 Good morning everyone and welcome to the final day of the conference Before I announce the Ludwig von Mies's Memorial Lecture I'd like to Recognize Nelson and Mary Nash who are a Hayek Society members and have just celebrated birthdays So the luncheon that follows this lecture will be in their honor and there will be birthday cake in the line So I would like to thank Nelson and Mary They've done a really a great deal for the Mies Institute and for the cause of human liberty and free markets Jeffrey Herbner is our Ludwig von Mies's Memorial Lecturer The title of his talk will be time and the theory of cost and it's sponsored by James Walker Dr. Herbner is chairman of the Department of Economics and professor of economics at Grove City College He earned his bachelor's degree in economics from Nebraska Wesleyan University And his master's degree in PhD in economics from Oklahoma State University Professor Herbner is the editor of two books The meaning of Ludwig von Mies's and the pure time preference theory of interest to which he has made a notable contribution in his introductory essay That book has been translated into Chinese He has published over a hundred articles in popular and scholarly venues Including the Wall Street Journal Investors Business Daily the quarterly Journal of Wall Street Economics and the Journal of Libertarian Studies Professor Herbner is a senior scholar at the Ludwig von Mies Institute and a fellow at the Center for vision and values at Grove City College He also teaches courses in Tom Woods Liberty classroom Please help me welcome Jeffrey Herbner. Thank you, Joe. It's a It's a great privilege to be able to deliver the lecture I want to say I'm kind of ambivalent about about Trump because of course my book sales in China will go way down if Trump is is elected but I Guess there may be more important reasons to think about Trump Anyway, I'd like to also Thank the sponsor for this lecture James Walker for his generosity and making making this lecture Feasible and for the support. Yes, indeed And for all the supporters the Nash is here who come Today as well And I'd also like to take this opportunity to thank Lou Rockwell for his entrepreneurial genius and tireless efforts in making the Mises Institute the World's leading center for the study of Austrian economics. Thank you, Lee You should probably quit while I'm ahead, but But James Walker paid for this so we're gonna we're gonna for John and the the title of my a talk is somewhat of a Illusion to my main field of research which has been in time and time preference and so on And I'd like to then in this talk sort of extend this discussion beyond just the time preference element of time and into other Aspects of time and what effect they have on the theory of cost. I take as my starting point Mises's admonition that we read here in the human action where he says Economists often erred in neglecting the element of time take for instance the controversy Considering the effects of changes in the quantity of money Some people are only concerned with long run effects That is with the final prices and final state of rest others saw only the short run effects The prices of the instant following the change in the data both were mistaken and their conclusions were consequently vitiated many more examples of the same blunder could be cited and so my contention is that the theory of cost is also a An example of this blunder where the element of time has not been fully Integrated into the theory of cost. So that's basically my Task here in the paper Now Rothbard I might point out is also a holds this position this is in a Commentary that he did on Israel Kursner's book market theory in the price system and Rothbard on page 7 said the Abstention from money is unfortunate but not fatal but the abstention from time and capital analysis is Problems of time capital and interest must be infused Into the price analysis Now as I thought through what that implied When we infuse time into the cost analysis what what implications it has I actually would like to Offer to Innovations or advancements One is that it has to do with this This substantive point that when we think about time in the theory of cost We have to take into account and we have not done this even in the Austrian School at least not analytically. We have to take into account Change and uncertainty that is bound up with real time and then the second contention that I'd like to Argue for in my remarks is a little bit more controversial I would like to contend that it's possible if in doing this to retain the analytical structure of cost curves Now I know that that contention is controversial and goes against Rothbard's own Views where here in man economy in state he expresses his His lack of appreciation for cost curves where he says as an explanation of the pricing of factors in the allocation of output It is obvious that cost curves add nothing new to the discussion in terms of marginal productivity At best the two are reversible But in addition the shift brings with it many grave deficiencies and errors now I find this a little bit Strange that Rothbard would take this position For the following reason and again, this this is really my motive in Putting this information together Rothbard very famously in man economy in state Provided the analytical apparatus That you don't find in human action So in mises we have all these great insights, but the presentation is completely verbal You don't see any demand and supply graphs or you know production curves or anything of the sort even though Verbally mises is giving us all that we need to understand these principles What Rothbard does in man economy in state is build in this apparatus That's a supply and demand curves and their Production relationships and so on and so forth and and so he's adding all of this standard economic apparatus to Mises his insights. He's building the apparatus for them And then when it gets to cost analysis, we just fall back into the narrative That there's there's no real analytics in in the treatment of cost Uh I'll have to suggest a caveat to that remark, but uh, Generally speaking, this is this is so And and so again one might think of my remarks as simply extending the Rothbard project providing a good solid analytics to the insights of mises In order to do this, let's um, let's just start with a brief account Of what the cost structure looks like that Rothbard is arguing against why did he reject The cost structure of the neoclassical school and all of you Studied neoclassical economics will recognize the short run and then we'll