Rothbard at 100: Five Economic Insights That Still Matter
Summary
No Stock Pitches: The episode focuses on Murray Rothbard’s economic insights rather than specific investment ideas, tickers, or sectors.
Inflation Mechanics: Detailed discussion on how deficits become inflationary only when financed via the banking system, highlighting the Federal Reserve’s role in credit expansion.
Market Structure: Critique of monopoly pricing and monopolistic competition, arguing mainstream models can mislead policy and entrepreneurial incentives.
Production Structure: Emphasis on the time structure of production and gross investment versus consumption, challenging simplistic circular flow and GDP interpretations.
Policy Implications: Cautions against interventions based on perfect competition models and misreadings of GDP where consumption appears to drive all output.
Welfare Economics: Reassessment of utility theory and welfare criteria, advocating demonstrated preference and voluntary exchange as markers of improved welfare.
Macro Context: Broader economic insights relevant to investors’ understanding of inflation, capital cycles, and policy risks, but without actionable company-specific recommendations.
Transcript
[music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's [music] your host, Dr. Bob Murphy. Hey everybody, welcome back to the Human Action podcast. Today is going to be a fun one. In honor of the 100th anniversary of Murray Rothbird's birth, I am going to go through and list some of the greatest hits of Rothbart's contributions to economics. But before we get into that, a quick word. Is California just a unique political mess, or is it a preview of America's future? For decades, California was known as a powerhouse of entrepreneurship and opportunity. Today, it's increasingly defined by high taxes, housing shortages, expanding bureaucracy, and a steady exodus of businesses and families. So, what exactly went wrong? And could the same forces be spreading across the rest of the country? On April 25th in San Diego, the Mises Institute is hosting a Mises Circle event titled California's decline, a warning to America, where scholars will examine the economic and political forces behind the Golden State's transformation. If you're in Southern California and want to understand what's happening and why it matters, learn more and register at mises.org/cap. That's mises.orgap org/cap for California human action podcast. One more time mises.org/ca hap. Hope to see you there. Okay, so here let me just go through I've got one, two, three, four, five of my sort of greatest hits of Murray Rothbart. The things that when I just sat back and thought what is it that Rothbart contributed that shaped me as an economist that really uh sunk in? Is that the phrase I want to use? And it's not even necessarily that these are the most important things, but just when I sat there and brainstormed, I mean, I can remember when I first read each of these and I was just blown away by it. And I want to be clear, Rothbart did a lot more than just write on economics, right? Obviously, he was a pioneer in anarchical capitalism, and that's an area where I've contributed to, I should should hope. And uh clearly Roford was the biggest influence on me in that realm. But here I want to just focus for the human action podcast on his economics work. Uh the first one is uh sort of a a pop thing and it comes from the collection the Mises Institute put out called making economic sense. So, it's just a collection of essays that Rothbart wrote. And this was something I read early on, you know, in my discovery of Austrian economics. And it was chapter number two titled 10 great economic myths. And it was his myth number one. So, let me go ahead and read much of this. And I'll just I don't need to expound too much because Rothberg was so clear on his own, but this is is critical. And I just to this day whenever people talk about inflation and government deficit spending usually people will get this one wrong. And Rothbird you know very clearly pointed out the right way to think about this stuff so long ago. All right. So here it is from Rothbird's uh collection making economic sense. This is chapter 2 10 great economic myths. And this is his myth number one. Deficits are the cause of inflation. Semicolon. deficits have nothing to do with inflation. Then here he goes. In recent decades, we have always had federal deficits. The invariable response of the party out of power, whichever it may be, is to denounce those deficits as being the cause of perpetual inflation. And the invariable response of whatever party is in power, has been to claim that deficits have nothing to do with inflation. Both opposing statements are myths. Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling treasury bonds to the public, then the deficits are not inflationary. No new money is created. People and institutions simply draw down their bank deposits to pay for the bonds and the treasury spends that money. Money has simply been transferred from the public to the treasury and then the money is spent on other members of the public. On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money in the form of bank deposits is then spent by the treasury and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of onetenth that amount. Thus, if banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately 10 billion of old Treasury bonds. This purchase increases bank reserves by 10 billion, allowing the banks to pyramid the creation of new bank deposits or money by 10 times that amount. In short, the government and the banking system, it controls and effect quote print new money to pay for the federal deficit. Thus, deficits are inflationary to the extent that they are financed by the banking system. they are not inflationary to the extent they are underwritten by the public. Okay, so I'll stop there um because he goes on and gives some historical commentary, but I really think that encapsulates. Now, just to warn you, there's been a lot of controversy uh I mean over the years, but it's flared up a lot in more recent times where certain economists recoil at the glib commentary Rothber just gave that they would call it the uh the discredited money multiplier theory of inflation. Okay? And so that's too much in the weeds for us to get into right here. But big picture why I loved that from Rothbart because it sort of helped clarify my own thinking when I was young reading that that it I think he puts his finger on exactly what the issue is. So yes, I think we all have this intuitive sense that massive government deficit spending surely has something to do with the weakening of the dollar and you know surely there's some relationship between the Fed or Nixon closing the gold window and then the explosion in federal debt. Um, but strictly speaking, a government budget deficit per se is not inflationary. Just by the same token that if a corporation wants to build a factory and they can't do it just out of their normal revenues and so they float some new corporate bonds to raise money to go build a factory, that by itself doesn't cause prices to go higher. It's just no, the whoever lent the money to the corporation now can't spend it and so they have to cut back on their spending and then the corporation spends more. So like the total amount of spending doesn't go up just because some person or institution in society decides to borrow money. Okay. So that's the essential insight. However, again that that if you just stop there, that would be naive that Rothbird points out. In practice, the financing of the government deficit is often accompanied by the expansion of bank credit, which in our system of so-called fractional reserves allows for the creation of, you know, new money. And so it's not merely, oh, if the federal government wants to run a hundred billion dollar deficit, that means the citizens cut back their spending by hundred billion and hand it over. That that's that's not how it works often. Okay, let's see. And by the way, I'm I'm going through these like I'm going from easiest to most sophisticated. All right, the next one I want to talk about is Rothbart in man economy and state has a critique of um the standard economic doctrine concerning monopoly pricing. And I won't get into it too much here because I want to keep these kind of breezy just to give you a survey. But what's interesting is here even though Rothbber doesn't like directly put Mises in his crosshairs he is um subtly in including Mises and also elsewhere when Rothbart takes on the doctrine of what's called consumer sovereignty he names William Hut but Mis has also talked about that right so um anyway it's I partly say this because there's accusations that oh you The Mises Institute is a cult and all you guys you just rever mees and you're not scientific and no even Rothbart himself in his magnumopus man economy and state is his great economic treatise actually does criticize you know Mises all right and doesn't just parrot whatever Mises said in human action okay so on the monopoly issue the what what I liked so much about it was Rothbart you know he he does does a great job of summarizing the existing literature and just showing like this is the way if you went and took a standard class in economics this is how they would teach it to you this is the way like you know like a Paul Samuelson or somebody because man economy and state came out in the early 60s right so he's state-of-the-art as of then in terms of how the stuff would be taught in a in a Keynesian framework and so Rothber explains what the ostensible problem is with monopoly pricing Um, and it has to do with what's called market power, right? So, I'm going to be real quick here, but the idea is that um oh, the the monopouist uh when he's setting quantity and price decisions or when he's setting quantity making quantity decisions considering the demand for his product, he um he thinks that the price depends on how much he brings to market, right? So he doesn't face a perfectly flat elastic demand curve. He thinks that if he wants to sell more units, he'll have to charge a lower price. And so in contrast, in the model of perfect competition, at least hypothetically speaking, each firm is considered to be what's called a price taker. And so we model it as if they think they can sell an infinite amount of the product um at the at the given market price. And there's various reasons that that's supposed to be ideal that that will lead firms to do the socially optimal thing. Okay. Again, this isn't the Austrians. This is the conventional mainstream view certainly as of the early 60s. Okay. So Rothber critiqued that from several different angles. And you might say, why is that a problem? And so one one of the issues is, well, if the monopouist thinks he's facing a downward sloping demand curve, like if he thinks he's like that his the demand curve for his product is the same thing as the market demand curve, which is downward sloping. Well, then if he plots out his marginal revenue curve, that's also falling. And so then if he sets output where marginal revenue crosses marginal cost, then that's not going to be the socially optimal spot. Okay? He's going to be there's going to be um gains from trade if he had made additional units um where the marginal benefit to the user, which is where the demand curve is, is higher