The History of Classical Economic Theories - Case Study Example

Austrian and Post-Keynesian theories ical theory The ical theory dominated economic topics in 18th and early19th century. The architects of classical economic theories were Adam Smith, David Ricardo and John Stuart Mill. The theory argues that market is self-regulating as individuals seek to profit themselves. It is the profits that individual seek that promote optimum allocation of society’s resources. The classical theory supports growth, competition and free trade. It discourages government from interfering with the market. Post Keynesian theory Post Keynesian theory is the continuation of Keynes theories. Keynes dwelled extensively on general theory and gave clear explanation on factors that determine output and employment levels of any given economy. Income distribution, uncertainty, consumers’ psychological behavior, entrepreneurs “animal spirits” and the government policies influences the total demand. King (200, p. 12) states that aggregate demand influence unemployment, distribution of income, deficits of the national, government’s budget deficits and inflation levels. On the other hand, post Keynesian theory dwells extensively on product distribution, pricing and competition. The Austrian Theory and Radical subjectivism Austrian theory was originally conceived in 1953 by Ludwig Von Mises. It was Later, enriched by Friedrich A. Von Hayek in1967. Austrian theory claims that individual’s actions and behaviors are dictated by their value system. Economic actions take place in a natural and social environment. The theory does not recognize scientific methods and empirical application to economic problems. The consumers have value scale that gives the products and services the value. Comparison and contrast of Austrian and Post-Keynesian Theorists Risk and Uncertainty Both the Keynesian and Austrian theories agree that uncertainty is unpredictable because its outcome is rare (uncommon). For example, it is extremely difficult to predict something that does not have history (experiences) or trends such as the likelihood of the earth leaving its orbit or the likelihood that a new product would receive good customers or not (Taylor, 2008, p. 30-36). Therefore, the likelihood of the earth leaving its orbit or new product getting many customers is uncertain as per the two theories. On the other hand, as much as both theories agree about uncertainty, there are two divergences about the risk. Austrian theory does not distinguish either and equates risk to uncertainty. Risk is in the notion of action and nobody knows the effect until the action has been done. If the future was known, an individual would not have to make choices because he or she knows exactly what brings good results. Austrian theory claims that individuals act in uncertain environmental conditions. Uncertainty occurs because it is extremely difficult to predict plans and actions of other individuals. This is because perfect knowledge does not exist. For example, a producer can only guess the product to produce and the price to charge customers. However, he or she cannot predict the actual reaction of its customers towards the product and its prices. A single plan or action of one person can inconvenience or disrupt other people’s plans or actions and its consequences can only be felt when the action has been executed. Post Keynesian theory separates risk and uncertainty while According to Pressman and Holt (2001, p. 52), Post Keynesian theory suggest that risk is measurable (quantifiable) and is awarded probabilities while uncertainty is immeasurable (non-quantifiable). Uncertainty can be evident between the principle and the agent due to biasness in information. Principal-agent theories handles challenges which results from differences of contractual relationship when the two parties are uncertain. Principal-agent objectives is to elaborate how to come up with contracts in order to align incentives between contracting parties and reduce costs resulting from challenges. The principal is the individual whose welfare is affected by the agent’s actions and is measured in monetary terms. The principal remains unaware party while the agent is well informed. The agent however, may not act as expected by the principal since the agent is expected to have other interests of his or her own. The principal task therefore is to come up with an incentive contract that tries to bring together both the agent and the principal through incentive. Competition Both theories acknowledge the influence of demand and supply forces in the market. Austrian believes that supply and demand forces regulate the producers. To both theories, increases in price make economic actors to adjust their consumption to the level where they can afford. Therefore, the higher the prices, the smaller quantities of goods and services consumed. However, Post Keynesian and Austrian theories have divergent views about competition. According to Austrian theory, competition is viewed as a dynamic (unstable). On the other hand, Post-Keynesian theory attests that competition is stable. Austrian theory considers completion as a process (a succession of events). Austrian economists view competition in different ways. According to Austrian theory, the demand for ones product and service depend on the number of competitors who enter those markets. The firms (producers) are constantly looking for ways to improve their products or services to attract more customers. Unfortunately, firms are unable to make successful competitive strategies because they do not have the perfect knowledge. To most Austrian theorist like Hayek, competition is a discovery affair and has no end. What makes the competition a process is ever changing production methods; new markets; new forms of firm organization; and new products as market competitors try to outdo each other. The theory further claims that information is a source of competitive edge for the producers and regulates the market. Furthermore, firms try as much as possible to manipulate product prices and trade practices to survive in the market. For example, firms resort to technological innovation as well as advertising and product differentiation to remain competitive. The theory acknowledges that there individual value scale is unique and does not necessarily represent the value of other economic actors. Post Keynesian theorists view competition as static (stable) and treat markets as at equilibrium (price = marginal cost). This is because economic actors possess perfect information about the market (entire economy) and individual value scale reflects the value scales of all economic participants. According to the Post Keynesian theory, competition is about domination and each firm try to dominate the others. Post Keynesian theory agrees that monopoly and oligopoly causes imperfect competition as it destabilizes existing structures. However, in the long-run, there is a possibility of factories and firms becoming of equal extent. It can be a scenario where several plants are included in a firm or a single plant being utilized by quite a number of firms. Post Keynesian economics highlights that the size of the firm becomes a constraint in the short run. Therefore, the capital is held constant and diminishing returns is presented by several factors of production used. Product/ service pricing According to Post-Keynesian theory, mark-up pricing is cost plus pricing. The additional price to cost is the margin a supplier of goods gets as a reward for producing the product. According to Post Keynesian theory, the degree of monopoly determines the markup. Monopoly gives the firm or entrepreneur the power to increase a mark-up on prime cost by raising price (King, 2003, p. 285-289). The degree of monopoly determined the market and mark up disparities is influenced by the power among firms in a given industry. Firms face existing and potential competitors in oligopolistic markets. Mark-up can function as a barrier to market entry because a firm can apply lower mark-up to undercut the competitor. Prices are set above costs but slightly below the competitors prices. Post Keynesian theory of growth and distributions observes full cost pricing. The firm’s survival in the long run is determined by the firm’s growth, as firms competitive strength is determined by the market share. In post Keynesian theory, price is a variable which is ex ante and its nature is a long period. Secondly, price is also viewed as being closer and compatible with the firm’s managerial theory, whereby growth rate of sales are maximized by the firms. If investments are greater as compared to savings, then the demand becomes excess as compared to the capacity of productivity at normal price. Therefore, the mark up is determined in a manner which brings about equilibrium state that equates investment to savings. The second approach insists that the operation of the firms is below their full capacity hence there are in a position to choose their own mark up prices. On the other hand, According to Boettke (1998, p. 155), Austrian theory asserts that price of consumer goods is dictated by their relative marginal utility. If a customer values a product, the price of that product is higher that prices. Entrepreneurship The two schools of thought tend to agree on the functions of the entrepreneur but differ as to the scope of entrepreneurship. Pheby (1989, p. 83) asserts that entrepreneurs are all economic agents. However, Post Keynesian theorists find this explanation unacceptable because not all economic agents are entrepreneurs. According to Murray (1999, p. 66), an entrepreneur is considered very important in the production of goods and services. An entrepreneur is a speculator who is actively seeking to utilize economic conditions to make a profit. They do so by willfully appraising economic conditions, bearing the uncertainty (risk) associated with a given economic activity and directing factors of production to produce. They are creative and innovative; have initiatives; actively