On Prices/Values

Economics, rather Political Economy attempted at providing a coherent theory of value. Economists such as Adam Smith, David Ricardo, Karl Marx, etc are associated with a ‘theory of value’. Currently, in economics, ‘value’ is not discussed in courses of relevance. However, students are exposed to value theories such as labour commanded, labour embodied and so on.

This post is the second in the series of posts ‘On Prices’. This posts attempts at clarifying concepts such as values, prices and costs of production. Note that all prices which are mentioned in economics textbooks (microeconomics, introductory economics, principles of economics, etc) pertain to relative prices or long-run prices. That is, they do not talk about market prices. The reason for this is because it is assumed/believed that market prices tend to fluctuate or hover around these relative prices. In other words, given a particular technology, these relative prices, in some sense, reflect the interrelationships in the economy. Hence, these natural/normal proces are studied in order to understand the workings of a capitalist economy.

Let me start with what is usually taught in various economics and management institutes across the world and even in higher secondary schools. Prices are determined by the interaction of supply and demand. This implies that an excess dmand leads to a price hike. Let us look at an example: Suppose I go to a toy shop and ask for a Meccano set and immediately, another customer asks for the same set. But, the shop has only one Meccano set. Will the price of the Meccano set increase’ Is such an explanation intuitive or common sensical’ This example talks of an isolated case.

Economics is interested in the formation of a spectrum of prices at the level of the economy. Interestingly, macroeconomics has nothing to offer on price formation. Often, or rather everywhere in the world, economics is taught as microeconomics and macroeconomics. The interdependence and interrelationship present in any economy is inadequately addressed. The closest one comes is probably through the ‘circular flow’ diagram which highlights the role of the firm as well as the households. In this diagram, the complex and strutural interdependence is oversimplified to that of a 2-way interaction between the firm and household via labour market, capital market, etc and the state is shown to play the role of a facilitator. The interrelated production structures goes unnoticed or is seldom mentioned. Why is this important’

How can prices be determined’ (The dominant factor will be mentioned.)

1) Demand & Supply – The prices which are determined in this way are the prices of vegetables and fish, prices of shares in the stock markets, price of real estate, etc. In some sense, these prices can be said to be supply determined. For, these commodities are more often subject to variations in supply than in demand.

2)Costs of Production – An alternative view which is present in the literature is that the prices of commodities are prices according to the prices paid to the means of production as well as adding a certain percentage as profit. According to Kalecki, the percentage depends on the monopoly power of the firm. What if the firm’s final product is an input for another firm’ Will this affect the price of the product’ This aspect is often forgotten in economics.

This forgetfulness is strongly associated to the lack of importance mainstream and even some heterodox economic theories gives to interrelationships in the production structures in an economy. To have a glimpse into this, one needs only to look at an Input-Output table.

If we assume (correctly) that production structures in a capitalist economy are interrelated then we can conceptually distinguish goods/services into – Basics and Non-Basics. [Sraffa 1960] Basic goods are those goods which directly or indirectly enter into the production of every commodity in the economy including its own. An obvious example would be foodgrains because they are needed for labourers and labour is required in all activities. And a tax on a basic good will have cascading effects on the prices of all the goods in the economy.

I shall quote Sraffa to point out the significance of accepting and studying interdependence.

The exchange-ratio (or relative prices) of non-basics is “merely a reflection of what must be paid for means of production, labour and profits in order to produce them – there is no mutual dependence.” [p 8, Sraffa 1960]

“But for a basic product there is another aspect to be considered. Its exchange-ratio depends as much on the use that is made of it ….” [pp 8-9, Sraffa 1960]

It is because of these issues that Sraffa uses values/prices than costs. Also, Sraffa knew that in an economy, “costs of production cannot be measured independently of, and prior to, the determination of the prices of products.” [p 9, Sraffa 1960] To conclude, dan we therefore think that Sraffa’s analysis is similar to the neoclassical analysis of price using demand and supply’

In brackets, Sraffa writes “one might be tempted, but it would be misleading, to say that ‘it depends as much on the Deamnd side as on the Supply side.'” [p 9, Sraffa 1960]

References

1) Kalecki, Michal (1971), Costs and Prices, in Selected Essays on the Dynamics of the Capitalist Economy 1933-1970, Cambridge University Press, pp. 43-61.
2) Sraffa, Piero (1960), Production of Commodities by Means of Commodities, Cambridge University Press.