than the marginal cost to producing it. Okay? And the answer is like if you did it geometrically, it's because if you draw a straight line demand curve that's downward sloping and then you plot the marginal revenue curve, it's also a straight line but it's got a steeper slope. Okay, that's you know if you geometrically that's what's going on. And so that's why when they you know the monopouist sets output where the marginal cost curve crosses the marginal revenue curve, not where it crosses the demand curve. Okay. And so in general the conclusion is oh the monopolist restricts output and raises prices. But again in a in a mainstream framework the reason that's bad is that on those additional units the marginal benefit to the consumers is higher than the marginal cost to the producer. And so there's gains from trade there that aren't being reaped by society. Right? It's not just a mere restricting output is bad. Right? In other words, there's such a thing as a firm producing too many units. And if that were some for some reason the case, you would want the firm to restrict output. Okay. [clears throat] So, among other critiques, Rothbird says, well, what if you know there's some pioneer like some entrepreneur and invents a completely new product, then he's the only one in the industry. At that point clearly that's person you know he's going to have a marginal uh revenue curve that's downward sloping and that you know is is the market he's going to face the demand the market demand curve if he's the only producer but why is that a problem like what are you comparing it to so yeah here I'm I'm paraphrasing but this is the way I kind of internalized the logic is saying yeah what really what they're showing when they're contrasting the bad market outcome under monopoly with this hypothetical perfect competition scenario. It's it's like you're implicitly saying, oh, if if some one innovator stumbles upon and is the first to create some new product or service that nobody else has thought of and he gets to market first and so for at least temporarily he's quote a monopolist. Uh, wouldn't it be better for society if there were a thousand identical firms that had the same technology and the same, you know, equipment and everything and then they each just thought they were catering to 1/100th of the market and they thought they basically faced a perfectly elastic demand curve. And I say, even if that's true, so what? That's not the world, right? Isn't it better that the monopouist came up with that new idea and brought that product to market and so now you know you can compare the inadequate output and gez if only he had create you know produced a few more units to reap on the margin that gap between marginal benefit marginal okay but that's not the right thing to compare it to the right thing to compare it to is zero units of output which is what would have happened before he came on the scene right so Robert's point is you know it's a very quote Austrian approach instead of looking at static models where all everybody knows all the relevant information and technological recipes and everything and it's just a geometry problem instead when you take into account entrepreneurship and the fact that people have to discover new techniques and processes and come up with like oh I bet you I bet you my customers would like this new thing if I were bring this to market and no one's thought of that before right and it's not just like technological discoveries like you have scientists in the R&D wing coming up with something. I mean it could just be like you know the famous Henry Ford coming up with the assembly line approach you know I'm sure he adapted that from other things he'd saw with predecessors right so that's not it's not that the product is new but just coming up with a better way to make an existing thing can also be an innovation that gives you an edge all right so by the government coming in and like quote breaking up monopolists and so on on the basis of these mainstream models of perfect competition the idea is you're taking away the incentive. Like part of the reason you would sit around dreaming up new products and services or spending millions or billions of dollars on R&D and everything in a free society is because, you know, oh, if we do hit on something great, we'll bring it to market first and we'll we'll be quote the monopolist for a while. And so that's partly why we would want to spend so much on the front end to try to find those things, right? Um related to that, Rothbart has a good exposition where he goes through and says, you know, there's a sense in which everybody's a monopolist, right? Like Murray Rothbard is the only one who could sell economic lectures by Murray Rothbart. Nobody else can produce that. So he's a monopolist, right? And so he's saying you could, you know, finally divide and and classify things that way. And so he's saying it it gets kind of vacuous when you do things like that. Okay, so I'll move on. But again, I just I thought that was great. Okay, here's one that's really fun. Um, so unfortunately, if you're just listening to the audio, you're not going to fully appreciate this, but um [clears throat] here he is. It's it's when he's talking about the alleged problems of um the par what's called the paradox of excess capacity. Okay. And the idea is that oh if if there's a firm and the average cost curve is like a U-shape um and we have what's called monopolistic competition where an industry is characterized by a small number of firms that each have some market power, right? And so the the classic examples here would be something like athletic sneakers, right? Or running shoes, right? Like Nike and Reebok and whatever. They each, you know, they're not monopolies, but they're it's also not like the market for wheat, which is pretty homogeneous. And, you know, there's not a lot of market brand name competition in the market for wheat, at least as far as I know. All right. Um and so the idea is that oh the Nike can because it's got product differentiation it it has some control like it can if it wants to charge more it can cut back its supply and charge more whereas the wheat farmer just says well what's the market price for a bushel of wheat and he just sells everything at that price. It's not that farmer Jones wheat, you know, has a certain clientele and they really like Farmer Jones wheat and so he can if he restricts output can charge a little bit more. That that's at least that's not how we model as economists. All right? There might be guys out in the Chicago markets that are going to scoff at us. But anyway, that's in the textbooks. That's kind of how they distinguish this stuff. And so you say, okay, well, what's the problem then with monopolistic competition? And so Rothbart faithfully reproduces the argument. man, economy and state. So we'll flash this up here. So this is figure 71 from page 732 and you can see there that oh the problem is that downward sloping demand curve is what the monopolistically competitive firm faces as a as a demand curve. All right. And notice so if if he sets the price you know like where does that where's that tangent to the average cost curve and oh it's at point F there. Okay. And so notice that if when the monopol when the firm in the monopolistically competitive industry optimizes, he necessarily restricts output and produces at a level where the average cost is higher than the minimum. And in contrast, if there's a firm in a perfectly competitive industry where the demand curve to that firm is perceived to be horizontal and then they go and you know optimize and they do it at the tangency point up that's at that minimum point E there. Okay. And so again, the the argument is this is showing why there's quote excess capacity and why the the factories don't run at the lowest cost level in a monopolistically competitive industry. Whereas if you had perfect competition, they would. And so that makes unit prices higher than they need to be. So that's why it's inefficient. And it, you know, gives scope for government intervention and so on. And so Rothbart says just logically that doesn't make any sense, right? Like how could it be that they would settle down and in the long run the sneaker manufacturers would just have excess capacity and they would realize, oh, if we had just built the factory differently, we could have had the same output but a lower unit cost. Like that's that's silly. Why would they do that? That's dumb. And he and he points out that really what this is coming this isn't about economics even though it seems to go intuitively with you know economics like economic reasoning but he said no really the way these demonstrations work it's because of geometry it's because they're smoothing they're assuming you know a straight demand curve and a smooth average total cost curve and then if you draw it like that well yeah the only way you know that's if it's got to be tangent and that's where the optimization is going to occur it has to be to the left and at a higher point um if you got a downward sloping one and only if it's a a horizontal line can you get the tangency to occur at that you know the minimum point on the average cost curve right and then Rothberg just says what if we relax that assumption so here we'll flash up a few pages later he's got this diagram and he just shows yeah if you assume that there's kinks in the average cost curve which in general that's fine right like it's just an assumption made for tractability to assume that the cost curve is a smooth is smooth, right? Like there's nothing in economics that says that. That's clearly just a conven, you know, convenient assumption. They said if you draw it like this with kinks in it, that downward sloping curve can hit the minimum point and there's no, you know, so there you go. All right. So I always I thought that was great. Incidentally, before I move on, if you're a purist, there's Rober's a little bit off as I recall here that the the optimum point isn't you don't you don't set the demand curve to be tanous to the cost cost curve. There's like another step involved here, but I the spirit of what he's doing here is definitely correct. And armed with this demonstration, you could then fiddle with it and, you know, dot all the eyes and cross all the tees. Okay. Um, what else do I want to hear? Okay, let me now spend a few moments on um what we might call the Austrian version or Rothbart's version of the circular flow diagram. Okay. So, if you have ever taken a a standard I don't know if they teach it in micro or macro, probably they teach it in macro. um economics course, you might have seen what's called the circular flow diagram here. We'll see if we can get one here and flash it up here for you. And it just kind of shows like, oh, money flows around, you know, one way and goods and services flow the other way. And it's kind of just captures the fact that, oh, one person's spending is another person's income. You know, in every period, the total amount of expenditures have to add up to the total income. And that's kind of like, oh, okay. And that is very seductive and and tends to lead to the faulty notion that like consumption is whatever 70% of GDP, right? Like you might hear talk like that and leading people think, oh, just as long as people spend more on u consumption, then you know, the economy will grow. or you know, oh