Mises on "Fixed Prices"

I don't know who this guy is or what he says, but I like him

After my critique (here and here) of the assertion that firms can control prices, I was reading Mises' book about money. I was glad to see that he already agreed with me from the beggining.

In The Theory of Money and Credit, Mises (1912a: 162-65) says:

"The modern theory of prices has stated all its propositions with a view to the case of direct exchange. Even where it does include indirect exchange within the scope of its considerations, it does not take sufficient account of the peculiarity of that kind of exchange which is dependent upon the help of the common medium of exchange, or money. This, of course, does not constitute an objection to the modern theory of prices. The laws of price determination which it has established for the case of direct exchange are also valid for the case of indirect exchange, and the nature of an exchange is not altered by the use of money. Nevertheless, the monetary theorist has to contribute an important addition to the general theory of prices.

If a would-be buyer thinks that the price demanded by a would be seller is too high, because it does not correspond to his subjective valuations of the goods in question, a direct exchange will not be feasible unless the would-be seller reduces his demands. But by indirect exchange, with money entering into the case, even without such a reduction there is still a possibility that the transaction may take place. In certain circumstances the would-be buyer may decide to pay the high price demanded, if he can hope similarly to obtain a better price than he had reckoned upon for those goods and services that he himself has to dispose of. In fact, this would very often be the best way for the would-be buyer to obtain the greatest possible advantage from the transaction. Of course, this will not be true, as in the case of transactions like those of the stock exchange, or in individual bargaining, when both parties cooperate immediately in the determination of prices and consequently are able to give direct expression to their subjective estimates of commodity and medium of exchange. But there are cases in which prices appear to be determined one-sidedly by the seller, and the buyer is obliged to abstain from purchase when the price demanded is too high. In such a case, when the abstention of the purchaser indicates to the seller that he has overreached his demand, the seller may reduce his price again (and, of course, in so doing, may possibly go too far, or not far enough). But under certain conditions a different procedure may be substituted for this roundabout process. The buyer may agree to the price demanded and attempt to recoup himself elsewhere by screwing up the prices of the goods that he himself has for sale. Thus a rise in the price of food may cause the laborers to demand higher wages. If the entrepreneurs agree to the laborers' demands, then they in turn will raise the prices of their products, and then the food producers may perhaps regard this rise in the price of manufactured goods as a reason for a new rise in the price of food. Thus increases in prices are linked together in an endless chain, and nobody can indicate where the beginning is and where the end, or which is cause and which effect.

In modern selling policies "fixed prices" play a large part. It is customary for cartels and trusts and in fact all monopolists, including the state, to fix the prices of their products independently, without consulting the buyers; they appear to prescribe prices to the buyer. The same is often true in retail trade. Now this phenomenon is not accidental. It is an inevitable phenomenon of the unorganized market. In the unorganized market, the seller does not come into contact with all of the buyers, but only with single individuals or groups. Bargaining with these few persons would be useless, for it is not their valuations alone but those of all the would-be purchasers of the good in question that are decisive for price determination. Consequently the seller fixes a price that in his opinion corresponds approximately to what the price ought to be (in which it is understandable that he is more likely to aim too high than too low), and waits to see what the buyers will do. In all of those cases in which he alone appears to fix prices, he lacks exact knowledge of the buyers' valuations. He can make more or less correct assumptions about them, and there are merchants who by close observation of the market and of the psychology of buyers have become quite remarkably expert at this; but there can be no certainty. In fact, estimates often have to be made of the effects of uncertain and future processes. The sole way by which sellers can arrive at reliable knowledge about the valuations of consumers is the way of trial and error. Therefore they raise prices until the abstention of the buyers shows them that they have gone too far. But even though the price may seem too high, given the current value of money the buyer may still pay it if he can hope in the same way to raise the price which he "fixes" and believes that this will lead more quickly to his goal than abstention from purchasing, which might not have its full effect for a long time and might also involve a variety of inconveniences to him. In such circumstances the seller is deprived of his sole reliable check upon the reasonableness of the prices he demands. He sees that these prices are paid, thinks that the profits of his business are increasing proportionately, and only gradually discovers that the fall in the purchasing power of money deprives him of part of the advantage he has gained. Those who have carefully traced the history of prices must agree that this phenomenon repeats itself a countless number of times. It cannot be denied that much of this passing on of price increases has indeed reduced the value of money, but has by no means altered the exchange ratios between other economic goods in the intended degree.

