right, the entrepreneur who's producing a particular electronic device, right, can lay out money for the factors of production anticipating that consumers will pay so much, I'll be able to sell a certain quantity, I'll earn a certain amount of revenue and then I find, lo and behold, that I didn't earn it, I was wrong, right? My estimates were wrong, my forecast were wrong, my judgment about what the future would bring was wrong. Consumers' preferences are different from what I anticipated. My rivals reacted in ways that I wasn't expecting. The government did something that I didn't anticipate and now I'm bringing in less revenue than I expected and maybe I've actually got a money loss, okay? So I take that into account, I make some adjustments or some corrections in guiding my future action. It may come to a point that I've made so many of these mistakes over time that I no longer have any capital to use in production and I'm out, I've become something, you know, less valuable like a college professor or whatever. So this agent that's making these judgments and bearing this uncertainty again is this is an agent that is missing for most contemporary neoclassical production theories but essential to the Austrian theory, namely the entrepreneur. Keep in mind that our general approach to production is what we sometimes call causal realist, right? Following the following manger, we typically describe ourselves as working within a causal realist tradition, causal meaning we're dealing with, you know, cause and effect, right? So this whole notion of production begins with very basic Aristotelian kinds of concepts like means and ends, right? So it's a teleological approach. We're interested in the purposes of the actors, the purposes of entrepreneurs who are trying to maximize their money income. We're interested in the purposes of resource owners who are bargaining with entrepreneurs to sell or rent factors that they own to achieve their own financial or other kinds of goals, same thing with labor, et cetera. So it's even though production theory deals with stuff like factories and machines, you know, it's not a mechanistic or mechanical approach within the Austrian tradition. It's a very humanistic or teleological approach. That's the causal aspect, right? The realistic aspect is that, you know, we're really trying to explain real prices and quantities, right? As Professor Salerno mentioned, Karl Manger was an economic journalist, a financial journalist before becoming a scholar and the reason he came up with his particular approach to economic theory was to be able to understand what was happening in real markets. What are real prices doing? So unlike some sort of contemporary mainstream approaches to production that are highly stylized, highly abstract, make all sorts of assumptions about characteristics of production processes that are deliberately unrealistic to explain sort of hypothetical prices that would obtain in hypothetical markets. No, that's not what Manger was trying to do. He was trying to explain real prices that obtain in real markets. That's exactly the same thing that we're trying to do here, okay? Just a few words about factor pricing. Actually, Dr. Salerno went over some of this in his Monday morning lecture on Manger and the origins of the Austrian school. It's worth spending just a few additional moments on because even among scholars who are not especially sympathetic to the Austrian approach, the Austrian theory of imputation, the way that prices get imputed from consumer preferences of the chain of production to the prices of factors is widely regarded as a unique and important Austrian contribution in the late 19th and early 20th centuries. Right, so we have these factors of production. Imputation is this idea, right, that while consumers do not value the factors directly, the valuations of the consumers for the products that factors ultimately make are imputed back to those factors of production, right? So if I were running Mises University, if I were an entrepreneur running Mises University as a for-profit activity and I wanted to maximize my money income, my net income, I might hire some workers, right? Like, oh, I don't know, Bob Murphy, let's say, right? I might hire Bob Murphy. I hope you're listening to this, Bob. Now, why would I hire Bob Murphy and how much would I be willing to pay him? Well, if you're asking how much am I willing to pay for an iPhone or how much am I willing to pay for, you know, a double cheeseburger or something, right? We can explain that in terms of utility, right? My subjective valuation of that iPhone or that double cheeseburger relative to other ends that I could possibly achieve is purely subjective. I have this ordinal ranking and so forth. If I'm an entrepreneur thinking of sort of purchasing a unit of Bob Murphy's time, I mean, I wouldn't be doing it, and I can assure you, I wouldn't be doing it just because of the subjective utility I get from hanging around Bob Murphy. I mean, you know, the guy's okay, it's singing, but he's not that great, and he's got a few jokes, but you know, they're mostly old jokes. No. I would still be willing to hire him, to pay him, to buy some of his time, but again, it's for a different reason, right? It's not because I value spending quality time with Bob, it's because I think that the students, the consumers will pay to take a class with Bob, right? Consumers will pay for the services produced by Bob's labor, and because I want those revenues in my pocket, I'm willing to pay for Bob's labor, right? So the amount that I'm willing to pay for an hour of Bob's time depends on, you know, how much lecturing or teaching or mentoring or whatever, I think Bob can do in an hour, and how much I think that teaching or lecturing or mentoring is worth on the market, to you guys, to the