Christmas time's great because the consumers are out there find, you know, driving the economy like they do. And that's very misleading. Okay. And the way to see that is to go through the diagram that Rothbird goes through in man economy and state. Okay. So here we go. So this is I'm looking here. It's in chapter eight. So I'm looking here at my study guide. Uh let's see. Well, it's figure one from page 369 of Man Economy and State. Incidentally, so I have a a study guide for Man Economy and State. And with all due modesty, I think if you're going to read Manon and State, you should have my study guide with you. All this stuff is available free PDF for the Mises Institute. Okay. So, here, let me just walk you through this. I'm going to take a little bit of time. Again, if you really need to be looking at the video for this one to make sense. All right. So, here what this is showing. It's um like I say, this is you could think of it as Rothbart's version of the circular flow diagram. And so it is going to just kind of show how oh if the once the economy gets into this rhythm and just period after period if this kept occurring then you know you could understand how one person's spending is another person's income right so you do still have that element but this richer framework let you understand more about the time structure of production whereas the standard circular flow diagram by itself self. It doesn't really give you that, right? Like you don't understand how long certain factors of production have been in process getting worked upon before they finally, you know, reach their end. Everything just seems kind of like they're spending and then, you know, out pops the uh the loaves of bread and the finished sports cars and stuff. Okay. So, here um don't get misled there. On the left there, you see like 1 2 3. Those aren't the numbers of the stages. That's not because you can see there's some duplicates there. That's just a coincidence. So, don't get misled by that. Um the way to think about it is the bottom is like the consumer good coming off the a finish line getting sold to consumer for 100 ounces. Rothbart, he's trying to get you away from thinking of fiat money. So here he's modeling a free society where they use ounces of gold is the money. Okay? So the idea is at the at the bottom there's um the finished goods, think of it as like loaves of bread at the grocery store get sold to the consumers and there's a bunch and so they get sold for collectively 100 ounces of gold. Okay? And then at the top that first you see that that 20 um or actually you should look at the 19 that is the starting point of this process. And so here given that the finished thing is is bread, loaves of bread, you can say this is wheat, right? So this is like just getting um you know the raw wheat taken from the ground. There's you know there's no tools involved. Okay. And so the idea is the first thing that happens every period this this recurs is um a capitalist spends 19 ounces of gold giving it to the farmer for wheat and then um a peri period later or I should say to to plant the harvest, you know, to to plant the the to grow wheat and the next period the wheat gets harvested and they sell it for 20 ounces. Okay? And so the you see that 20 there's like a an arrow going left and so that's showing that you had to advance 19 the prior stage and then one stage later you get to sell the the product of that for 20 and so that one flows to the left whereas the 19 went to the farmer. Okay. And then the idea is at that stage now somebody takes the wheat and then hires the miller to crunch it into flour. Okay? And he has to pay 8 ounces of gold to the miller for that service. Okay? Okay. And so the idea is at that stage somebody is paying 20 ounces of gold for the wheat and then paying eight additional ounces of gold to the miller to grind it. Okay? And so this person now has advanced 28 and then the idea is next period now the flower is sold for 30 ounces of gold. All right? And so the person who advanced the 20 plus the eight is the so that person invested 28 in the prior period and now sells the finished product for 30. So that's a gain of two, right? And so that's why that two flows to the left and you just keep doing that, right? So that person, you know, so now that product at that stage is sold for 30. An additional 13 ounces of gold is spent on land and labor factors. Land means any kind of natural resource. And so that's a total of 43 spent. And then next period, whatever those two things produce is sold to the next stage for 45 ounces of gold. And so 30 + 13 is 43. So the 45 means 2 ounces of gold accured is interest. And that flows left. Okay? So you just keep doing that. And then finally you get to the second last stage where somebody bought the product from the prior stage for 80 ounces spent an additional 15 ounces of gold out of pocket to hire land and labor factors to you know mix with that product from the prior stage. So that's a total expenditure of 95 ounces. A a period later that ripens into the finished loaves of bread. All right. So maybe it was they bought 80 ounces worth of gold from of of like whole loaves of bread from the baker at the wholesale level and then they paid 15 ounces of gold for people to slice them, put them in bags and put them on a truck and drive to the grocery store. Okay? And so then the 100 ounces, like I say, is the final consumer in the grocery store getting the finished loaves of bread and paying 100 ounces for it. And so that last stage there because the you know the capitalist who runs the grocery store let's say had paid you know earlier had advanced 80 ounces to get the raw you know the whole loaves of bread in n in 15 to have it sliced up and everything. So he had invested 95 ounces of gold in the prior stage had to wait one period and then could sell it for 100 so he made an interest income of five and that's what that flows to the left. Okay. Okay. So then when you just step back and look at the whole thing, if that just keeps happening every period, then you just get a, you know, a system going like it takes time to get it up and running. But once you have it up and running and each of those processes repeats every period and you settle down into a steady state, the idea is there would be a cumulative 17 ounces of interest income, right? If you added up the one, the two, three, you know, on the left side, that adds up to 17. And if you add up the things going up, that adds up to 83. And that's not a coincidence that the 100 ounces of gold spent on the finished product adds up to the income that was spent to, you know, to the various factors of production, including the capitalists who, you know, advanced the capital and then earned interest on it. And then so that's how the consumers have 100 ounces of gold to spend, right? That the people buying the finished product include the capitalists who earned 17 ounces of gold that period and the owners of the you know the land and what other natural resources were involved at each of the stages and the workers who collectively all earned 83 ounces. And that's how if they each spent their entire income buying the bread, they could, you know, pay the 100 ounces for it and then the whole thing it just keeps repeating like that. Okay? So that gives you a much richer structure to understand the market process. And then notice here how much total investment there is right if you said oh this economy like put it this way in a mainstream textbook they would look at this economy and they would say 100% of real GDP is constituted by consumption spending and 0% of GDP comes from government spending or uh private investment right because in this economy you say what's consumption private consumption spending and say oh every period 100 ounces of gold gets spent on bread by the consumers and you say what's total income in this economy oh it's 100 ounces so GDP flows entirely from consumer spending in this in this the way you know a mainstream economist would look at this but you can see that's extremely misleading it involves to keep this system up and running to keep those lows of the 100 ounces worth of loaves of bread flowing off, you know, onto the grocery store shelves period after period such that, you know, the the workers and land owners who collectively get paid 83 ounces go and they buy 83 ounces worth of bread each period. And the capitalists who earn collectively 17 ounces of interest income each period go and spend it buying bread. In order for that to work, the capitalists at each stage have to engage in gross investment, right? So like the guy who um invests 60 to buy you know whatever is rolling over from the prior stage and then invest an additional 16 in order to spend a total of 76 that period and then he holds it and sells the output for 80 the next period thus pocketing four in interest income. Every period when he gets paid that 80 he can't consume all of it. he can only consume four. He's got to take the 76 and reinvest it back in, you know, buying the thing from the prior stage at for 60 and then spending 16, hiring land and labor factors to work on it for a period and then sell the thing next period for 80. Right? So, of that 80 in gross receipts that he's getting, he can only consume four and he's got to reinvest. So he has what would be considered gross investment of 76 but that's not included in GDP the way the standard macro accounting works that that only means net investment okay but if you looked at the gross investment here it's it's really high okay it's in fact gross so here I'm reading from my study guide in the original structure gross income is 418 ounces which equals 100 plus 80 plus 15 plus 60 plus 16 plus 45 plus 12 and so on. Total consumption is 100 ounces and gross investment is the difference namely 318 ounces. Okay. So again in this hypothetical economy here that Rothbart imagined consumption is 118 or sorry is 100 ounces whereas gross investment is 318 ounces. So in that sense investment is three you know three times as big plus as consumption but yet again the way a mainstream economist would classify this they would say consumption constitutes 100% of GDP okay and also too you could see if you know you were a Keynesian and wanted to encourage consumption and discouraging uh saving because oh we we got to maintain spending and if everybody just rushed to grocery store and tried to spend all of their income, you know, all 418 ounces on bread, what would that do? That would just push up the price of bread. And if they didn't reinvest, then everything would collapse, right? If if the guy who normally spends 95, right, he spends 80 buying the thing from the prior stage in 15 hiring land and labor factors to work on it in order to make the finished. If he instead took the 100 ounces he got and tried to spend it all on bread and didn't reinvest 95 of it, well then that stage wouldn't happen. And then next period after that, there'd be no new, you know, no finished sliced bread getting to the grocery store. And way back, you know, if somebody didn't pay the farmer to plant, well then, you know, it would it would take longer. it would start, you know, rippling through the system and then a few periods later that hole would show up and then yeah, there wouldn't be bread on the shelves because they'd say, "Why?" They say, "Oh, because five periods ago the farmer didn't