On Property Rights and Economic Development

India is ranked 46th alongside Costa Rica, Kuwait and Slovenia. Finland has secured the first rank and Bangaldesh is given the last rank in the IPRI 2009 report.

Property rights is an issue that all scientists, social scientists and others have had to think about directly or indirectly in their lives. It is property rights that we are talking about when a new product is introduced, a new book is released, two siblings fight over their father’s property, people are displaced from land which they had considered to be their own, prime agricultural land is handed over to giant companies, etc. This post questions the notion that property rights ’causes’ economic development by focusing attention on the International Property Rights Index (IPRI) 2009 report.

The 2009 IPRI shows that economic growth is intimately related to ownership. Such a statement is derived from a positive correlation that is seen to exist between a country’s protection of both physical and intellectual property rights and its economic well-being. In order to analyse this claim, the post looks at concepts such as economic growth, ownership and correlation.

Ownership
Property rights is considered to be fundamental to all human rights. Of course, lack of property rights makes governance difficult and also makes business cumbersome. But, one needs to understand the history of ‘property rights’ or ‘ownership’. This is where Karl Marx can aid us. It is the forced separation of the labourer from his means of production that led to the emergence of ‘private property’. In Das Kapital Volume I, Marx talks of the brutal and coercive policies that were carried out so as to divorce workers from their land. This is a section which all students who are concerned about property rights must read.

Economic Growth
There is an increasing tendency to equate economic growth with economic well being. Though, very often rates of economic growth surge without any ‘real’ improvement in the livelihood of the populace. Economic growth is to be understood as the rate of growth of GDP in a country over a period of time. At times, per capita GDP is used in the calculation. Which ever definition is used, one must always keep in mind that they are only statistical indicators, which are arrived at on the basis of a lot of assumptions. This is not to say that such indicators are useless or meaningless, but rather to emphasise their power in framing policies. Hence, the need to use them with utmost caution.

Correlation
It is alarming when correlation analysis provides ‘scientific support’ to causation. Such instances are in plenty within the discipline of Economics. Economics as a discipline tries to identify cause and effects so that appropriate policies can be framed. But, causation is a philosophically challenging concept. Philosophers still grapple with it and will continue to do so. However, economists seem happy to be talking about causes and effects by making use of just correlation!

Positive correlation between IPRI and GDP per capita
Source: IPRI 2009 Report

How can one conclusively establish that it is property rights which leads to high GDP per capita’ Couldn’t it be possible that it is the high per capita GDP that is resulting in stronger property rights’ Is it is on the basis of statistical correlation that property rights are considered to be a significant factor for economic growth’

Inflation: Theory vs Reality

The shift of focus from employment generation to inflation targeting seem to have taken place during the period India was being liberalised. Inflation, however, is a concern to the populace of any nation where wages are not indexed to inflation. In India, inflation poses problems as a rise in prices reduces the real wages and hence their purchasing power. Life, itself, can become difficult.

This post briefly tries to clarify how inflation is conceptualised in economics (neoclassical). Initially, it needs to be pointed out that neoclassical economics analyses equilibrium positions and differences between them – commonly termed as comparative statics. Another significant issue is that, in neoclassical demand and supply, the analysis is entirely carried out in logical time. Now, let us take a look at how prices are formed in equilibrium. In equilibrium, it is required that total demand of a commodity equals its total supply. And, if demand is more than the supply, prices are caused to rise, in order to restore equilibrium. Surprisingly, it is this insight that forms the basis of the current theory of inflation, which is mentioned in the media and talked about by economists.

Thinking through this ‘insight’, a few points come to my mind. First, an economy is never in a state of equilibrium. And neoclassical theory does not have the necessary tools to understand disequilibrium. Though, neoclassical theory can point out the characteristics of disequilibrium positions vis-a-vis equilibrium position. I doubt whether this is adequate. Secondly, prices in an economy does not rise, just because demand increases. Such a behaviour is commonly seen in markets for vegetables, fruits, meat, etc. It seems absurd to posit that prices of manufactured commodities will move according to changes in demand.