ultimate consumers. So I'm trying to put myself in the shoes of the consumer and anticipate how much utility consumers would derive from, you know, the services of Bob Murphy, and that lets me decide how much I'm willing to pay to have Bob Murphy, right? So it's indirect, in other words, of course utility is still the driver here, right? What's determining the value of Bob's services on the market, his consulting rate or his wage or whatever, it's all being determined by subjective utility, but through an indirect mechanism, right? You guys are paying me for Bob's services, for Bob's outputs, then I'm paying, kicking some of that money back to Bob, okay? But the point is my demand for Bob's services is arrived at a slightly different way than my demand for the double cheeseburger, okay? The Austrian theory of imputation is designed to explain exactly this in a more precise way, right? What exactly determines the value of Bob Murphy's labor? What exactly determines the prices of land that you can buy here in Auburn or in New York or anywhere in the world? What determines the prices at which resources will be rented on the rental market? Machines that you can rent, trucks and cars that you can rent, houses that you can rent and so forth, right? So the Austrians spend a lot of time explaining how the valuations of consumers are imputed backwards or imputed up the chain of production to put market prices on those producer goods, those intermediate goods. As Joe pointed out, Manger kind of hinted at the explanation but didn't work through all the details. It was left to Bombaverk and others in the late 19th and early 20th centuries to work this out. And so you've already been introduced to some of these concepts and Professor Salerno even gave you some numerical examples, right? I can give you some more if you're interested. Ask me later. The sort of conclusion, first conclusion from this sort of analysis is that the prices of factors that you rent, the rental prices of factors tend to be equal to their discounted marginal revenue products. Rental prices are equal to their discounted marginal revenue products, right? So the marginal revenue product is the marginal product of the input, the amount of output that is produced by that input in physical terms, multiplied by the price at which that output is sold on the market, right? So marginal revenue product is a value term, it's a monetary term. Marginal product is measured in terms of physical units, right? So the marginal revenue product of an hour of Bob's labor is how much money I think I can make from offering Bob's labor services to the market. And of course, because production takes time, right? If I have to pay Bob now for his time and I only get the revenues from the consumers later on in the production process, then Bob will not get for me the full marginal revenue product of the services, it'll be discounted by the interest rate, okay? Rothbard uses the term marginal value product instead of marginal revenue product, but those are perfect synonyms. That's the general theory of how rental prices are determined. There are some conditions and there are some exceptions, you know, factors that are purely specific to one particular production process or that are essential to the production of one particular process where there's no possible substitution of other factors, right? I mean, in this case, we know that if Bob's not available, I could just as easily get, you know, one of these other guys and they are all pretty much the same, right? There's nothing about Bob that's unique, but if Bob were really unique, he were the only one who could give this particular lecture that he might be able to bargain a little bit more for me than his discounted marginal revenue product or rather to put it more precisely, his marginal revenue product, discounted marginal revenue product is arrived at in a slightly different way. But in general, for factors that can be substituted at least partially across lines of production, their prices will tend to equal their discounted marginal revenue products. Now, if you can buy the thing outright, then the purchase price will be equal to, you know, the present discounted value of the stream of expected rental prices in the future, okay? So, you know, if you can rent a car or you can rent a house or an apartment, you pay so many dollars per month, if you can buy the thing outright, buy the house or buy it as a condo, then the purchase price will tend to equal what you and the seller agree upon as the anticipated stream of future rental prices discounted back to the present by the interest rate. Sort of a, you know, footnote on this, who cares, why is this so important? And again, Joseph Lerner already sketched out a little bit of this yesterday. I mean, this sort of, this notion that the valuations of consumers ultimately determine, sorry, the valuations of consumers as expressed in prices of consumer goods are the ultimate determinants of the prices in factor markets, which the entrepreneur sees as the cost that must be paid to produce. This goes against the sort of classical notion, the British classical notion that the prices of consumer goods are determined by the costs of production from the firm's point of view, right? So the Austrians are doing, sort of offering the inverse of this, right? So the Marxist notion of, the Marxist exploitation theory, as Tom Woods pointed out, as you know, the sort of Ricardian notion, classical notion that the producer's cost will determine the prices that consumers pay on the market, that theory was sort of completely inverted by the, exploded, Mises would say, by the Austrian teaching, right? That it's valuations of consumers and prices in consumer markets that are the determinants of what the entrepreneur sees as costs, namely the prices that are