plant and grow more wheat." Okay. So again, I just think that kind of a diagram diagrammatic framework allows you to see the important role of gross capital investment in this the time structure of production which you literally can't see in the very crude simplistic circular flow diagrams of mainstream economics. Okay. Um, the last thing I'll touch on, one of Rothbird's most sophisticated works, he's got this essay called Toward a Reconstruction of Utility and Welfare Economics that he published in 1956. Um the if you're a professional economist, I would encourage especially if you're not familiar with the Austrian or if you're an expert in the Austrian, if you're not a card carrying Austrian and you're just kind of dabbling and oh yeah, I like to, you know, be eclectic and I'll listen to this human action podcast and you know, maybe somebody sent you this episode, I encourage you to read this, especially if you think, oh yeah, those Austrians don't know math and they didn't keep up with the literature and they're just these cranks in the corner. read this 1956 essay from Rothburn. He is very up to speed with the cutting edge work in mainstream neocclassical um utility and welfare economics. Okay. And just you could just tell from the citations and stuff he knows what he's talking about. He even gets uh in the weeds with like Vonoyman uh Morgan Stern utility functions and with risk aversion and things like that and and what does it mean is is utility in the mainstream approach ordinal or cardinal and oh well you know they use cardinal utility functions but really it's ordinal preference ranking although with you know the way they model decision-m under uncertainty with vonoman Morgan Stern it's you know unique up to a monotonic uh what is it aine transformation right so he's he gets into all that stuff so you can see Rothbart is very conversant with the literature as of you know the mid1 1950s here so big picture what does he do so he first so in case people are confused so utility theory has to do with explaining human choices is. And so, oh, why did somebody with a given budget and facing certain prices going into the grocery store, how come this guy walked out with that basket of goods and that woman walked out with that b a different basket of goods? Even, let's say, they had the same budget. You'd say, "Oh, cuz they're, if you were a mainstream econ, the utility functions were different." If you were an Austrian, you might say, "Cuz their preferences were different." Okay? And but you would say, "Oh, because each person bought the basket of goods that maximized their utility or gave them the most utility." Okay. And so, but whereas with welfare economics, that has to do with um it's not like welfare like soup kitchens and food stamps. It means promoting human happiness. All right? And so like what can we say about are certain arrangements in society better or worse? like that's what welfare economics has to do with. And so Rothbird spends the first half of his essay summarizing and critiquing the current state of utility theory and welfare theory, you know, in the standard economics literature and it's it's very compelling. Um and one of the one of the points he makes is that he says um he points out a confusion that in the mathematical mainstream approach they thought marginal utility meant like the increment in total utility, right? And especially like if you get into calculus and say, "Oh, what's the derivative of the utility function, you know, in this neighborhood or something?" And that's that's what the marginal utility is that you know oh if you give me an infinite decimal more amount of good X then um how much does my total utility go up and that's the marginal utility of X at that point and so if you reject the notion of cardinal utility then if you think marginal utility means the delta in total utility then obviously marginal utility goes the window too and then clearly so does diminishing marginal utility cuz what the heck you know you're just doing further operations on nonsense and that's actually what happened um like John Hicks following paro did that in his um value and capital he you know Hicks threw out so Robert agreed we have to abandon a notion of cardinal utility it doesn't make sense and what Hicks did is he said okay so these older ideas of like margin utility and diminishing margin utility. We can't use that anymore. But he replaced it with indifference curves. And he said, "Okay, what we used to think of as diminishing margin utility and the fact that oh yeah, you get more and more of one good on the margin you don't value it as much. And so that's why like the trade-off between it and some other good gets worse and worse." He said that doesn't make sense anymore because if you don't have total utils, you can't have margin utility and you can't have diminishing margin utility. But he said, 'Oh, we can have the marginal rate of substitution. So he kind of saved a bunch of the results from old consumer theory and showed here's how we can talk about that stuff in a framework that's more robust that doesn't rely on this notion of car utility that we realize is kind of philosophically dubious. All right. So, Rothburn appreciates what he did there and like the consistency of his view, but he said the problem is Hicks and Paro and all those guys, they were using the wrong definition of margin utility. Don't think of it as the delta in total utils, which he agreed that doesn't make sense. He said instead, no, it's not the change in total utility. It's not like Roth says explicitly that the mainstream economist they would think like oh what does it mean for the margin utility of the fifth unit the mainstream economist thought oh what that means is if you have discrete units is what's the total utility of five units and subtract the total utility of four units and whatever that delta is that's the margin utility of the fifth unit right showing how many more utils do you get by adding the fifth unit but if you don't think utils exist well then that means nothing and Rothber was No, that's not the way to he says you can still talk about utility in an ordinal sense. And the marginal utility is the utility of the marginal unit, right? And so you you can just have an ordinal preference ranking. And so just like you can say, oh, I would rather have a car than an apple, right? Right? So on my my ordinal value scale, a car ranks higher than an apple does. Likewise, I could say the first apple is higher on my value scale than the second apple is. It doesn't mean because I assign more utils to the first apple, just like I didn't have to assume the car got 2,000 utils and the apple only got 20. No, I wasn't assuming the cardinal utils existed. I can still say I prefer the car to an apple or if you want I can say the car gives me more utility than the apple does. Okay, doesn't mean there are cardinal units of it. Right? So that's one of the things Rothberg does here. But um so as the title suggests toward a reconstruction of utility and welfare economics uh sorry let me mention one more thing. Another great point Rothburn makes is he says um you know faced with the problem of trying to be valuefree and scientific and objective the economists realize well geez if there's no such thing as interpersonal cardinal utility comparisons. How can we say that, you know, how can we justify our government intervention or, you know, what would it mean to say that free trade is good and tariffs are bad or whatever? And he's saying, oh, the the trick that Paro tried to use was unonymity and to say, oh, something, you know, is a paro improvement if we make every single person better off or in some settings make at least one person better off and don't hurt anybody. And Robert says, "But that's not you, in practice, that's pretty useless because just about anything you do, some people are going to object to, so that doesn't really help us." And he said, "Another efficiency criterion was offered by Kaldor and Hicks." And so something's called Kaldor Hicks efficient um or is a is a is a movement towards Kaldor Hicks efficiency. if the gains to the winners outweigh the losses to the losers. And the way that's justified, you know, quote, scientifically or rigorously is to say because we could we could take the some of the gains from the winners and compensate the losers and then make everybody better off. And Rothbra says okay but if in practice you don't actually do that if you don't compensate the losers then it's not clear that you have by your own standard then you haven't necessarily made you know engage in a social improvement so he's you know he just thought they were kind of fooling themselves right so he's got like I say he's got some very informed rigorous critiques of the state of utility theory and welfare economics as of the mid1 1950s and he was you know well verssed in the cutting edge literature with you know citing savage and so on if you're familiar with the modeling of uncertainty choices under uncertainty um that was you know developed in this period but then the Torah reconstruction so then Rothber says all right I've just gone through and you know ripped a new one and what these mathematical economists have been doing so what do I propose and he says all right and he founds it on what he calls demonstrated preference and so there the idea is utility preference rankings don't exist independent of choices. And so this was another element that he was saying um like Paul Samuelson had something that Samson called revealed preference. And Rothbart says by the way that I would have called my thing revealed preference but I couldn't because Samson already used the term. And so what the way Samson would use revealed preference is he would just assume that oh yeah someone's got this static list of ordinal preference rankings and then he keeps going back to the market and making choices based on when prices and income change and I can just watch his choices over time and if his preference relationship obeyed certain axioms then you know we could make certain deductions and things like that. But you know what? In practice, you see violations of this stuff all over the place. And so you can't do that. And and so one of the things is like, oh, if somebody, you know, on day one prefers A to B, and on day two, you can tell from their choices they prefer B to C, well then it better be the case that on day three they prefer A to C because of transitivity. But Rothbart points out, well, no, their preferences could have changed, right? So there's a difference between constancy and consistency. Okay, so he gets in all that stuff. So anyways, really great stuff. Again, showing he's familiar with the literature. So then how does Rothbird deal with this? He says focus on what's called demonstrated preference. So it's just, you know, all you can do is say when you see people making concrete choices, if someone chooses A over B, you know they preferred A to B, that A gave him more utility than B. And then in terms of welfare, he says we can say things like um whenever there's a voluntary market exchange, both parties at least exanty expected to benefit. That's why it was voluntary and they did it. And so there's in that sense, you've improved social welfare. You've made those two people better off. Okay? And so that's the approach he takes. And uh anyway, it's like I say, it's it's a very good essay showing Rothbart to his finest being quite conversant with the literature and then offering uh a a replacement of what the mainstream guys are doing that, as you can see, is very consistent with libertarian free market orthodoxy. Okay, so that's my greatest hits from Rothbird the Economist in commemoration of the 100th anniversary of his birth. Thanks for tuning everybody. See you next time. >> Check back next [music] week for a new episode of the Human Action podcast. In the meantime, you can find more content like this on mises.org. [music] [music]