venturesome; have quick eyes as compared to normal people; push and promote economic improvement through trade. They entrepreneurs are always trying to outsmart each other through price bidding and product differentiation. Entrepreneurship can also mean individuals who play the roles of the entrepreneur. They identify wants of the people and try to satisfy them in many ways. In addition, entrepreneurs try to sell goods and services on behalf of the owners at a profit. Entrepreneurs are perceived as agencies resisting moves whereby, consumers try to meet their most urgent wants at a lower price. However, the entrepreneurs compete and bring prices of goods and service to equilibrium. Radical Subjectivism The theory acknowledges that people rank their needs according to their importance. Those that are valued most are ranked the highest and awarded the highest value. It further claims that value is subjective depending on the circumstances surrounding the individual and cannot be measured mathematically (can only be ranked ordinal). According to Casson (2006, p. 116), economic actors are unique because of difference in knowledge, interpretations, varying expectations and alertness. The subjective valuations of goods and services by an individual create the economic value of those goods and services. Radical subjectivism suggests that no equilibrium will be achieved in the market because different people think and react differently (Langlois, 1989, p. 29). Austrians focus is on individual agent and not the whole economy while Post Keynesians are concerned with whole economy. The Austrian theorists refused the use of empirical method to investigate economic phenomena while Post Keynesians believes that the only way to quantify and explain the economic factors is to compute economic factors statistically. Distribution of income Post Keynesian theory asserts that distribution is the relation between prices and wages which utilizes the principle of multiplier. When full capital utilization and full employment of labour is continual, savings to investment change affect changes in prices relative to money wages (Harcourt, 2006, p. 114-115). This brings about income redistribution between wages and profits or among the different classes of income recipients. In the state where capital stock and labour force is not fully utilized, there is a possibility of savings changing investment through the level of employment and the level of capital utilization. This happens without any marked alteration in the real wage rate which is within limits. According to Rothbard and Block (1990, 39-40), Austrian theorists suggest that distribution of income is planned and executed by minds of individuals. 4. Conclusion Both theories are important in explaining economic phenomena and do not agree with neoclassicism positivist pretention. They also acknowledge the work of preceding seminal writers as they include old interpretations in their current work. Austrian theorists believe that individuals make economic decision based on their own value scale while Post Keynesian theorist investigates and considers aggregate economic phenomena. Austrians do not acknowledge empiricism in defining and explaining economic phenomena. Uncertainty is prevalent both Austrians and Post Keynesians. To Austrian theorists, competition is defined by entrepreneurship while Post Keynesian theories are of the view that the structure of the market dictates the competition landscape. For Austrian theorists, prices depend on cost of production while prices are influenced by other factors including costs in the case of Post Keynesian theory. Post Keynesian sum up the social benefits and cost and try to compare them. Entrepreneurship is considered as a discovery process as firms try as much as possible to meet clients’ needs and wants. Entrepreneurs are seen a superior beings who are able to discover opportunities and implement them to earn some profit. Bibliography Boettke, JP 1998, The Elgar companion to Austrian economics, Edward Elgar Publishing, Cheltenham. Casson, M 2006, The Oxford handbook of entrepreneurship, Oxford University Press, Oxford. Harcourt, GC 2006, The structure of post-Keynesian economics: the core contributions of the pioneers, Cambridge University Press, Cambridge. King, JE 2003, A history of post Keynesian economics since 1936, Edward Elgar Publishing, London. Langlois, NR 1989, Economics as a process: essays in the new institutional economics, CUP Archive, Cambridge. Murray NR 1991, Review of Austrian Economics, Volume 5, Ludwig von Mises Institute, Las Vegas. Pheby, J 1989, New directions in post-Keynesian economics, Edward Elgar Publishing, Cheltenham. Pressman, S & Holt, R (Ed) 2001, A new guide to post Keynesian economics, Routledge, London. Rothbard, NM & Block, W 1990, The Review of Austrian Economics, 1990, Volume 4, Ludwig von Mises Institute, Las Vegas. Thomas C. Taylor, CT 2008, Ludwig Von Mises Institute An Introduction to Austrian Economics Ludwig von Mises Institute, Alabama. Read More