paid in factor markets for products. Joseph Lerner gave a couple of examples, I think from the art, you know, with the diamond, the diamond that Kobe Bryant bought for his fiance, sorry, spouse, whatever. The doghouse diamond, or whatever you'd call it. Mises gave the example with land that's pretty, that illustrates it. Well, I mean, this is, this picture is from the Champagne-Champagne region of France, right? So in France, and by the way, according to EU food labeling laws, right? You can't call it Champagne unless the grapes are grown here, right? What you can get from California is called sparkling wine, but it's not really Champagne unless it comes from this particular region. So the classical approach would say, well, gosh, you know, if I wanna buy a bottle of fine Champagne at the grocery store, maybe to celebrate the end of Mises University, I wanna go down to the Kroger, the Walmart, whether they don't have the best Champagne, but simply say, you know, this bottle of really fancy Champagne, it's gonna be expensive, right? It's gonna be 50 bucks for even cheap Champagne or 100 bucks if I buy the premium, you know, the kind that James Bond, you know, would drink. It might cost me 500 bucks or something for a bottle. You know, why is Champagne so darned expensive? The classical approach would be, well, the only way you can make Champagne is you gotta get grapes from here. And have you looked at the land prices in this part of France? I mean, the land is really expensive. If you wanna set up shop as a Champagne maker, you gotta buy that really expensive land. And so, of course, you're gonna have to mark up the bottle pretty high to be able to recover those costs. I mean, Mises points out that no, that's exactly the reverse of the causal realist logic that's going on, right? The reason that that land is so expensive, right, is because consumers place a very high valuation on Champagne, right? They're willing to pay high prices for the Champagne drink. Therefore, lots of entrepreneurs would like to be in the business of producing it. And they're competing against each other for this land. So entrepreneurs are bidding up the price of this land because you need this land to be able to produce the drink that consumers really like. But, you know, to see why that must be the case, imagine, you know, do a thought experiment that, you know, for whatever reason, there's some kind of religious revival or there's some health report that comes out everybody in the world becomes a teetotaler. Everybody in the world stops drinking alcoholic beverages or just everybody stops drinking Champagne. No one wants to drink Champagne anymore. Well, what's gonna happen to the prices of these vineyards? What's gonna happen to the, well, you just look at, do a supply and demand analysis, the price of a fine bottle of Champagne will plummet because no one wants to buy it, right? The price of the grapes on the wholesale grape market will go down. The wages that are paid to the grape harvesters and the winemakers and so on and the transporters and the importers and so on will all fall and the prices of land will fall as well. Okay, so it can't be that the value of the land is determining the price of the bottle and must be the other way around. You can see this also logically if you just think through what we mean by cost. Again, the revolutionary inside of Manger also arrived at in through slightly different means by Jevons and Valras, right? Was that costs are opportunity costs, right? The cost of being in this lecture this morning is the value of the other goods and services you could be consuming if you were not in the lecture today, that's the cost, not the admission charge at the door, which was zero, right? We know from this theory of imputation or marginal productivity theory, as it's called, factor prices tend to equal their discounted marginal revenue products, factors tend to be allocated to their highest valued uses in production where valued use means is able to satisfy the highest ranked consumer ends as expressed by people's willingness to pay with money in the market for consumer goods, okay? So costs are opportunity costs, therefore costs cannot be the determinants of price. Now, it's easy to get confused on this if you think about this from the accountant's point of view or the bookkeeper's point of view, right? You know, I'm running a little small business out of my house and I've got an income statement with revenues and costs. Oh my gosh, I gotta buy this, I gotta buy that. I need whatever this particular input I go down to Home Depot and get it and I need lumber, I get it from Home Depot and it costs this much, therefore that's my costs. I gotta make sure to mark up my selling prices so I can cover those costs. But I mean, it may appear to the bookkeeper that the prices that you pay for the materials you need are given exogenously, right? You just wake up one morning and there they are and sometimes they go up and sometimes they go down and those are just my costs and yeah, I've gotta be able to cover my costs otherwise I can't run a business, right? That's the wrong perspective from the economist's point of view, right? Yeah, I mean it's true that for the individual small shop owner maybe a certain kind of lumber he needs is 3.99 a foot down at Home Depot but the question is why is it 3.99 a foot? And not 4.99 or 5.99 or 1.99 or whatever, right? We need a theory to explain what determines the costs from the bookkeeper's point of view. Again, the costs from the bookkeeper are the prices that are paid in markets for those inputs and just as Austrians can explain market prices and other market phenomena in consumer goods markets we likewise can explain them in producer goods markets. So we need some theory to explain what determines those factor prices and it's the