Rothbard at 100: Five Economic Insights That Still Matter
Summary
Transcript
[music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's [music] your host, Dr. Bob Murphy. Hey everybody, welcome back to the Human Action podcast. Today is going to be a fun one. In honor of the 100th anniversary of Murray Rothbird's birth, I am going to go through and list some of the greatest hits of Rothbart's contributions to economics. But before we get into that, a quick word. Is California just a unique political mess, or is it a preview of America's future? For decades, California was known as a powerhouse of entrepreneurship and opportunity. Today, it's increasingly defined by high taxes, housing shortages, expanding bureaucracy, and a steady exodus of businesses and families. So, what exactly went wrong? And could the same forces be spreading across the rest of the country? On April 25th in San Diego, the Mises Institute is hosting a Mises Circle event titled California's decline, a warning to America, where scholars will examine the economic and political forces behind the Golden State's transformation. If you're in Southern California and want to understand what's happening and why it matters, learn more and register at mises.org/cap. That's mises.orgap org/cap for California human action podcast. One more time mises.org/ca hap. Hope to see you there. Okay, so here let me just go through I've got one, two, three, four, five of my sort of greatest hits of Murray Rothbart. The things that when I just sat back and thought what is it that Rothbart contributed that shaped me as an economist that really uh sunk in? Is that the phrase I want to use? And it's not even necessarily that these are the most important things, but just when I sat there and brainstormed, I mean, I can remember when I first read each of these and I was just blown away by it. And I want to be clear, Rothbart did a lot more than just write on economics, right? Obviously, he was a pioneer in anarchical capitalism, and that's an area where I've contributed to, I should should hope. And uh clearly Roford was the biggest influence on me in that realm. But here I want to just focus for the human action podcast on his economics work. Uh the first one is uh sort of a a pop thing and it comes from the collection the Mises Institute put out called making economic sense. So, it's just a collection of essays that Rothbart wrote. And this was something I read early on, you know, in my discovery of Austrian economics. And it was chapter number two titled 10 great economic myths. And it was his myth number one. So, let me go ahead and read much of this. And I'll just I don't need to expound too much because Rothberg was so clear on his own, but this is is critical. And I just to this day whenever people talk about inflation and government deficit spending usually people will get this one wrong. And Rothbird you know very clearly pointed out the right way to think about this stuff so long ago. All right. So here it is from Rothbird's uh collection making economic sense. This is chapter 2 10 great economic myths. And this is his myth number one. Deficits are the cause of inflation. Semicolon. deficits have nothing to do with inflation. Then here he goes. In recent decades, we have always had federal deficits. The invariable response of the party out of power, whichever it may be, is to denounce those deficits as being the cause of perpetual inflation. And the invariable response of whatever party is in power, has been to claim that deficits have nothing to do with inflation. Both opposing statements are myths. Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling treasury bonds to the public, then the deficits are not inflationary. No new money is created. People and institutions simply draw down their bank deposits to pay for the bonds and the treasury spends that money. Money has simply been transferred from the public to the treasury and then the money is spent on other members of the public. On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money in the form of bank deposits is then spent by the treasury and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of onetenth that amount. Thus, if banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately 10 billion of old Treasury bonds. This purchase increases bank reserves by 10 billion, allowing the banks to pyramid the creation of new bank deposits or money by 10 times that amount. In short, the government and the banking system, it controls and effect quote print new money to pay for the federal deficit. Thus, deficits are inflationary to the extent that they are financed by the banking system. they are not inflationary to the extent they are underwritten by the public. Okay, so I'll stop there um because he goes on and gives some historical commentary, but I really think that encapsulates. Now, just to warn you, there's been a lot of controversy uh I mean over the years, but it's flared up a lot in more recent times where certain economists recoil at the glib commentary Rothber just gave that they would call it the uh the discredited money multiplier theory of inflation. Okay? And so that's too much in the weeds for us to get into right here. But big picture why I loved that from Rothbart because it sort of helped clarify my own thinking when I was young reading that that it I think he puts his finger on exactly what the issue is. So yes, I think we all have this intuitive sense that massive government deficit spending surely has something to do with the weakening of the dollar and you know surely there's some relationship between the Fed or Nixon closing the gold window and then the explosion in federal debt. Um, but strictly speaking, a government budget deficit per se is not inflationary. Just by the same token that if a corporation wants to build a factory and they can't do it just out of their normal revenues and so they float some new corporate bonds to raise money to go build a factory, that by itself doesn't cause prices to go higher. It's just no, the whoever lent the money to the corporation now can't spend it and so they have to cut back on their spending and then the corporation spends more. So like the total amount of spending doesn't go up just because some person or institution in society decides to borrow money. Okay. So that's the essential insight. However, again that that if you just stop there, that would be naive that Rothbird points out. In practice, the financing of the government deficit is often accompanied by the expansion of bank credit, which in our system of so-called fractional reserves allows for the creation of, you know, new money. And so it's not merely, oh, if the federal government wants to run a hundred billion dollar deficit, that means the citizens cut back their spending by hundred billion and hand it over. That that's that's not how it works often. Okay, let's see. And by the way, I'm I'm going through these like I'm going from easiest to most sophisticated. All right, the next one I want to talk about is Rothbart in man economy and state has a critique of um the standard economic doctrine concerning monopoly pricing. And I won't get into it too much here because I want to keep these kind of breezy just to give you a survey. But what's interesting is here even though Rothbber doesn't like directly put Mises in his crosshairs he is um subtly in including Mises and also elsewhere when Rothbart takes on the doctrine of what's called consumer sovereignty he names William Hut but Mis has also talked about that right so um anyway it's I partly say this because there's accusations that oh you The Mises Institute is a cult and all you guys you just rever mees and you're not scientific and no even Rothbart himself in his magnumopus man economy and state is his great economic treatise actually does criticize you know Mises all right and doesn't just parrot whatever Mises said in human action okay so on the monopoly issue the what what I liked so much about it was Rothbart you know he he does does a great job of summarizing the existing literature and just showing like this is the way if you went and took a standard class in economics this is how they would teach it to you this is the way like you know like a Paul Samuelson or somebody because man economy and state came out in the early 60s right so he's state-of-the-art as of then in terms of how the stuff would be taught in a in a Keynesian framework and so Rothber explains what the ostensible problem is with monopoly pricing Um, and it has to do with what's called market power, right? So, I'm going to be real quick here, but the idea is that um oh, the the monopouist uh when he's setting quantity and price decisions or when he's setting quantity making quantity decisions considering the demand for his product, he um he thinks that the price depends on how much he brings to market, right? So he doesn't face a perfectly flat elastic demand curve. He thinks that if he wants to sell more units, he'll have to charge a lower price. And so in contrast, in the model of perfect competition, at least hypothetically speaking, each firm is considered to be what's called a price taker. And so we model it as if they think they can sell an infinite amount of the product um at the at the given market price. And there's various reasons that that's supposed to be ideal that that will lead firms to do the socially optimal thing. Okay. Again, this isn't the Austrians. This is the conventional mainstream view certainly as of the early 60s. Okay. So Rothber critiqued that from several different angles. And you might say, why is that a problem? And so one one of the issues is, well, if the monopouist thinks he's facing a downward sloping demand curve, like if he thinks he's like that his the demand curve for his product is the same thing as the market demand curve, which is downward sloping. Well, then if he plots out his marginal revenue curve, that's also falling. And so then if he sets output where marginal revenue crosses marginal cost, then that's not going to be the socially optimal spot. Okay? He's going to be there's going to be um gains from trade if he had made additional units um where the marginal benefit to the user, which is where the demand curve is, is higher than the marginal cost to producing it. Okay? And the answer is like if you did it geometrically, it's because if you draw a straight line demand curve that's downward sloping and then you plot the marginal revenue curve, it's also a straight line but it's got a steeper slope. Okay, that's you know if you geometrically that's what's going on. And so that's why when they you know the monopouist sets output where the marginal cost curve crosses the marginal revenue curve, not where it crosses the demand curve. Okay. And so in general the conclusion is oh the monopolist