put up the long run cost curves In the sense in which Rothbard in the previous quote, uh claimed that the cost curves are reversible And so what he what he is referring to is that the u shape of the cost curves Is just the mirror image of the of the Hump shape the parabola shape of the production relationship. So we have marginal physical product Where we have a fixed capital capacity We add more and more labor to the fixed capital and we have increasing and then diminishing returns to the additional labor And then if an entrepreneur is buying that labor buying that additional labor in the market And calculating his costs per unit of output his marginal cost the additional cost per unit of output Then the the cost case of curves, excuse me will be u shaped So rothbard's point in man economy state quite correct. I don't dispute What he claims is that we don't need cost curves In order to do the basic analysis of factor prices and then production decisions that that I agree with this So we we just have marginal physical product and then as he shows the entrepreneur will assess the marginal revenue product The revenue that can be generated by hiring the factor of production And then make uh his his demands for the factor of production accordingly And then with those demands we get prices for factors of production And those prices are sufficient for us to do cost analysis. So this is how he proceeds But we might ask the question what exactly is the objection The the fundamental objection to employing the cost curve and here I'll have a quote in a minute to verify this But rothbard says the problem is of course there there's the assumption of fixed factor prices So as the entrepreneurs are buying more and more labor The assumption is that the price of labor is staying the same no matter the demand for labor now that seems You know a false on the face of it or at least not a general principle the neoclassical economist course Justified this assumption by a further assumption that all of the entrepreneurs in this market are Atomistic right there small and so when they increase their demand it doesn't affect the market demand That of course as we'll see in a minute to rothbard objects to this Even if that's true as rothbard points out it this uh overlooks the Fixed price of the capital that's being used The fixed cost right of the capital that's being used and so we have to take into account capitalization In doing a proper cost analysis But I don't think it's necessary to throw out the entire apparatus Okay, so this is what rothbard says about the capital right to further the Results of abstention from capital leads to all the crucial errors of cost curve analysis It's because because again you get this Uh just one to one correspondence between production Marginal product and marginal cost when in fact what's happening is the the whole cost structure is changing As the entrepreneur's demand is changing for the factors of production Okay, so he says uh for example, so one of the errors he points out he says for example That a firm will invest funds in production up to the point where marginal revenue equals marginal cost But once again, I think the problem here is in the assumptions of the neoclassical model and not in the apparatus itself I think we we can we can modify the apparatus we can adapt it to better more realistic Assumptions and preserve it Uh Anyway, I what I would say about this marginal revenue equals marginal cost remember again this as we showed on the last Panel is the idea that if an entrepreneur is in this short run period with fixed capital And fixed factor prices and then a revenue structure a demand for his product Then he'll produce unit by unit as long as marginal revenue exceeds marginal costs right out to the point where marginal revenue is equal to marginal cost Now it seems to me the problem with this harkens all the way back to the a marginalist revolution and the distinction between the way that menger thought of the marginal in His analysis and the way the neoclassical economists eventually thought of the marginal in their analysis So as if we adopt the mangarian view though, I think we avoid this problem of looking at technical units one by one altogether What we need to do is simply recognize that the marginal unit as menger Advised is the unit that the actor selects as suitable to His or her action So it isn't the technical unit that we're interested in when we Buy and sell and act In the market. It's the amount of the good that we're choosing as suitable so spring has come early in pennsylvania And the grass is already growing very unusual for This early in the year And so I've already gone down to the gas station and filled up my one gallon one gallon can of gasoline that I used for my lawnmower So when I was down at the gas station filling up my gas can My unit the unit I was interested in buying was you know, just under a gallon Uh when I fill up my car, it's 12 gallons or some other amount, right? I'm not I'm not interested in the technical unit of a gallon. I'm interested in the amount of the good that's suitable for my purposes Now entrepreneurs are no different entrepreneurs engage in production runs Where where they're interested in producing a certain they have a time horizon in mind They're interested in producing a certain amount of a good over some period and then selling that good They have a period of production or period of provision that they're interested in so, uh, just a simple illustration of this is Some of you may know that Apple ink has come out with a new iteration of the iphone the iphone se Which is a small four inch screen iphone with packed with all the cutting-edge tech inside And the uh tim cook and his entrepreneurial group of course have already Produced a large number of you know large number of units of these iphones And uh, you know, maybe say 10 million of them And it's that that they're thinking about when they think about cost. In other words, they six months ago They were thinking If we want to produce 10 million iPhones over the first year What exactly is the asset configuration under which we'll do this? And and that's how they make decisions, right? They don't say hey, we have fixed assets And then each unit we just think about how how things proceed So so I think this this basic idea of economizing of just saying, you know We're comparing the marginal revenue to the marginal cost of the actual units that people are acting with can be preserved While we jettisoned the this artificial technical unit part of the analysis In the neoclassical approach Now in doing