In order to guard against any possible misunderstanding, it should be explicitly stated that there is no justification for drawing the conclusion from this that all increases of prices can be passed on in this way, and so perhaps for assuming that there is a fixed exchange ratio between the different economic goods and human efforts. To be consistent, we should then have to ascribe the rise in the money prices of goods to the vain efforts of human greed. A rise in the money price of a commodity does as a rule modify its exchange ratio to the other commodities, although not always in the same degree as that in which its exchange ratio to money has been altered.

The champions of the mechanical version of the quantity theory may perhaps admit the fundamental correctness of this line of argument, but still object that every variation in the objective exchange value of money that does not start from changes in the relations between the supply of money and the demand for it must be automatically self-correcting. If the objective exchange value of money falls, then the demand for money must necessarily increase, since in order to cope with the volume of transactions a larger sum of money is necessary. If it were permissible to regard a community's demand for money as the quotient obtained by dividing the volume of transactions by the velocity of circulation, this objection would be justified. But the error in it has already been exposed. The dependence of the demand for money on objective conditions, such as the number and size of the payments that have to be coped with, is only an indirect dependence through the medium of the subjective valuations of individuals. If the money prices of commodities have risen and each separate purchase now demands more money than before, this need not necessarily cause individuals to increase their stocks of money. It is quite possible, despite the rise of prices, that individuals will form no intention of increasing their reserves, that they will not increase their demand for money. They will probably endeavor to increase their money incomes; in fact this is one way in which the general rise of prices expresses itself. But increase of money incomes is by no means identical with increase of money reserves. It is of course possible that individuals' demands for money may rise with prices; but there is not the least ground for assuming that this will occur, and in particular for assuming that such an increase will occur in such a degree that the effect of the decrease in the purchasing power of money is completely canceled. Quite as justifiably, the contrary assumption might also be hazarded, name1y that the avoidance of unnecessary expenditure forced upon the individual by the rise of prices would lead to a revision of views concerning the necessary level of cash reserves and that the resultant decision would certainly be not for an increase, but rather for even a decrease, in the amount of money to be held." (bold and italics are mine)

It must be emphasized that this quote is present even in the original 1912 german edition (Mises, 1912b: 180-84), where "festen Preise" means "fixed prices" (according to Google). 

Milton Shapiro explains this very well in his refutation of “administered price” theory in his book (Shapiro, 1974: 366):

“For instance, no real-world firm really has the "power" to suspend the law of demand and supply—that is, to avoid ending up with a surplus for overpricing its product, or to avoid less-than-maximum profits by underpricing its product and realizing a shortage. Sooner or later, after trial-and-error searching for the market-clearing price, every real-world firm finds itself eventually having to "take" the market price that actually clears its supply. Thus real-world firms are "price-takers" no less than firms in pure competition, the only difference being this: PC firms "take" their P from the market right from the start (they have perfect knowledge!), whereas real firms "take" their P only after trial-and-error search in the market. Irony of ironies: real firms are, in an ultimate sense, price-takers, too!”

Two things must be clear:

1) Firms do not and can not violate or suspend the Law of supply and demand.

2) Firms do not violate consumer sovereignty by “fixing prices”.

Bibliography

Mises, Ludwig von (1912a), The Theory of Money and Credit. New Haven: Yale University Press. 1953.

Mises, Ludwig von (1912b), Theorie des geldes und der Umlaufsmittel. Munchen und Leipzig: Ferlag von Duncker & Humblot. 

Shapiro, Milton M. (1974) Foundations of the Market Price System. University Press of America, Inc. 1985.