restricts output and raises prices. But again in a in a mainstream framework the reason that's bad is that on those additional units the marginal benefit to the consumers is higher than the marginal cost to the producer. And so there's gains from trade there that aren't being reaped by society. Right? It's not just a mere restricting output is bad. Right? In other words, there's such a thing as a firm producing too many units. And if that were some for some reason the case, you would want the firm to restrict output. Okay. [clears throat] So, among other critiques, Rothbird says, well, what if you know there's some pioneer like some entrepreneur and invents a completely new product, then he's the only one in the industry. At that point clearly that's person you know he's going to have a marginal uh revenue curve that's downward sloping and that you know is is the market he's going to face the demand the market demand curve if he's the only producer but why is that a problem like what are you comparing it to so yeah here I'm I'm paraphrasing but this is the way I kind of internalized the logic is saying yeah what really what they're showing when they're contrasting the bad market outcome under monopoly with this hypothetical perfect competition scenario. It's it's like you're implicitly saying, oh, if if some one innovator stumbles upon and is the first to create some new product or service that nobody else has thought of and he gets to market first and so for at least temporarily he's quote a monopolist. Uh, wouldn't it be better for society if there were a thousand identical firms that had the same technology and the same, you know, equipment and everything and then they each just thought they were catering to 1/100th of the market and they thought they basically faced a perfectly elastic demand curve. And I say, even if that's true, so what? That's not the world, right? Isn't it better that the monopouist came up with that new idea and brought that product to market and so now you know you can compare the inadequate output and gez if only he had create you know produced a few more units to reap on the margin that gap between marginal benefit marginal okay but that's not the right thing to compare it to the right thing to compare it to is zero units of output which is what would have happened before he came on the scene right so Robert's point is you know it's a very quote Austrian approach instead of looking at static models where all everybody knows all the relevant information and technological recipes and everything and it's just a geometry problem instead when you take into account entrepreneurship and the fact that people have to discover new techniques and processes and come up with like oh I bet you I bet you my customers would like this new thing if I were bring this to market and no one's thought of that before right and it's not just like technological discoveries like you have scientists in the R&D wing coming up with something. I mean it could just be like you know the famous Henry Ford coming up with the assembly line approach you know I'm sure he adapted that from other things he'd saw with predecessors right so that's not it's not that the product is new but just coming up with a better way to make an existing thing can also be an innovation that gives you an edge all right so by the government coming in and like quote breaking up monopolists and so on on the basis of these mainstream models of perfect competition the idea is you're taking away the incentive. Like part of the reason you would sit around dreaming up new products and services or spending millions or billions of dollars on R&D and everything in a free society is because, you know, oh, if we do hit on something great, we'll bring it to market first and we'll we'll be quote the monopolist for a while. And so that's partly why we would want to spend so much on the front end to try to find those things, right? Um related to that, Rothbart has a good exposition where he goes through and says, you know, there's a sense in which everybody's a monopolist, right? Like Murray Rothbard is the only one who could sell economic lectures by Murray Rothbart. Nobody else can produce that. So he's a monopolist, right? And so he's saying you could, you know, finally divide and and classify things that way. And so he's saying it it gets kind of vacuous when you do things like that. Okay, so I'll move on. But again, I just I thought that was great. Okay, here's one that's really fun. Um, so unfortunately, if you're just listening to the audio, you're not going to fully appreciate this, but um [clears throat] here he is. It's it's when he's talking about the alleged problems of um the par what's called the paradox of excess capacity. Okay. And the idea is that oh if if there's a firm and the average cost curve is like a U-shape um and we have what's called monopolistic competition where an industry is characterized by a small number of firms that each have some market power, right? And so the the classic examples here would be something like athletic sneakers, right? Or running shoes, right? Like Nike and Reebok and whatever. They each, you know, they're not monopolies, but they're it's also not like the market for wheat, which is pretty homogeneous. And, you know, there's not a lot of market brand name competition in the market for wheat, at least as far as I know. All right. Um and so the idea is that oh the Nike can because it's got product differentiation it it has some control like it can if it wants to charge more it can cut back its supply and charge more whereas the wheat farmer just says well what's the market price for a bushel of wheat and he just sells everything at that price. It's not that farmer Jones wheat, you know, has a certain clientele and they really like Farmer Jones wheat and so he can if he restricts output can charge a little bit more. That that's at least that's not how we model as economists. All right? There might be guys out in the Chicago markets that are going to scoff at us. But anyway, that's in the textbooks. That's kind of how they distinguish this stuff. And so you say, okay, well, what's the problem then with monopolistic competition? And so Rothbart faithfully reproduces the argument. man, economy and state. So we'll flash this up here. So this is figure 71 from page 732 and you can see there that oh the problem is that downward sloping demand curve is what the monopolistically competitive firm faces as a as a demand curve. All right. And notice so if if he sets the price you know like where does that where's that tangent to the average cost curve and oh it's at point F there. Okay. And so notice that if when the monopol when the firm in the monopolistically competitive industry optimizes, he necessarily restricts output and produces at a level where the average cost is higher than the minimum. And in contrast, if there's a firm in a perfectly competitive industry where the demand curve to that firm is perceived to be horizontal and then they go and you know optimize and they do it at the tangency point up that's at that minimum point E there. Okay. And so again, the the argument is this is showing why there's quote excess capacity and why the the factories don't run at the lowest cost level in a monopolistically competitive industry. Whereas if you had perfect competition, they would. And so that makes unit prices higher than they need to be. So that's why it's inefficient. And it, you know, gives scope for government intervention and so on. And so Rothbart says just logically that doesn't make any sense, right? Like how could it be that they would settle down and in the long run the sneaker manufacturers would just have excess capacity and they would realize, oh, if we had just built the factory differently, we could have had the same output but a lower unit cost. Like that's that's silly. Why would they do that? That's dumb. And he and he points out that really what this is coming this isn't about economics even though it seems to go intuitively with you know economics like economic reasoning but he said no really the way these demonstrations work it's because of geometry it's because they're smoothing they're assuming you know a straight demand curve and a smooth average total cost curve and then if you draw it like that well yeah the only way you know that's if it's got to be tangent and that's where the optimization is going to occur it has to be to the left and at a higher point um if you got a downward sloping one and only if it's a a horizontal line can you get the tangency to occur at that you know the minimum point on the average cost curve right and then Rothberg just says what if we relax that assumption so here we'll flash up a few pages later he's got this diagram and he just shows yeah if you assume that there's kinks in the average cost curve which in general that's fine right like it's just an assumption made for tractability to assume that the cost curve is a smooth is smooth, right? Like there's nothing in economics that says that. That's clearly just a conven, you know, convenient assumption. They said if you draw it like this with kinks in it, that downward sloping curve can hit the minimum point and there's no, you know, so there you go. All right. So I always I thought that was great. Incidentally, before I move on, if you're a purist, there's Rober's a little bit off as I recall here that the the optimum point isn't you don't you don't set the demand curve to be tanous to the cost cost curve. There's like another step involved here, but I the spirit of what he's doing here is definitely correct. And armed with this demonstration, you could then fiddle with it and, you know, dot all the eyes and cross all the tees. Okay. Um, what else do I want to hear? Okay, let me now spend a few moments on um what we might call the Austrian version or Rothbart's version of the circular flow diagram. Okay. So, if you have ever taken a a standard I don't know if they teach it in micro or macro, probably they teach it in macro. um economics course, you might have seen what's called the circular flow diagram here. We'll see if we can get one here and flash it up here for you. And it just kind of shows like, oh, money flows around, you know, one way and goods and services flow the other way. And it's kind of just captures the fact that, oh, one person's spending is another person's income. You know, in every period, the total amount of expenditures have to add up to the total income. And that's kind of like, oh, okay. And that is very seductive and and tends to lead to the faulty notion that like consumption is whatever 70% of GDP, right? Like you might hear talk like that and leading people think, oh, just as long as people spend more on u consumption, then you know, the economy will grow. or you know, oh Christmas time's great because the consumers are out there find, you know, driving the economy like they do. And that's very misleading. Okay. And the way to see that is to go through the diagram that Rothbird goes through in man economy and state. Okay. So here we go. So this is I'm looking here. It's in chapter eight. So I'm looking here at my study guide. Uh let's see. Well, it's figure one from page 369 of Man Economy and State. Incidentally, so I have a a study guide for Man Economy and State. And with all due modesty, I think if you're going to read Manon and