FOUNDATIONS OF THE MARKET-PRICE SYSTEM UNIVERSITY PRESS OF AMERICA Copyright ©1985 by University Press of America,™ Inc. 4720 Boston Way Lanham,MD 20706 3 Henrietta Street London WC2E 8LU England All rights reserved Printed in the United States of America ISBN (Perfect): 0-8191-4543-2 ISBN (Cloth): 0-8191-4542-4 Copyright 1974 by Milton M. Shapiro Originally published by California State Polytechnic University, Pomona, California All University Press of America books are produced on acid-free paper which exceeds the minimum standards set by the National Historical Publications and Records Commission. TO MY PARENTS Baruch and Rivkah, who gave me life and TO MY FAMILY Jeanne, Johanna and Arthur, who fulfill that life. iii IV ACKNOWLEDGMENTS First, intellectual debts. The greatest of them, and most gratefully acknowledged, are to those thinkers who helped create, shape, and nourish the Austrian tradition in economics. Chief among these men are Ludwig von Mises and Friedrich A. Hayek—who never lost sight of the bridges linking economics with the other sciences of human action—and Murray N. Rothbard and Israel, M. Kirzner, current regenerators of the tradition and innovators on their own. The Austrians have taught us to view man as a whole person and not as mere "economic man" geared to a materialist calculus, nor as a figment of abstract mechanical constructs—that is, man in his total reality instead of the fore- shortened reality viewed through the prism of mathe- matical models. Thus they have treated economics as but one facet of the general science of human action. In this connection I must also mention the late Professor Clyde W. Phelps, who fortunately turned me on to the Austrians in the first place during the final years of my graduate studies, and Henry Hazlitt, whose works feature tributes to the Austrians. Also, like an oasis in the desert was the Foundation for Economic Education, Irvington-on-Hudson, N.Y., whose monthly The Freeman has featured works by the Austrians and on the free-market system, and whose inspired president, the late Leonard E. Read, made sure there was always enough water to refresh the "remnants." Other intellectual debts are no less noteworthy. Important insights were provided by Armen A. Alchian and William R. Allen in their pathbreaking texts, Univer- sity Economics and Exchange and Production. Other of these debts are expressed in my references throughout these pages, while still other debts may regretfully go without specific acknowledgement owing to infirmities of memory. Gratitude of another sort is extended to those who took time out to review early drafts, particularly Professors Rothbard, Alchian, and Ludwig M. Lachmann. Needless to say, none of the above can be held respon- sible for any misinterpretation or misuse of their work on my part. On a more practical level, this book would not have been possible without creative and Sabbatical leaves granted by the California State Polytechnic University, Pomona, nor without fellowships and grants from the Institute for Humane Studies, Menlo Park. At the Institute it was my good fortune to receive from the outset the personal encouragement of the late Floyd A. Harper, as well as Kenneth S. Templeton, Jr., both of them dedicated spokesmen for liberty and property rights in a humane society, as well as promoters of research and writing on the free market. In a similar vein, I am most grateful to the directors of the University Press of America reprint program for their recognition of this book's merits and for this opportunity to reach a much wider audience. Finally, but no less deserving of recognition are Karen Meade, for her typing skills and editorial acumen, and Robert M. Marvos, for his bold graphics. vi CONTENTS Acknowledgments v Contents vii Tables and Figures ix Tables ix Figures ix Preface xi Introductions to Chapters xvii Chapters: I. How Can People Get By? 1 II. Scarcity—the Basic Economic Problem 9 III. Division of Labor and the Origin of Money.. 31 IV. Production, Income, and Economic Growth.... 59 V. Scarcity and Individual Choice 81 VI. The Demand Side of the Market 115 VII. Price-Elasticity of Market Demand 145 Appendix: The Coefficient of Elasticity 177 VIII. How the Market Determines Prices 179 Appendix: Will the Real Supply Stand Up?.. 229 IX. Profits — and Other Incomes 235 X. The Consumers' Sovereignty Problem 279 Appendix: The Galbraith Effect.., 312 XI. Competition: "Perfect" vs. Real 319 For Further Reading 373 Index 383 vii viii TABLES AND FIGURES Tables I. Demand for Gasoline 129 II. An Increase in Demand for Gasoline 133 III. Compound Interest on One Dollar 247 IV. Present Discounted Value of a Future Dollar 248 V. Present Discounted Value of a One-Dollar Annuity 262 VI. Marginal Revenue 344 Figures 1. Scarcity Implies Production 15 2. Relations Between Households and Firms 18 3. Production is the Source of Income 21 4. The Firm As Intermediary 22 5. Basic Elements of the Market-Price System.... 