This much said, let us examine the impact of money supply on prices in an economy. Is there a relation between money supply and prices’ The first question which needs to be answered is how are prices formed. According to neoclassical economics, when demand rises, it implies that money supply in the economy has risen compared to the equilibrium state of affairs. The quantity theory of money seems to corroborate the hypothesis that money supply and prices are directly related. But what if they are not’ Wouldn’t the policies fail’

It is dangerous to build flimsy theories; for, policies draw arguments from these theories. For instance, the central bank tries to reduce money supply during inflationary conditions by raising the interest rates (indirectly) or through open market operations. How far are they effective’ Or, is inflation just a temporary phenomenon’ It needs to be mentioned that cases of hyperinflation is significantly different as they are strongly correlated with the breakdown of institutions.

This post ends by asking whether an increased rate of interest leads to decreased money supply’ Or whether an increased rate of interest causes prices to rise because the cost of borrowing increases’ Also, high interest rates attract capital from abroad. Very often, causes of inflation are not properly identified, which makes policy construction very difficult.

On Prices

This is a part of a series which aim at elucidating the notion of ‘prices’ in various periods in history and according to various economists (mainly heterodox). What do prices convey’ How are prices formed’ Is there any mechanism underlying the formation of prices or is it random in nature’ Is there a possibility of finding ‘natural laws’ which determine prices’

In reality, we often come across various kinds of prices ‘ wholesale price, retail price, administered price, maximum retail price (mrp), etc. In economics, neoclassical theories posit that prices are determined owing to the interaction or intersection of supply and demand. What prices are they talking about’ These are prices which are abstract in nature. Theorising is done for practical purposes; therefore, theoretical entities are constructed in order to understand the ‘real’ world. Does the demand-supply theory enlighten us’ Does it provide an approximation of price formation in reality’ Or does it only tell us about a special set of commodities’ In the secondary market which carries trading in shares, prices are formed according to the demand and supply. But, would it be right to say that prices of automobiles, mobile phones, eatables, etc are fixed by the same mechanism’ Wouldn’t it be the producer who fixes theprice taking into account the cost of producing and transporting it, over which she/he charges a percentage as profit’

Keeping these questions in mind, let us move on to the issues pertaining to ‘prices’ in period between 12th and 16th centuries. The period is roughly before the period known as the mercantile period. The establishing of a ‘just price’ was a significant issue then. Actually, this debate goes back even to the time of Aristotle. Prices then has more to do with ethics and morality than with objective mechanisms of equilibrium or competitive conditions. Now, it is clearly seen how ‘economic theory’ rationalities a lot of price hikes by providing the reason that ‘demand is more than supply’. I ask the question which prevailed in early centuries: is such a price rise just’ How does one say that it is rational for prices to increase when there in excess demand’ Where does the rationale come from’ Economic theory! Who constructs these theories’ And what are the implications’ Who does it benefit’

In the earlier centuries, trading or exchange was carried out only by a few people. People exchanged after their needs were met. According to Thomas Aquinas, just price was the price that prevailed in the markets in the absence of fraud or monopolistic practices. This conception is reminiscent of the underlying power structure which prevailed at time. ‘Just’ did not necessarily mean just. And, this period was characterised by a lot of political interventions (especially, in Italy). Some other writers considered as ‘just’ that price which allowed producers to maintain a standard of living befitting their position in society. That is, the cost structure was determined by social stratification.

In the debates on ‘price’, references to utility and rarity was abundant. Another price ‘ the legitimate price also prevailed. It referred to the price which was fixed in any transaction agreed on by the participants freely. Again, the ‘freedom’ here is questionable. For, liberal authors argue that the transaction carried out by a CEO and a wage labourer is ‘just’ because both of them are freely participating. Surprisingly, the origin of property rights is seldom mentioned.

To conclude, this is a post inspired by the sub-disciplines of economic history and history of economic thought, which is rapidly vanishing from the departments of economics.

Reference

1) Roncaglia, A (2005), The Wealth of Ideas: A History of Economic Thought, CUP.