State, you should have my study guide with you. All this stuff is available free PDF for the Mises Institute. Okay. So, here, let me just walk you through this. I'm going to take a little bit of time. Again, if you really need to be looking at the video for this one to make sense. All right. So, here what this is showing. It's um like I say, this is you could think of it as Rothbart's version of the circular flow diagram. And so it is going to just kind of show how oh if the once the economy gets into this rhythm and just period after period if this kept occurring then you know you could understand how one person's spending is another person's income right so you do still have that element but this richer framework let you understand more about the time structure of production whereas the standard circular flow diagram by itself self. It doesn't really give you that, right? Like you don't understand how long certain factors of production have been in process getting worked upon before they finally, you know, reach their end. Everything just seems kind of like they're spending and then, you know, out pops the uh the loaves of bread and the finished sports cars and stuff. Okay. So, here um don't get misled there. On the left there, you see like 1 2 3. Those aren't the numbers of the stages. That's not because you can see there's some duplicates there. That's just a coincidence. So, don't get misled by that. Um the way to think about it is the bottom is like the consumer good coming off the a finish line getting sold to consumer for 100 ounces. Rothbart, he's trying to get you away from thinking of fiat money. So here he's modeling a free society where they use ounces of gold is the money. Okay? So the idea is at the at the bottom there's um the finished goods, think of it as like loaves of bread at the grocery store get sold to the consumers and there's a bunch and so they get sold for collectively 100 ounces of gold. Okay? And then at the top that first you see that that 20 um or actually you should look at the 19 that is the starting point of this process. And so here given that the finished thing is is bread, loaves of bread, you can say this is wheat, right? So this is like just getting um you know the raw wheat taken from the ground. There's you know there's no tools involved. Okay. And so the idea is the first thing that happens every period this this recurs is um a capitalist spends 19 ounces of gold giving it to the farmer for wheat and then um a peri period later or I should say to to plant the harvest, you know, to to plant the the to grow wheat and the next period the wheat gets harvested and they sell it for 20 ounces. Okay? And so the you see that 20 there's like a an arrow going left and so that's showing that you had to advance 19 the prior stage and then one stage later you get to sell the the product of that for 20 and so that one flows to the left whereas the 19 went to the farmer. Okay. And then the idea is at that stage now somebody takes the wheat and then hires the miller to crunch it into flour. Okay? And he has to pay 8 ounces of gold to the miller for that service. Okay? Okay. And so the idea is at that stage somebody is paying 20 ounces of gold for the wheat and then paying eight additional ounces of gold to the miller to grind it. Okay? And so this person now has advanced 28 and then the idea is next period now the flower is sold for 30 ounces of gold. All right? And so the person who advanced the 20 plus the eight is the so that person invested 28 in the prior period and now sells the finished product for 30. So that's a gain of two, right? And so that's why that two flows to the left and you just keep doing that, right? So that person, you know, so now that product at that stage is sold for 30. An additional 13 ounces of gold is spent on land and labor factors. Land means any kind of natural resource. And so that's a total of 43 spent. And then next period, whatever those two things produce is sold to the next stage for 45 ounces of gold. And so 30 + 13 is 43. So the 45 means 2 ounces of gold accured is interest. And that flows left. Okay? So you just keep doing that. And then finally you get to the second last stage where somebody bought the product from the prior stage for 80 ounces spent an additional 15 ounces of gold out of pocket to hire land and labor factors to you know mix with that product from the prior stage. So that's a total expenditure of 95 ounces. A a period later that ripens into the finished loaves of bread. All right. So maybe it was they bought 80 ounces worth of gold from of of like whole loaves of bread from the baker at the wholesale level and then they paid 15 ounces of gold for people to slice them, put them in bags and put them on a truck and drive to the grocery store. Okay? And so then the 100 ounces, like I say, is the final consumer in the grocery store getting the finished loaves of bread and paying 100 ounces for it. And so that last stage there because the you know the capitalist who runs the grocery store let's say had paid you know earlier had advanced 80 ounces to get the raw you know the whole loaves of bread in n in 15 to have it sliced up and everything. So he had invested 95 ounces of gold in the prior stage had to wait one period and then could sell it for 100 so he made an interest income of five and that's what that flows to the left. Okay. Okay. So then when you just step back and look at the whole thing, if that just keeps happening every period, then you just get a, you know, a system going like it takes time to get it up and running. But once you have it up and running and each of those processes repeats every period and you settle down into a steady state, the idea is there would be a cumulative 17 ounces of interest income, right? If you added up the one, the two, three, you know, on the left side, that adds up to 17. And if you add up the things going up, that adds up to 83. And that's not a coincidence that the 100 ounces of gold spent on the finished product adds up to the income that was spent to, you know, to the various factors of production, including the capitalists who, you know, advanced the capital and then earned interest on it. And then so that's how the consumers have 100 ounces of gold to spend, right? That the people buying the finished product include the capitalists who earned 17 ounces of gold that period and the owners of the you know the land and what other natural resources were involved at each of the stages and the workers who collectively all earned 83 ounces. And that's how if they each spent their entire income buying the bread, they could, you know, pay the 100 ounces for it and then the whole thing it just keeps repeating like that. Okay? So that gives you a much richer structure to understand the market process. And then notice here how much total investment there is right if you said oh this economy like put it this way in a mainstream textbook they would look at this economy and they would say 100% of real GDP is constituted by consumption spending and 0% of GDP comes from government spending or uh private investment right because in this economy you say what's consumption private consumption spending and say oh every period 100 ounces of gold gets spent on bread by the consumers and you say what's total income in this economy oh it's 100 ounces so GDP flows entirely from consumer spending in this in this the way you know a mainstream economist would look at this but you can see that's extremely misleading it involves to keep this system up and running to keep those lows of the 100 ounces worth of loaves of bread flowing off, you know, onto the grocery store shelves period after period such that, you know, the the workers and land owners who collectively get paid 83 ounces go and they buy 83 ounces worth of bread each period. And the capitalists who earn collectively 17 ounces of interest income each period go and spend it buying bread. In order for that to work, the capitalists at each stage have to engage in gross investment, right? So like the guy who um invests 60 to buy you know whatever is rolling over from the prior stage and then invest an additional 16 in order to spend a total of 76 that period and then he holds it and sells the output for 80 the next period thus pocketing four in interest income. Every period when he gets paid that 80 he can't consume all of it. he can only consume four. He's got to take the 76 and reinvest it back in, you know, buying the thing from the prior stage at for 60 and then spending 16, hiring land and labor factors to work on it for a period and then sell the thing next period for 80. Right? So, of that 80 in gross receipts that he's getting, he can only consume four and he's got to reinvest. So he has what would be considered gross investment of 76 but that's not included in GDP the way the standard macro accounting works that that only means net investment okay but if you looked at the gross investment here it's it's really high okay it's in fact gross so here I'm reading from my study guide in the original structure gross income is 418 ounces which equals 100 plus 80 plus 15 plus 60 plus 16 plus 45 plus 12 and so on. Total consumption is 100 ounces and gross investment is the difference namely 318 ounces. Okay. So again in this hypothetical economy here that Rothbart imagined consumption is 118 or sorry is 100 ounces whereas gross investment is 318 ounces. So in that sense investment is three you know three times as big plus as consumption but yet again the way a mainstream economist would classify this they would say consumption constitutes 100% of GDP okay and also too you could see if you know you were a Keynesian and wanted to encourage consumption and discouraging uh saving because oh we we got to maintain spending and if everybody just rushed to grocery store and tried to spend all of their income, you know, all 418 ounces on bread, what would that do? That would just push up the price of bread. And if they didn't reinvest, then everything would collapse, right? If if the guy who normally spends 95, right, he spends 80 buying the thing from the prior stage in 15 hiring land and labor factors to work on it in order to make the finished. If he instead took the 100 ounces he got and tried to spend it all on bread and didn't reinvest 95 of it, well then that stage wouldn't happen. And then next period after that, there'd be no new, you know, no finished sliced bread getting to the grocery store. And way back, you know, if somebody didn't pay the farmer to plant, well then, you know, it would it would take longer. it would start, you know, rippling through the system and then a few periods later that hole would show up and then yeah, there wouldn't be bread on the shelves because they'd say, "Why?" They say, "Oh, because five periods ago the farmer didn't plant and grow more wheat." Okay. So again, I just think that kind of a diagram diagrammatic framework allows you to see the important role of gross capital investment in this the time structure of production which you literally can't see in the very crude simplistic circular flow diagrams of mainstream economics. Okay. Um, the last thing I'll touch on, one of Rothbird's most sophisticated works, he's got this essay called Toward a Reconstruction of Utility and Welfare Economics that he published in 1956. Um the if you're a professional economist, I would encourage