this It should be apparent to you that marginal cost then doesn't refer to just the cost of the variable Input right if it refers to the cost of all the inputs that are chosen in this production run And so so that's the modification. That's what uh rock bard is referring to as capital Capitalization, right? How do how are the assets being valued and how do they enter into the cost? Uh, that's relevant for decision Uh, so here's how rock bard puts it. He says There's no one simple determinant marginal cost because as we have seen above There's no one identifiable short run period such as assumed by current theory The firm faces a gamut of variable periods of time for the investment and use of factors And its pricing and output decisions depend on the future period of time, which it is considering It might look something like this if we were to do any the simple analytics of it would look something like this We're in this diagram. We've got a different different Units of production and sale of a good A smaller production and sale and then a medium production and sale and a larger production and sale And then the total revenue and total costs that are associated with those different decisions So uh to to extend my uh My example of the iphone Se it might be that if uh, tim cook and his entrepreneurial group if they thought that the production run was going to be a four million iPhones that they would choose a production apparatus for this let's say contracting out the production to Some you know american producer For this that would be associated with the revenue stream that Would keep the cost structure in line with the revenue stream They can do this in advance as a matter of choosing right Then if they to the contrary if they thought that the production run was going to be 10 million They would incur in a in a different uh arrangement of assets they might they might uh transfer the production to A single factory that they have in china, let's say and produce all the iphone se's in that single factory For various reasons the cost structure would be different But it would be in alignment again with the revenue That they anticipate from uh from the sale of that volume of of the iphone and so on right So so this would be the simple analytics of thinking about how we would do cost analysis Again, we don't have cost curves here, right? This is just the The austrians have already done this kind of analysis, right? We're already thinking in these terms With respect to the cost structure again, I I want to suggest that there are two improvements In this kind of basic analysis that we can engage in And just to reiterate and we'll go through the demonstration in a minute one has to do with the Forward-looking nature of costs And therefore the element of time and the other has to do with the the actual analytics of cost curves Now Joe Salerno said something in his talk yesterday that I think is helpful in framing this Joe Salerno used the phrase I believe the phrase was uh first order abstractions and second order abstractions So he was talking about first order abstractions being things like the value scale That that we have that that's an analytical apparatus a concept of analysis that we use That relates to people's choices that we use to analyze people's choices Then the demand curve is a second order abstraction. It's further abstract from the actual action of people Right, but but yet it's useful. It's it's useful to have demand and supply and to use demand and supply Analysis even though there's second order abstractions So again, I would suggest that cost curves are second order abstractions Do we absolutely need them to do the analysis? No, we can stick with first order abstractions and And everything is actually in the analysis that we need To to understand the world, but second order abstractions have some usefulness they they have some value added to Our understanding and once again austrians are not shy about using these second order abstractions We all use demand and supply apparatus and and so on. So again, I don't think we should be uh, I think is uh Carl Friedrich is real uh Admonish us about econometrics. We shouldn't be afraid right to think think these things through Okay, so one more uh one more uh quote from Rothbard on this particular point. He says Some factors are best used in a certain quantity over a certain range of output while others yield best results over other ranges of output The result is not a dichotomy between fixed and variable costs as in the neoclassical view But a condition of many degrees of variability for the various factors And once again, just to uh, see what rothbard speaking about let's be reminded of how the neoclassical economists do a long run Uh cost analysis So here we have the long run uh envelope curve where the each short run production technique Falls within this long run curve and again the the problem the basic problem with this that rothbard has identified already is that um There's the assumption of fixed factor prices Not not only for each short run production technique But now also for the capital assets that are involved in each long run technique, right? They're they're uh, they're just a given uh price for the for the uh factories and equipment in In the production technique one and then production technique two and so on and so forth Uh, and this is again, I think uh, what uh, what rothbard is fundamentally objecting to Maybe not the second order abstraction itself, but these underlying unrealistic assumptions Now we might ask again the question. How do the neoclassical economists justify this? We saw before with the short run. They justify the fixity of Variable input prices in the short run by saying that we we have to assume that we have uh atomistic producers All little teeny tiny producers so that when they change their demand it won't if their individual demand It won't affect the market and so factor prices are fixed as the demand changes and they move from one production level to another Uh here the it's slightly different because here we can have a whole industry of course moving at once And so that particular assumption wouldn't seem to help us in thinking about why factor prices for assets should be fixed And here I think the basic assumption that uh allows this or justifies this Is it in the neoclassical analysis? each of these selection alternatives Is assumed to be instantly or fully adjusted to every other aspect of the economy Right, so we have a general equilibrium in other words that's pertaining For each choice that the entrepreneur makes in this particular