interactions between entrepreneurs who wish to acquire those factors who are the demanders and the owners of those factors the suppliers, right? Interacting in markets. I mean in fact you could say that if suppose the price of lumber went up dramatically maybe, oh I don't know, say there's like a natural disaster maybe Hurricane Katrina and people need to re-build houses and buildings and so forth and my business making little wooden figurines I find that the cost of the wood the prices of the wood have gone up, right? Well, I mean you can't just say oh well, okay so my costs have gone up I'm gonna have to shut down my little wood carving entity. Now as economists we want to say well if you look at the system, the system level, right? What that means is that, you know wood is more urgently needed for other lines of production. The people in New Orleans or whatever on the Gulf Coast who are rebuilding houses and businesses wood ranks higher on their value scale than it would rank on the value scales of those who would wish to buy little wooden figurines, right? And so the demand for the wood has increased in this other activity relative to its demand in this present activity. So we can understand why those prices change and why that leads to a reallocation of resources, okay? Just as a side note, right? If you look at those five chapters in man economy and state you'll also notice that one thing they're missing is all of the standard sort of intermediate microeconomics textbook neoclassical cost curves the marginal cost curve, the average total cost curve the average variable cost curve and the profit maximization diagrams that you find in standard text. You don't see those in man economy and state. You don't see those in menger, a bum bopper, why? Because again they are subject to this fallacy that they treat the prices of inputs as exogenously given, right? You cannot use cost curve analysis to explain the prices of factors. The way conventional textbooks try to do it is in a completely circular manner, right? Of starting with perfectly competitive firms as they so-called taking factor prices as given, making certain decisions that allow you to derive a demand curve for those factors which then when combined, when then combined with a supply curve for the factor gives you the price of the factor. Did you catch that? So starting by assuming factor prices are exogenous then manipulate certain things in the production function to give you a demand curve for factors which you can then interact with a supply curve for factors to explain the prices of factors. That's a circular kind of reasoning and invalid and rejected by Rothbard and by other Austrians. Okay, just a word or two about entrepreneurship. Mises and Rothbard use this long run equilibrium construct of the evenly rotating economy, right? Which you already know a little bit about. So this is, it's sort of a, you know, it's an equilibrium construct in the sense that once you're in the evenly rotating economy, things, behaviors continue to repeat themselves over and over again in exactly the same way. So it's not static, meaning there isn't any activity. It's that the same activities are repeated over and over again or to focus on the key element, there's absolutely no uncertainty about what will happen in the subsequent round of activity. Right, so there's a purely fictitious hypothetical construct used by Mises and Rothbard to illustrate certain key points, sort of illustrative device or heuristic device if you like. So there's no uncertainty, right? So factors of production including your white collar jobs, management jobs, earn their discounted marginal revenue products. Capitalists earn, the owners of capital goods earn interest, right? Again, that interest is a reward if you like for foregoing present consumption in exchange for consuming more in the future. But there aren't any profits and losses. Why are there no profits and losses? Because if there were, if there were profits, right? If entrepreneurs could purchase factors of production that add up to say $20,000 and use it to produce goods and services that could be sold for $25,000 ignoring discounting for a moment, leaving $5,000 left over, well then lots of entrepreneurs would wanna enter that activity and the prices of those factors would be bid up until the total expenditure that you need to get $25,000 worth of output is $25,000, right, without anything left over. So if all factors are being paid their discounted marginal revenue products, then there's nothing left over. There's no residual for the entrepreneur either profit or loss, okay? So what's the point of thinking about a world like that? That's obviously not the world that we live in because it helps you to see that the source of profit and loss is the fact that we are not actually in an evenly rotating economy. Right, outside the evenly rotating economy there is uncertainty about the future. The future does not play itself out in exactly the same way as the past. So entrepreneurs can earn profits or losses based on their abilities to successfully or their failure and unsuccessfully anticipating future market conditions including or especially the demands of consumers. So you do have profit and loss outside the entrepreneur, outside the evenly rotating economy. Therefore, therefore the reason for introducing this analytical device of the evenly rotating economy is to explain where profit and loss come from or more precisely to distinguish entrepreneurial profit and loss from other kinds of business income, things that might be lumped together on an income statement like interest income, like the business owner's opportunity wage, implicit wage, right? If you leave, you can still have those things in the ERE but you don't have any economic profit and loss because economic profit and loss