Austrian Economics Re-Examined Austrian Economics Re-Examined: the economics of time and ignorance is an expanded version of the 1996 edition of The Economics of Time and Ignorance . This work is a classic statement of the role of subjectivism, radical uncertainty and change through real time in Austrian economics specifi cally, and in modern economics more generally. The new book contains the full text and Introduction of the earlier edition as well as the comprehensive, previously unpublished essay “What Is Austrian Economics?” and a new Introduction. The essay is a comprehensive overview of the central themes of the book from a somewhat different perspective than in the book itself. It supplements the analysis in the book. The new Introduction explains that the 2007–08 fi nancial crisis and recent developments in behavioral economics have made the book more relevant than ever before. Austrian Economics Re-Examined develops and systematizes the funda- mental principles of the Austrian tradition and applies them to the analysis of rational expectations, business cycles, monetary theory, competition and monopoly, and capital theory. Gerald P. O’Driscoll, Jr. is Senior Fellow, Cato Institute, USA. Mario J. Rizzo is a Professor in the Department of Economics at New York University. He is also Director of the Program on the Foundations of the Market Economy and Co-director of the Classical Liberal Institute at the New York University School of Law, USA. Routledge Foundations of the Market Economy Series editors: Mario J. Rizzo New York University Lawrence H. White George Mason University A central theme in this series is the importance of understanding and assessing the market economy from a perspective broader than the static economics of perfect competition and Pareto optimality. Such a perspective sees markets as causal processes generated by the preferences, expectations and beliefs of economic agents. The creative acts of entrepreneurship that uncover new information about preferences, prices and technology are central to these processes with respect to their ability to promote the discovery and use of knowledge in society. The market economy consists of a set of institutions that facilitate voluntary cooperation and exchange among individuals. These institutions include the legal and ethical framework as well as more narrowly “economic” patterns of social interaction. Thus the law, legal institutions and cultural and ethical norms, as well as ordinary business practices and monetary phenomena, fall within the analytical domain of the economist. Previous books in this series: 1. The Meaning of Market Process 4. Laissez-Faire Banking Essays in the development of Kevin Dowd modern Austrian Economics 5. Expectations and the Meaning of Israel M. Kirzner Institutions 2. Prices and Knowledge Essays in economics by Ludwig A market-process perspective Lachmann Esteban F. Thomas Edited by Don Lavoie 3. Keynes’ General Theory of 6. Perfect Competition and the Interest Transformation of Economics A reconsideration Frank M. Machovec Fiona C. Maclachlan 7. Entrepreneurship and the Market 17. Microfoundations and Process Macroeconomics An enquiry into the growth of An Austrian perspective knowledge Steven Horwitz David Harper 18. Money and the Market 8. Economics of Time and Essays on free banking Ignorance Kevin Dowd Gerald P. O’Driscoll, Jr. and 19. Calculation and Coordination Mario J. Rizzo Essays on socialism and 9. Dynamics of the Mixed transitional political economy Economy Peter J. Boettke Toward a theory of interventionism 20. Keynes and Hayek Sanford Ikeda The money economy 10. Neoclassical Microeconomic G. R. Steele Theory 21. The Constitution of Markets The founding Austrian version Essays in political economy A. M. Endres Viktor J. Vanberg 11. The Cultural Foundations of 22. Foundations of Entrepreneurship Economic Development and Economic Development Urban female entrepreneurship David A. Harper in Ghana Emily Chamlee-Wright 23. Markets, Information and Communication 12. Risk and Business Cycles Austrian perspectives on the New and old Austrian Internet economy perspectives Edited by Jack Birner and Pierre Tyler Cowen Garrouste 13. Capital in Disequilibrium 24. The Constitution of Liberty in The role of capital in a the Open Economy changing world L ü der Gerken Peter Lewin 25. Liberalism against Liberalism 14. The Driving Force of the Market Javier Aranzadi Essays in Austrian economics Israel Kirzner 26. Money and Markets Essays in honor of Leland B. 15. An Entrepreneurial Theory of Yeager the Firm Edited by Roger Koppl Fr é d é ric Sautet 27. Entrepreneurship and Economic 16. Time and Money Progress The macroeconomics of capital Randall G. Holcombe structure Roger