market And so there they're saying that the end point asset price then after the adjustment takes place the end point asset price would be set or fixed So again, I think we can reject that assumption. It's certainly fanciful and incorrect And yet perhaps retain The analysis the apparatus of cost curves As the first quote that I gave you from mises points out and the next one from rothbard If we think about the austrian analysis with respect to time Then what are the time frames at the time frames for to reject the neoclassical time frames a short run long run because we Think again that that's completely completely wrong and not just arbitrary, but it lends It generates the wrong result in analysis because it doesn't allow for capital values to change Um, then what are the right time periods? Well, the right time periods as mises alluded to And as rothbard here explicitly says are the immediate run And then the long run so rothbard says furthermore there are remember here. He's saying not just in price theory He says furthermore there are in production theory Two important interesting concepts involving periods of time One is what we may call the immediate run the market prices of commodities and factors based On the basis of given stocks and speculative demands. You see you already you already has this verbally He already has the notion that i'm pressing for That we have to integrate into our analysis the anticipations of the entrepreneur the the expectations of the entrepreneur And given consumer valuations the other important concept is that of the final price Or the long run equilibrium price the price established in the e re The question again is if we think about this just in the austrian framework the question then that was posed initially by mises in in my first quote is How exactly then in a framework constrained like this Do we engage in dynamic so to speak dynamic analysis over time? Capitalization is going to happen over time as demands change and entrepreneurs adapt to this change So so don't we need some kind of intermediate time frame to think about like the neoclassicals have You know some short run time frame or long run time frame. How can we operate within this? Uh constraint so to speak and again i'm uh What my suggestion is that we can in fact operate in this constraint And that thinking more carefully about the element of time and and expectations Is the way to see that this framework? Can remain intact and and be in fact useful in doing analysis like this Now once again, let me just rehearse a little bit of this In anticipation of how we might amend this analysis, so this is the immediate run price of a good I I got this diagram directly from man economy and state. This is in chapter 10 and those of you are You know very familiar with uh rottbart's work know that chapter 10 is dealing with competition and monopoly And rottbart is grappling with the standard arguments about monopoly And so he's using a kind of standard apparatus, right? He goes ahead and uses a a more neoclassical apparatus including cost curves But he begins Well at one point I should say he he introduces this immediate run analysis that he uh borrows from uh wick sell Where we have the total stock of a good at any point in time That's given total stock of a good and then we have the total demand for the good by all the participants in the market This again is something that jose lerno was mentioning in his talk that it's better to The more general way of thinking about all Analysis of pricing and so on is in terms of stocks These are the fundamental things, right? We have goods. We have actual existing goods to to act with And uh, and that is sufficient of thinking about that is sufficient for us to explain where the prices of these things come from And flows are always implications right effects From the way we act with respect to the stocks of things Now, uh, let me mention one more thing about this the the total demand the dd curve the total demand Rothbard in another place points out can be broken into two parts There's the exchange demand by the buyers. So they're let's say again. This is the The market for iphone se So there there's demand You know from you and I people like you and I customers who want to buy the iphone This is called exchange demand by rothbard and then there's reservation demand by apple so apple owns the iphone's they're going to supply them and They're their action of supplying could also be thought of as Reservation demand. So at certain prices, they'd be willing to supply more by holding less By releasing the supply and then at lower prices. They'd be willing to sell less and retain Uh more of the supply So we can break uh, we can then do the standard analysis right breaking out the Exchange demand from the reservation demand. This is what the standard analysis would look like we have demand From the consumer subjective values for the iphone And then we have supply by the entrepreneur's opportunity costs And this is just the reservation demand turned around, right? And then the further point of analysis again where we get to the expectations part of this Um, we can break the the categories of entrepreneurs opportunity costs into two Uh one is personal use And for most entrepreneurs the personal use of the good that they produced is pretty low, right? So Presumably, uh tim cook is already using the prototype of uh iphone seven and won't personally use any of these iphone successes And then he can either you know, apple can either sell to a customer right now in this market Or they can hold the good again and sell it into the future, right to customers in the future So there's demand in the future Would be an opportunity cost that they give up if they sell the good uh today So so again, this is the standard analysis of immediate run Um prices of goods Okay, then same thing for factors of production, right? We have immediate run prices of the factors of production And uh, it's exactly the same analysis except here we're looking at say tech workers who are hired by apple and other uh tech companies and we have the supply uh by the workers And how how is that determined? Well, they supply based on their opportunity costs based on the offer and the opportunity cost And the opportunity cost could be one of two things they could have personal use for their human effort or they could Um anticipate a greater demand in the future by a different entrepreneur And they could reject one offer and hold out and then supply their tech services to uh someone else in the future And then we have demand on the part of uh apple