24 6. "Non-Income" Sources of Purchasing Power 26 7. Effect of a New Technique of Production on Profit-Margin 70 8. Demand for Gasoline 128 9. Different Degrees of Elasticity of Demand.... 131 10. Shifts in the Demand Schedule 134 11. Elasticity of Demand in the Case of a Price Cut 148 12. Elasticity of Demand in the Case of a Price Increase 153 13. Degrees of Elasticity Preferred by the Firm 156 14. Price-Changes and Price-Elasticity of Demand 159 15. Availability of Substitutes and Elasticity of Demand 161 16. Preference-Ranking and Elasticity of Demand 167 17. Social Income-Structure and Elasticity of Demand 170 18. The Ex-Post Supply Schedule 181 19. Demand, Supply, and Market-Price 185 20. Surpluses, Shortages, and Selling Prices 187 21. Supply Restriction and Shortages 189 22. Surplus, Shortage, and Quantities Supplied 197 IX Figures (continued) 23. Non-Profit Underpricing 211 24. Shifts in Supply Schedules 214 25. Increase in Demand While Supply is Fixed 215 26. Decrease in Supply While Demand is Fixed 217 27. Decrease in Demand While Supply is Fixed 219 28. Increase in Supply While Demand is Fixed 220 29. Long-Run Decline in Prices 223 30. Long-Run Rise in Prices 225 31. Market-Determination of Wage-Rate 274 32. Relations Between Households and Firms 281 33. Comparison of Perfect Competition and Imperfect Competition 333 34. Origin of Horizontal Demand Schedule 335 35. Price-Taker's Horizontal Demand Schedule 339 36. Total Costs and Marginal Costs 341 37. Marginal Revenue Curves 346 38. Profit Maximization 348 39. Price-Taker as Quantity-Adjuster 350 40. Innovative Cost-Cutting and Profit Differentials 358 41. Oligopolists Produce More At Lower Price 369 A. Ex-Ante Supply 231 B. Ex-Ante Supply and Market Price 231 PREFACE This book on introductory micro-economics was forged as a by-product of some 20 years' teaching of university economics. Earlier editions appeared under the title The Common Sense of Economics. From its incep- tion in 1974 it has been used as a text in my classes. Nevertheless, it was also conceived to appeal to the "common sense" of the general audience, as well as to the practical-minded business school student. Indeed, the original title, inspired by Philip Wicksteed's The Common Sense of Political Economy (1910, 1946), was meant to reflect the book's underlying methodology as much as to pay homage to that great writer. Last but not least: This book, being of conven- ient length, can also serve as a suitable companion to other texts. Although it treats of the standard mater- ial, it does so in a truly alternative and complementary fashion, and is only minimally duplicative. Furthermore, it is thoroughly devoid of mathematical impedimenta. This new edition incorporates extensive editor- ial changes and the addition of appendixes to Chapters VIII and X, a vastly expanded introduction and other front matter, an index, and a reading list. Thus, it was also a fitting occasion for the change in title to one that is more descriptive of the book's substance. Although this is primarily a textbook in the principles of micro-economics, my desire is to give it relevance to a wider audience. Thus, I have reached out beyond the traditional confines of other texts to include non-technical elements which I believe are re- quired for two purposes: to elucidate the ultimate foundations of the subject, and to create links or bridges between human action in the realm of economics and human action ^Ln general, particularly in the dimension of subjective motivation and decision-making. In this connection it is pertinent to note that an ironic strain is intermittently played in this book, starting in Chapter I, precisely because it is so XI instructive. The irony involves playing off the primi- tive Robinson Crusoe (the wilderness man of economics), who lives so grimly alone in the bosom of nature, against modern man who lives so much more richly at ease in the advanced modern division of labor. Specifically, the irony is based on the following elements. On the one hand, with respect to the relevance of the basic economic principles of survival and prosperity there is no essential difference between the case of Crusoe and that of modern man (see especially Chapter IV). However, when it comes to being directly aware of the basic natural laws of existence, it is Crusoe who has it over modern man. The reason is that man living alone in nature's wilderness learns soon enough the lessons that nature implies for him: the need to work and produce and live by his wits; the need to assume the natural right to do all of these things as well as the right to keep and cherish the fruit of his labors; and, above all, the need to assume the burdens of self-responsibility.