Garrison 28. The Theory of Dynamic 31. Understanding the Culture of Effi ciency Markets Jes ú s Huerta de Soto Virgil Storr 29. Mind, Society and Human 32. Producing Prosperity Action An inquiry into the operation of Time and knowledge in a theory the market process of social-economy Randall G. Holcombe Richard E. Wagner 33. Austrian Economics 30. Markets, Morals and Re-Examined Policy-Making The economics of time and A new defence of free-market ignorance economics Gerald P. O’Driscoll, Jr. and Enrico Colombatto Mario J. Rizzo Austrian Economics Re-Examined The economics of time and ignorance Gerald P. O’Driscoll , Jr. and Mario J. Rizzo First published 2015 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2015 Gerald P. O’Driscoll, Jr. and Mario J. Rizzo The right of Gerald P. O’Driscoll, Jr. and Mario J. Rizzo to be identifi ed as authors of this work has been asserted by them in accordance with the Copyright, Designs and Patent Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice : Product or corporate names may be trademarks or registered trademarks, and are used only for identifi cation and explanation without intent to infringe. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication data O’Driscoll, Gerald P. [Economics of time and ignorance] Austrian economics re-examined : the economics of time and ignorance / Mario Rizzo and Gerald P. O’Driscoll, Jr. pages cm. – (Routledge foundations of the market economy) Includes bibliographical references and index. 1. Austrian school of economists. 2. Time and economic reactions. 3. Uncertainty. I. Rizzo, Mario J. II. Title. HB98.O372 2014 330.15′7–dc23 2014016617 ISBN: 978-1-138-02300-0 (hbk) ISBN: 978-1-315-77673-6 (ebk) Typeset in Times New Roman by Out of House Publishing To the Memory of Ludwig M. Lachmann (1906–90) This page intentionally left blank Contents List of fi gures xi Preface xii P A R T I Introduction 2014: a changing world 1 A changing world 3 PART II What is Austrian economics? 17 What is Austrian economics? 19 PART III The economics of time and ignorance 47 Acknowledgments 4 9 Introduction: time and ignorance after ten years 51 1 An overview of subjectivist economics 68 SECTION I Framework 78 2 Static versus dynamic subjectivism 78 3 Knowledge and decisions 92 4 The dynamic conception of time 105 5 Uncertainty in equilibrium 119 x Contents SECTION II Applications 135 6 Competition and discovery 135 7 The political economy of competition and monopoly 162 8 A subjectivist theory of a capital-using economy 185 (Chapter 8 by Roger Garrison) 9 The microanalytics of money 207 10 Some unresolved problems 239 Bibliography 245 PART IV Austrian economics: recent work 261 Austrian economics: recent work 263 Mario J. Rizzo PART V Responses to criticism 281 Twenty-fi ve years after 283 Gerald P. O’Driscoll, Jr. Foundations of The Economics of Time and Ignorance 288 Mario J. Rizzo Index 297 Figures I.1 Velocity of M1 money stock 5 I.2 Gaussian vs. Cauchy distribution chart 6 III.1 Value theory: a utility scheme 100 III.2 Airline pricing 165 III.3 Firm behavior 167 III.4 Market pricing 173 III.5 Determination of interest rates 219 III.6 Interest rate dynamics 224 Preface We are extremely happy to see Austrian Economics Re-Examined in print. This is an expanded edition of The Economics of Time and Ignorance , published by Routledge in 1996. The new edition contains many important additional features. There is a substantially updated Introduction that explains why, in our view, the book is more relevant than ever before. Perhaps most importantly, we are including the previously unpublished essay “What Is Austrian Economics?” Although this article is more of a survey than is the book, it was the basis from which we wrote the book. There is also the full text of the New Palgrave Dictionary of Economics article “Austrian Economics: Recent Work,” fi rst published in 2009. Finally, we are including our largely self-contained responses to criticism we received at a session of the Southern Economics Association on November 19, 2011, that was held in recognition of the twenty-fi fth anniversary of the original Blackwell edition of the book. If readers want to see the full symposium, it is contained in The Review of Austrian Economics , 2013, vol. 26, issue 1. We are indebted to Professor David Harper of New York University for organizing this session. We have also decided to create a website with recommendations for fur- ther reading, photos and other material helpful for a further appreciation of the book. We are indebted to Professors Simon Bilo (Allegheny College) and Shruti Rajagopalan (Purchase College) for urging the construction of the website and for their invaluable help in gathering the relevant content.