especially if you're not familiar with the Austrian or if you're an expert in the Austrian, if you're not a card carrying Austrian and you're just kind of dabbling and oh yeah, I like to, you know, be eclectic and I'll listen to this human action podcast and you know, maybe somebody sent you this episode, I encourage you to read this, especially if you think, oh yeah, those Austrians don't know math and they didn't keep up with the literature and they're just these cranks in the corner. read this 1956 essay from Rothburn. He is very up to speed with the cutting edge work in mainstream neocclassical um utility and welfare economics. Okay. And just you could just tell from the citations and stuff he knows what he's talking about. He even gets uh in the weeds with like Vonoyman uh Morgan Stern utility functions and with risk aversion and things like that and and what does it mean is is utility in the mainstream approach ordinal or cardinal and oh well you know they use cardinal utility functions but really it's ordinal preference ranking although with you know the way they model decision-m under uncertainty with vonoman Morgan Stern it's you know unique up to a monotonic uh what is it aine transformation right so he's he gets into all that stuff so you can see Rothbart is very conversant with the literature as of you know the mid1 1950s here so big picture what does he do so he first so in case people are confused so utility theory has to do with explaining human choices is. And so, oh, why did somebody with a given budget and facing certain prices going into the grocery store, how come this guy walked out with that basket of goods and that woman walked out with that b a different basket of goods? Even, let's say, they had the same budget. You'd say, "Oh, cuz they're, if you were a mainstream econ, the utility functions were different." If you were an Austrian, you might say, "Cuz their preferences were different." Okay? And but you would say, "Oh, because each person bought the basket of goods that maximized their utility or gave them the most utility." Okay. And so, but whereas with welfare economics, that has to do with um it's not like welfare like soup kitchens and food stamps. It means promoting human happiness. All right? And so like what can we say about are certain arrangements in society better or worse? like that's what welfare economics has to do with. And so Rothbird spends the first half of his essay summarizing and critiquing the current state of utility theory and welfare theory, you know, in the standard economics literature and it's it's very compelling. Um and one of the one of the points he makes is that he says um he points out a confusion that in the mathematical mainstream approach they thought marginal utility meant like the increment in total utility, right? And especially like if you get into calculus and say, "Oh, what's the derivative of the utility function, you know, in this neighborhood or something?" And that's that's what the marginal utility is that you know oh if you give me an infinite decimal more amount of good X then um how much does my total utility go up and that's the marginal utility of X at that point and so if you reject the notion of cardinal utility then if you think marginal utility means the delta in total utility then obviously marginal utility goes the window too and then clearly so does diminishing marginal utility cuz what the heck you know you're just doing further operations on nonsense and that's actually what happened um like John Hicks following paro did that in his um value and capital he you know Hicks threw out so Robert agreed we have to abandon a notion of cardinal utility it doesn't make sense and what Hicks did is he said okay so these older ideas of like margin utility and diminishing margin utility. We can't use that anymore. But he replaced it with indifference curves. And he said, "Okay, what we used to think of as diminishing margin utility and the fact that oh yeah, you get more and more of one good on the margin you don't value it as much. And so that's why like the trade-off between it and some other good gets worse and worse." He said that doesn't make sense anymore because if you don't have total utils, you can't have margin utility and you can't have diminishing margin utility. But he said, 'Oh, we can have the marginal rate of substitution. So he kind of saved a bunch of the results from old consumer theory and showed here's how we can talk about that stuff in a framework that's more robust that doesn't rely on this notion of car utility that we realize is kind of philosophically dubious. All right. So, Rothburn appreciates what he did there and like the consistency of his view, but he said the problem is Hicks and Paro and all those guys, they were using the wrong definition of margin utility. Don't think of it as the delta in total utils, which he agreed that doesn't make sense. He said instead, no, it's not the change in total utility. It's not like Roth says explicitly that the mainstream economist they would think like oh what does it mean for the margin utility of the fifth unit the mainstream economist thought oh what that means is if you have discrete units is what's the total utility of five units and subtract the total utility of four units and whatever that delta is that's the margin utility of the fifth unit right showing how many more utils do you get by adding the fifth unit but if you don't think utils exist well then that means nothing and Rothber was No, that's not the way to he says you can still talk about utility in an ordinal sense. And the marginal utility is the utility of the marginal unit, right? And so you you can just have an ordinal preference ranking. And so just like you can say, oh, I would rather have a car than an apple, right? Right? So on my my ordinal value scale, a car ranks higher than an apple does. Likewise, I could say the first apple is higher on my value scale than the second apple is. It doesn't mean because I assign more utils to the first apple, just like I didn't have to assume the car got 2,000 utils and the apple only got 20. No, I wasn't assuming the cardinal utils existed. I can still say I prefer the car to an apple or if you want I can say the car gives me more utility than the apple does. Okay, doesn't mean there are cardinal units of it. Right? So that's one of the things Rothberg does here. But um so as the title suggests toward a reconstruction of utility and welfare economics uh sorry let me mention one more thing. Another great point Rothburn makes is he says um you know faced with the problem of trying to be valuefree and scientific and objective the economists realize well geez if there's no such thing as interpersonal cardinal utility comparisons. How can we say that, you know, how can we justify our government intervention or, you know, what would it mean to say that free trade is good and tariffs are bad or whatever? And he's saying, oh, the the trick that Paro tried to use was unonymity and to say, oh, something, you know, is a paro improvement if we make every single person better off or in some settings make at least one person better off and don't hurt anybody. And Robert says, "But that's not you, in practice, that's pretty useless because just about anything you do, some people are going to object to, so that doesn't really help us." And he said, "Another efficiency criterion was offered by Kaldor and Hicks." And so something's called Kaldor Hicks efficient um or is a is a is a movement towards Kaldor Hicks efficiency. if the gains to the winners outweigh the losses to the losers. And the way that's justified, you know, quote, scientifically or rigorously is to say because we could we could take the some of the gains from the winners and compensate the losers and then make everybody better off. And Rothbra says okay but if in practice you don't actually do that if you don't compensate the losers then it's not clear that you have by your own standard then you haven't necessarily made you know engage in a social improvement so he's you know he just thought they were kind of fooling themselves right so he's got like I say he's got some very informed rigorous critiques of the state of utility theory and welfare economics as of the mid1 1950s and he was you know well verssed in the cutting edge literature with you know citing savage and so on if you're familiar with the modeling of uncertainty choices under uncertainty um that was you know developed in this period but then the Torah reconstruction so then Rothber says all right I've just gone through and you know ripped a new one and what these mathematical economists have been doing so what do I propose and he says all right and he founds it on what he calls demonstrated preference and so there the idea is utility preference rankings don't exist independent of choices. And so this was another element that he was saying um like Paul Samuelson had something that Samson called revealed preference. And Rothbart says by the way that I would have called my thing revealed preference but I couldn't because Samson already used the term. And so what the way Samson would use revealed preference is he would just assume that oh yeah someone's got this static list of ordinal preference rankings and then he keeps going back to the market and making choices based on when prices and income change and I can just watch his choices over time and if his preference relationship obeyed certain axioms then you know we could make certain deductions and things like that. But you know what? In practice, you see violations of this stuff all over the place. And so you can't do that. And and so one of the things is like, oh, if somebody, you know, on day one prefers A to B, and on day two, you can tell from their choices they prefer B to C, well then it better be the case that on day three they prefer A to C because of transitivity. But Rothbart points out, well, no, their preferences could have changed, right? So there's a difference between constancy and consistency. Okay, so he gets in all that stuff. So anyways, really great stuff. Again, showing he's familiar with the literature. So then how does Rothbird deal with this? He says focus on what's called demonstrated preference. So it's just, you know, all you can do is say when you see people making concrete choices, if someone chooses A over B, you know they preferred A to B, that A gave him more utility than B. And then in terms of welfare, he says we can say things like um whenever there's a voluntary market exchange, both parties at least exanty expected to benefit. That's why it was voluntary and they did it. And so there's in that sense, you've improved social welfare. You've made those two people better off. Okay? And so that's the approach he takes. And uh anyway, it's like I say, it's it's a very good essay showing Rothbart to his finest being quite conversant with the literature and then offering uh a a replacement of what the mainstream guys are doing that, as you can see, is very consistent with libertarian free market orthodoxy. Okay, so that's my greatest hits from Rothbird the Economist in commemoration of the 100th anniversary of his birth. Thanks for tuning everybody. See you next time. >> Check back next [music] week for a new episode of the Human Action podcast. In the meantime, you can find more content like this on mises.org. [music] [music]