and other tech companies that want to hire the workers And here we have the entrepreneur's judgment of that labor's discounted marginal revenue product And that's as far as our analysis of time has gone Really in the analytics of austrian economics that we haven't gone beyond this point really Now just again to uh illustrate why this analysis is important What what advance it has made on the neoclassical is this idea of discounted marginal revenue product We can see that the if we do immediate run analysis what uh what we get is the conclusion is We have prices for the iphone se Right now three hundred ninety nine dollars right now Right because we have a stock and we have total demand and that price clears the market And then we have prices for tech labor right now So right now the companies are paying whatever To hire, you know 200 000 to hire some some technician some it person Right right now But obviously the the hiring that's going right on right now is not generating the revenue from the sale of the good right now Is generating the revenue or will generate revenue in the future for goods sold in the future So here apple is just hiring the tech person today who's working on the iphone seven And then revenue will be generated next year, you know after Well late in the fall or whenever The product comes out. So that's the reason for the discount right that we don't think of A demand for the factors of production like the neoclassical economists do in a timeless way But that we have this element of time Sequence involved we have a time structure In our analysis that leads us to this important difference Now what we might ask the question then, uh, what What implication would this have for cost analysis? And interestingly enough and this is the caveat that I mentioned earlier when I said that Rothbard doesn't do cost analysis Uh, he he does this one step. He does take one step and this one step He states this way He says in the ere, of course all costs and investments will be adjusted and irrevocably incurred costs for all firms will equal the price of the product Minus pure interest return to the capitalist entrepreneur. That's the discounting that you talked about And also as we see minus the return to the discounted marginal productivity Uh of the owners a factor which does not enter into the firm's cost. You see he's He's noticed this right. Well, what does he make of this? Well in chapter 10? He gives us again, this is Uh, I just reproduced this from chapter 10 of Uh, man economy in state. He gives us this analysis. This is the chapter on monopoly And again for those of you, you know Economists in the room, you know that in monopolistically imperfect markets The argument is that uh, the demand curve and the cost curve will be tangent Because there won't be any monopoly return to in that market And that implies if you if you were to move that cost curve up and make it tangent at point f It it shows that this firm is Has invested too much in capital They have excess capacity They're not operating at the minimum point of their average cost curve They've invested in this capital capacity and then they don't utilize it fully And that's an inefficiency and rothbard saying no no no if we include the element of time discount We can see that that's not true. The the entrepreneur will not Equate the price of his product with his average cost He'll he'll uh, he'll discount the cost, right? And this certainly allows for the possibility that he would operate at the minimum point of average cost And we don't get this inefficiency at all. This is a wonderful insight, right? That that rothbard has achieved by using the standard cost analysis and just Integrating this element of time preference discount Into the analysis. It's one, you know, wonderful thing Okay, so Then the the next so what i'm suggesting what i'm suggesting is we can just generalize this We we could generalize this right for all production in the e re if it's if it's true for a monopolistically Imperfectly competitive Firm well, it would have to be true of all firms in the e re So so let's think about an example like that Um and here again the rothbard's comment Uh that leads us to this he says once we bring investment interest return into the picture We see the whole elaborate cost curve structure is totally Faulty and should be tossed into the discard. That's where I disagree with rothbard. I think it could be I think his own analysis shows it can be retained Usefully right it is somewhat helpful for us to do this In fact, if nothing else it allows us to converse more fully with our neoclassical friends, right? And to show them that if if they actually did a more realistic analysis That they they wouldn't reach the conclusions they reach But but if we're not willing to you know Show them this and they're Using the apparatus of cost curves they they might just reject it on those grounds, right? We're not analytical. We're not being you know, we're not adopting some sort of standard Economic analysis just like we would be rejected. Perhaps if we didn't use demand and supply analysis by certain By certain persons. So at least if nothing else there's a rhetorical advantage to be gained Okay, so I think uh, I would say then that the the key element here if we want to think about the generalization of this is in Is in the idea of capitalization again So in just to orient our minds toward this, uh, rothbard says man economy and state costs are not fixed by an invisible hand But are determined precisely by the total force of entrepreneurial demand for factors Of production as boombab work and the austrians pointed out costs conform to prices and not the other way around So we know in the ere cost must be conforming to prices, right? And so we must get this regularity somehow in the ere and if we integrate the um The idea of a discount of an interest rate discount the analysis would go something like this now. Let let me Provide a concrete example that I'm illustrating here Let's suppose in the ere. We have a market Where all the sellers sell a homogeneous product So let's say it's the corn market And so whether you're a corn producer in pennsylvania a corn producer in in uh, Nebraska You're going to get the same price It's a homogeneous units of the good. So that that's the setup the p the dots above the q1 and q uh, two Are at the same price level But it's certainly possible in the real world outside of the model of the neoclassical economist where this would be assumed away It's certainly possible in the real world for the production Uh, the efficient production arrangement