are uniquely the result of the ability, the skill with which the entrepreneur bears uncertainty. In fact, the way I would characterize the unique role of the entrepreneur in the theory of production in the firm is to arrange the factors of production under conditions of uncertainty. This is a characterization of the entrepreneur that was articulated explicitly by the American economist Frank Knight in his famous book, Risk, Uncertainty and Profit. It's also the theory of the entrepreneur that's in Mises. I would argue though, it's not quite as clear and explicit in Mises as it could be. It's also the theory of the entrepreneur that is laid out in some of the brilliant future classic works by Austrians like me. For example, in my book that came out last year called Organizing Entrepreneurial Judgment, I allow, which you can find at a very good price, downstairs, and is available for autographs and so forth. My co-author and I outline a more explicit treatment to the entrepreneur that we pull out of Knight and Mises in which entrepreneurship is conceived as this arranging of the factors of production under conditions of uncertainty. Now that's not the same as the way entrepreneurship is always conceived even within Austrian and Austrian fellow traveler circles. A lot of people associate entrepreneurship with the ideas of Joseph Schumpeter, the great economist who was Austrian by birth and by training but not Austrian by inclination, the sense of being a mangarian. Schumpeter associated entrepreneurship with innovation, introduction of new things, whereas this notion of entrepreneurship as decision-making under uncertainty or judgmental decision-making under uncertainty can also apply to existing activities, mundane and routine activities. This is also a little bit different from Israel Kursner's notion of entrepreneurship as the discovery of exogenously given opportunities for profit because in a world of uncertainty there are no exogenously given opportunities for profits. There are conjectures by entrepreneurs about what kinds of ideas might yield profit but there are no opportunities, there are no actual, actually existing profit opportunities that you can recognize and grasp and earn money from. So this particular view of entrepreneurship as arranging factors under uncertainty also links entrepreneurship to ownership. So the entrepreneur in the Knight-Mieses Klein conception must be a resource owner who has control of resources, not just sort of abstract discoverer or innovator who is floating above the mundane activities of day-to-day production. I'll just say a word or two about the theories of sort of the firm as an organization, right? So let's assume that we understand this notion of production. How are productive activities sort of organized into business firms? Where a firm is a legally distinct entity, right? With some boundaries around it, right? So we can say that certain productive activities are within General Electric and certain other productive activities are outside General Electric. There's a boundary, right? Things can be inside the firm or outside the firm based on who has ownership title of the various assets that are used in production. So the firm should not be thought of in a mechanistic way as a mathematical formula. If you've taken an intermediate microeconomics course at a regular university, what they call the theory of the firm is basically a production function and a bunch of cost curves, right? That's not the theory of the firm in an organizational sense, right? Think of the firm as a collection of heterogeneous capital resources owned by an entrepreneur, hence controlled by an entrepreneur, deployed in the production of some consumer goods, okay? So an entrepreneur plus some assets, some productive resources equals a business firm, okay? Now the entrepreneur may choose to involve other humans, other people in the production process, maybe by hiring subordinates, right? And so these subordinates can be delegated certain decision rights, you know, you can have subordinates, right? And so in the language of the judgment-based approach to the firm, the entrepreneur as the ultimate decision maker with the residual control rights, exercises what I call original judgment, this is my terminology, but may delegate some authority with some limits and temporal limits, right? To subordinates who are asked to act as if they were the owners of the resources even though they aren't, right? And I call this delegated judgment or derived judgment. So you can think of a multi-person organization as a kind of nested hierarchy, it's a term that comes from Knight, a nested hierarchy of judgment over the deployment of resources, okay? Why do firms exist to pose the question as it was famously posed by Ronald Coase in 1937? Because entrepreneurial judgment, the ultimate decision authority about how resources will be used is not something you can buy and sell in a market, okay? You can buy and sell assets, you can buy and sell resources, but the ultimate decision rights that go with those resources, you only get when you own them, okay? So entrepreneurs can hire consultants, they can ask people for advice, they can delegate some authority to subordinates, but they cannot give up their ultimate decision authority over those resources unless they sell the resources and then they're not the owners anymore, okay? I'm gonna skip a couple slides on Coase, I wanna make one point about some legal issues before stopping to take a couple questions. There's always a lot of interest in Austrian circles and libertarian circles about particular kinds of firms, especially corporations, large corporations because they are extremely important in most advanced economies, it's the sort of 80-20 kind of rule, you know, 80% of the output is produced by something like 20% of the