to be different in different places So I mentioned pennsylvania and nebraska simply to illustrate this So in nebraska, they're Wide open spaces I grew up in nebraska and uh You know, I didn't think this was strange at all until I've moved to pennsylvania But in nebraska the roads are even all Uh constructed in sections In mild square sections. So if you drive out of the rural towns You'll drive on, you know, country roads as we would say they're not really country roads like they are, you know here in the south but Rural roads and they're all in a grid pattern At 90 degree angles and they're all one mile on a on a side, right? And they're farms that take up, you know, several sections Of land Now in pennsylvania, you cannot do this In pennsylvania, there's no farm. There's no level farmable land that that's uh, you know, big enough to have like a section Like a mile square area where you're farming all in corn and you can imagine the difference then in the production techniques So in nebraska, they have these gigantic pivoting, uh Irrigation processes gigantic machines that uh, that pivot around a a fixed point to irrigate the corn Now you could not set those up in pennsylvania Even on even on the you know, the most level ground they wouldn't run because it it's Undulating right and a machine would just fall apart or stop, you know grind to a halt or whatever So you don't use that technology use something else So you have these gigantic reaping machines in nebraska because you can just sweep across these flat areas And then in in pennsylvania, you just have tractors just regular old tractors and And so on so in the ere if we had an ere, what would what would happen? And and the answer is well, we know that the price of corn the price of the output is the same The rate of return has to be the same in the two industries, right? Because it's higher in one and lower in the other The adjustment would take place the arbitrage the investors would take place and they'd move out of the low return and into the high return And they they'd push the returns to equality So if the price is the same and the rate returns the same then then the cost has to be the same The average cost has to be the same so it would have to look something like this It doesn't look like an envelope curve Right, it looks something like this And that I think is the key the key insight of how capitalization can You know what effect it has with respect to time At least this element of time Now here's the here's the next step We know that this production process and again, hopefully my pennsylvania nebraska corn example illustrates this uses both Non-specific factors of production and specific. We've already mentioned some of the specific factors of production these gigantic irrigation systems and huge Reaping machines and so on that can only be used in these midwest farms in the great plains farms And then they're not they're not of much use in the you know farms in other places Uh, but the labor might command the same wage across across agriculture in these two states A fertilizer would probably have the same price, right? So all the all the non-specific factors of production again in the re would have the same price Across these two production processes So if the costs are going to be the same and the prices of the The specific or the non-specific goods are the same and yet the production the actual production of the of the Assets the specific assets are different than their prices must be different, right? So if it's much more productive to grow corn in In a nebraska then the prices of the reapers and the And the irrigation systems much to be proportionately higher than the prices of the assets used in pennsylvania Right that it's capitalized into into the prices of the assets and that is what sets the price structure That's what keeps the price structure in nebraska from being lower than the price structure even though It's more physically productive than the price structure in pennsylvania. It'll be higher because the asset prices are higher And so again, we can depict this just by showing shifts of the cost structure up and down Okay, so that's the idea And here again, i'm not saying that murray doesn't recognize this. He clearly understands all this This is all verbally again in the austrian writings The various costs that is prices of the factors Determined by their various discounted marginal value products In alternative uses are ultimately determined solely by consumer demands for all the uses It must not be forgotten furthermore that changes in demand And selling price will change the prices in incomes of specialized factors. That's the key point, right? That they're the locus of capitalization In the same direction so if demand goes up for the product the the specific asset prices will rise But if the specific asset prices rise the cost structure has gone up You see and and prices conform to I mean the cost conformed to prices So the cost curve so fashionable and current economics is seeing fixed factor prices Ignoring this variability and again, we can reject that assumption. I think without rejecting the cost curve apparatus itself Now let's take another illustration of what would happen Now this is the final state of rest. So now we're not in the e re but in the final state of rest and again, just who are all in the same page When economists do final state of rest analysis, they take a a given equilibrium So we're in a given situation where there's no further change and then one factor changes And then we trace through All the other factors that would change Since the economy is an integrated unit Over time and then and then we state what the final New equilibrium would look like So so that's doing final state of rest analysis. So let's suppose that We think through the cost curve Implications of an example for the final state of rest. So here my example We start at the at the demand and cost relationships that generate the price p1 And the average cost structure for some producer is ac1 So again, it's a discounted. So the cost lies below the the price, right? And then the demand falls And we want to trace through the effects. So the demand goes down for this product And the way I've depicted it the the demand has gone down to the point where the price Falls below the average cost structure the losses Would ensue if the cost structure stayed at that point But to the contrary, of course, what would happen in the final state of rest is that investors would Decapitalize this industry, right? They'd sell out the assets And then the asset prices would fall the specific asset prices would fall right not the Not the Non-specific factor prices. They might say the same wages might stay the same And so on material prices, but the asset prices would fall once the asset prices fall then Profitability is restored right the rate of return is restored. And so the production continues Uh, let me give you a couple of examples from Our recent circumstances on this We've all heard about the uh the introduction of uber And what's happened to the uh taxi Industries in various cities in the face of uber competition So a few months ago there were stories in the Bloomberg financial about What's happened to the price of taxi medallions in new york city? So that's a that's a highly specific asset to run a taxi business, right? So when when uber competition starts to shift demand away from the taxi Industry, this doesn't mean that the taxi industry suffers You know ongoing production losses It means that the specific asset prices fall they they suffer capital loss Right, that's the effect. They suffer an immediate capital loss And all the future profitability of having the taxi medallion is now Is now discounted into the present value of those new asset prices And so if you want to buy into the taxi industry today, or if you're an ongoing Business running a taxi, you're you're still profitable Right because you suffered a one-time capital loss, but your ongoing production Is profitable Precisely because your asset prices have fallen You know another and by the way then my final state of rest analysis here is truncated obviously i'm not Because actually what would happen in this case is that the specific assets of running an uber Business would rise in price the specific assets of running a standard taxi would fall And then resources would shift toward the production of of uber specific factors of production, right? And out of the out of the production of taxi medallion But so it's a rent seeking with diminish or whatever We can also think of the this analysis applied to the recent term oil and oil markets And the closing of shale Oil wells in the u.s. So it's a similar sort of thing You know you read bloomberg financial during this period and they they were They were perplexed, you know, they would put out these stories that would say You know here the cost of production of a barrel of oil and Saudi Arabia It's 16 dollars a barrel or whatever and here they are in iran It's 22 dollars a barrel and here they are in texas and it's uh, whatever 40 dollars a barrel And here they are in the shale industry in uh, north dakota and it's 80 dollars a barrel And yet when the price of a barrel of oil fell from 100 down through 60 down to 40 The north dakota producers were still producing Okay, well, you know what's going on and what's going on is they're still producing because well at some point They stop right we'll get to that in a minute But they're still producing because the value of the shale oil wells themselves have collapsed They suffered their loss boom just like that They suffered their capital loss and now at that lower value of the assets Their cost structure has fallen and it's still it's still Useful for them to continue right even though the price has gone below what bloomberg reports is their cost They haven't adjusted their cost for the capitalization change And that's what's Going on By the way, you know that the price of oil has been going back up and the shale Wells have not been brought back into production Yet right even though they were in production at at 40 dollars a barrel on the way down They're not back in production at 40 dollars a barrel now. They're they're of course nuances to this analysis, but The basic reason for this with respect to capitalization is that capitalization is always forward looking That's the that's the key to the whole thing It's always forward looking It's always the opportunity cost of what we can do in the future if we don't give up The the opportunity to take that action in the present And so they're anticipating in other words Uh even higher prices in the future that they can hold back then their asset And employ it then in the future when the price structure has been restored Yeah Okay, so Now the next step in this then Is to get to the to the actual substantive point which i've been alluding to all throughout this The the addition of uncertainty into the analysis And so here we again i take my cue from mises where he says the notion of change implies the notion of a temporal sequence A rigid eternally immutable universe would be out of time But it would be dead the concepts of time and change are inseparably linked together Action aims at change and is therefore in the temporal order So when we talk about time and the theory of cost, we also have to include uncertainty That that's an element of time right and and hence my the title of my talk Rothbard is the same it takes the same position He says this in commenting on kerzner's book He makes a general comment for the book. Why has there been no discussion of the important influence of speculation on price determination? That's a very good question. Shouldn't shouldn't we integrate speculation into price determination? Okay, so then the question is uh, what happens if we do this? So let me let me just provide now a kind of comparative summary of my Analysis and and then we'll go through the details of it So it would look something like this if we're in the neoclassical world, it's timeless And this again is the labor market For some for some type of labor And they would say the wage is determined by the marginal revenue product the demand the entrepreneurs have the marginal revenue product And then the supply of the workers And it's timeless in the sense that we don't have this time sequence, right? So there's no discounting and And the wage is being paid today is somehow synchronous with the prices of the outputs and and so on And then what we have in Mises and Rothbard is a time sequence. We have time, but it's just the time sequence of The stages of production. We have the time structure of production And here we see then that the entrepreneurs will not base their demand on marginal revenue product But they'll discount the marginal revenue product So they'll only pay a price today That uh that allows them to earn a rate of interest When they pay for the inputs and then receive the revenue in the future And then what i'm suggesting is and again, i'm not claiming that the this insight is not in the literature What i'm claiming is we need to put this insight this further insight into our analytics And