largest companies, most of which are organized as corporations, yeah, a corporation is just a particular legal form in which a firm is, under which a firm is governed, right? Where people can own shares of stock in the firm and the shareholders jointly exercise this judgment function as the ultimate owners of the resources. A lot of writers, especially even Austrian writers, libertarian writers, have pointed out a lot of weaknesses of the corporate form, right? Possible drawbacks of the corporate form of organization, like the separation of ownership and control and I think it's important to acknowledge those drawbacks but to start with the presumption that all feasible forms of organization are imperfect, right, any way you want to organize a firm in the real world, you know, employees are not always gonna do exactly what you want to do, there will be disagreements among owners if ownership is shared and that's true in a corporation, in a proprietorship, in a partnership, in a cooperative in any kind of organization, right? But historically, the reason that a lot of industrial activity, commercial activity has been organized in corporations is because the corporate form provides a lot of advantages, right, by selling shares and allowing people to invest a small amount of their own resources in the business entity. You can raise a lot of capital in a short amount of time. You don't have to have partners, all of whom chip in large amounts of resources. You can have many owners, each of whom contributes small amounts of resources and, you know, there's certain legal advantages in being able to write contracts as the corporation and so forth. But there are also costs, agency problems, separation of ownership and control. There's some remedies that firms try to use to mitigate these problems, but not perfectly. But what interests a lot of Austrians or a lot of libertarians is the city that, well, the corporate form itself is somehow statist or that the corporation is not consistent with the free market because the corporate status is granted by the state, and therefore being a corporation gives a firm access to state privileges and state protection. I mean, I understand where this view is coming from, but I think it's a little bit, I think we need to be really careful here to get it right. I mean, it is true, of course, that many, many large companies in the world, most of which are organized as corporations, get all kinds of special benefits and privileges from the state, subsidies and barriers from competition, special protection. I mean, yes, of course, large businesses are, many of them are thoroughly in bed with the state. The question is, is that something that's specific to the corporate form or is that just the fact that in a mixed economy, lots of people get benefits from the state, large, small, corporate, non-corporate and so forth. And of course it is true that all kinds of business entities are both in some ways privileged by and in other ways harmed by the state. The question is, is there a systematic tendency for the state to favor corporations over other kinds of firms? I think the answer is no, but even if it were yes, I mean, again, that could be coincidental to the fact that most large firms are organized as corporations. What people typically, critics typically focus on is this notion of limited liability, right, that courts grant corporations, the owners of corporations, the shareholders, limited immunity from certain kinds of legal actions. So if an employee of the corporation commits a tort, runs over you with their car, the shareholders are not personally liable. They're liable only up to the amount that they invested in the corporation. And some libertarian critics have said, well, this is a special state privilege, right? We're not talking about limited liability in the purely financial sense of what happens in bankruptcy, because that's a purely voluntary contractual arrangement between creditors, shareholders, and the firm. The question is whether this limited liability from torts is a state privilege. I argue that it's not from the point of view of both sort of legal theory and legal history, right? Conventionally, the notion of limited liability has been accepted in the common law, even without any formal state grant of privilege. I mean, it's true that in most states, you actually get a little certificate from the state when you're incorporated, right? But you also get a little certificate from the state when you become a barber, right? That doesn't mean that barbership or barberhood is a unique grant of state privilege, is the state has taken over a certification function that without the state would be provided privately in the market. I think it's even under sort of any kind of libertarian legal system, Rothbardian legal system, whatever, it would not be the case and should not be the case that investors in a joint stock company would be or should be personally liable for criminal acts of employees. So I don't think limited liability is a unique, is a grant of the state per se that implies something sort of uniquely illegitimate about the corporation. Okay, Mark's giving me the evil eye. This is my takeaway slide. Austrian economics does offer a theory of production. That is unique. It's not just a verbal rendition of mainstream neoclassical production theory. It's causal realistic. It's thoroughly grounded in the mangarian approach to marginal utility. It's economic, not technological, and it emphasizes the role of the entrepreneur. Having said that, there are lots of opportunities for future scholarship to flesh out more aspects come up with more applications to reformulate some of the foundations of Austrian production theory and I look forward to seeing many of you be the ones who carry on that future work. So let's go to lunch.