the further insight is uncertainty So we have not only not only does time imply a Time structure where we have to take account of the discount time also implies uncertainty And so we have to take account of anticipations So this is anticipated discounted marginal revenue product And again, it's not my claim that Mises and Rothbard don't You know have this insight is my claim that they make almost no use of this in their analytics They don't they don't sort of build it explicitly into their analytics So what happens when we do this if we return? um If we return to the analytics the immediate run price of goods and the immediate run price of factors And then make a concluding remark So here we just notice that the supply and demand both sides of the market are based on the entrepreneur's anticipation Of the future of the opportunity costs in the future. So again to use my iphone example tim cook and the entrepreneurs uh at apple are Setting the supply their Their willingness to sell at 3.99 today the To the buyers of the iphone they've taken into account their anticipations of what demands will be in the future Will they be will they be higher next month? Will it will the Phone proved to be popular or will it be lower or they've already they've already built that into their supply today Right if that's a fundamental feature of it. And then the same with the customers the customers who buy the iphone uh se Can only anticipate the the usefulness of it to them in the future It isn't it isn't that they know this or that their subjective values will always be realized But they are just engaged in anticipations Now again, why does this matter? Well, I would say that it's important for us one important implications of this is that It reinforces uh boom bop works Marginal pairs analysis And again distinguishes our analysis quite sharply from the neoclassical Or in the neoclassical world they basically have this notion of a Of a given economic agent Right and the economic agent just has a a preference map or something And the trade between the different economic agents occurs mainly because they have different endowments to begin with But their utility structures are basically the same And so we don't get any sort of individual spectrum of valuing things At the margin we do but not fundamentally right, but we can see that this difference is really fundamental Because each consumer is just is just anticipating what the value will be and obviously every consumer will have a different Accuracy of their anticipations for some their expectations will be met for some and they'll be exceeded for some Uh, they won't be reached and then the person will react again right will act again in the in the face of that And the same thing then for For the supply side So when we get to factors of production Then we can see that uh the entrepreneur's demand for the factors of production is also based upon just their anticipation Of what realize discounted marginal revenue product will come from hiring this This input or purchasing this input and once again why this is helpful is that it clearly Implies that that this this Spectrum of demand this downward sloping demand curve is based not Uh, solely upon let's say different starting points for the different entrepreneurs who see everything exactly the same way Quite the contrary. It's embedded into Uh, the differences that exist among human persons and that some of the entrepreneurs simply perceive the future Results more favorably and some perceive them less favorably the same situation and some perceive it You know somewhere in the middle So we've get we have this boom of archie and marginal pairs analysis brought to the forefront To to help us see this See this Divergence Okay, and then the final point that I want to make uh It has to do then with the adjustment process the final point about Once we integrate the anticipations into uh into the Standard analysis, then how does this help us with the dynamic explaining the dynamic process? So here's Mises again There's nothing automatic or mechanical in the operation of the market The entrepreneurs eager to earn profits appears bitters at an auction as it were in which the owners of the factors of production put up For say a land capital goods and labor the entrepreneurs are eager to outdo one another By bidding higher prices than their rivals Their offers are limited on the one hand by their anticipation of future prices of the products And then the other by the necessity to snatch a snatch the factors of production away from the hands of other entrepreneurs competing with them But again Unsaid is other entrepreneurs are doing the same thing, right? They just have anticipations of the future and so we have one entrepreneur More accurate anticipations and another entrepreneur with less accurate Expectations and the entrepreneur with more accurate is able to bid away the factor So let me take one more illustration of this Let's say we have a given industry where the current conventional production process Is ac zero So most of the producers are using this production process They're selling the product at p zero and selling a quantity of q zero And then there's another group of entrepreneurs that recognize an existing alternative technology That would allow them to better cater to the Customers and so fetch higher prices And yet because the the potential in these assets is not recognized by its competitors They're able to buy the assets at low prices And so they see this profit opportunity And so they jump in first And they're able to acquire the assets at very low prices And then when the other entrepreneurs see the realized value of this investment structure They will then modify theirs right the investors will simply shift more heavily into this new configuration and the and then and then the market adjusts to a new Point where the rate of return on the new investment Structure will be normalized And and You know, that's how the dynamic would work itself out Now the final thing let me put up a final quote by Mises indicating this and make one just final remark as you read that quote Here he's just talking about the superiority of certain entrepreneurs So this is what I'm claiming The superior entrepreneurs jump in first and obtain the profit and their action then moves the prices of assets to their new equilibrium, if you will I don't have time to discuss this But I in my own judgment this this modification is is pregnant with implications And I hope all of us think think through these implications and and push forward the austrian paradigm Thank you very much