Objective Economics: The Implications of Ayn Rand’s Philosophy on the Science of Economics is featured this month at Capitalism Magazine.
Archive | March, 2011
Preface to Objective Economics: How Ayn Rand’s Philosophy Changes Everything About Economics
This book is the product of forty-eight years spent studying Ayn Rand’s philosophy of Objectivism and the science of economics. When I read Atlas Shrugged in 1962, I was stunned that Ayn Rand rejected everything I had been taught in two economics courses. Like most of economics in 1962, the purpose of those courses was to justify government intervention in the economy. Ayn Rand advocated laissez-faire capitalism, that is, an economy with no government intervention. I set out to find the truth. Forty-eight years later, I have learned a lot about what is wrong with modern economics and where much of the truth lies. In particular, I have figured out some of the implications for economics of Ayn Rand’s concept of objective. The purpose of this book is to communicate that knowledge.
To the best of my knowledge, this book represents the first attempt to rewrite economics in the light of Ayn Rand’s philosophy of Objectivism. As such, it is an application of Objectivism to the theory of how a free economy works, that is, to the theory of how men’s independent, self-interested actions to produce and exchange economic values are integrated into an economic system. Ayn Rand did not leave us a new economics, but something much more important—a philosophical foundation for all the special sciences. My purpose is not to present the Objectivist philosophy, but to apply Objectivism to economics. For an authoritative account of Objectivism, there is no substitute for Ayn Rand’s own writings.
This book is written for any man who wants to know how a free economy works and/or some of the implications of Ayn Rand’s philosophy for economics. In the body of the book, I have done my best to presuppose no knowledge of economics or Objectivism. I have confined my critique of modern economics to four appendices. Particularly in the appendices, I refer frequently to modern economics and modern economists, by which I mean academic economists, that is, economists employed in colleges and universities. By “modern,” I mean roughly the last fifty years. Undergraduates are taught essentially the same economic principles today that I was taught in 1960.
This is not a disinterested study. If one wants to live on earth, what is required to sustain man’s life on earth is of urgent interest. The subject matter of economics is how the members of an economic system obtain the material values of man’s life, such as food, clothing, and shelter. These things do not fall from heaven. They are the result of a specific and, in the history of the human race on earth, an unprecedented economic system.
In principle, the fundamental choice of economic systems is between laissez-faire capitalism and government controls. In politics, the equivalent choice is the choice between freedom and tyranny. In terms of concrete results, this is the choice between life and death. If one chooses life, then one chooses freedom, which includes economic freedom, and economic freedom, if it means anything, means laissez-faire capitalism. Unfortunately, economic freedom has no definite meaning to most people. They take it as meaning today’s mixed economy, which is not free, which is far from laissez-faire, and which has been sliding haltingly, but inexorably, toward complete state control for over a hundred years. In the concept “laissez-faire capitalism,” laissez-faire is redundant. In principle, anything other than laissez-faire is not capitalism and is not free. Consequently, throughout this book, I use the terms free enterprise, free economy, free markets, market economy, and capitalism interchangeably, to mean the same thing, that is, laissez-faire capitalism.
In the slide from freedom toward tyranny, modern economics has played a not inconsequential role. For a hundred years, all of its esoteric theories have carried a single message that the general public has absorbed and that they now take as self-evident—the message that laissez-faire capitalism is impractical.
The practicality of capitalism is my general thesis; Ayn Rand’s concept of objective is my starting point. The general reader may be surprised to hear that philosophy has implications for economics, but I promise that if this seems unlikely here, at the beginning of the book, it will seem inescapable by the end.
The philosophical overview of my book is this: Modern economics is the product of modern philosophy. Since on every important issue, Objectivism is the opposite of modern philosophy, Objectivism changes everything about economics. This includes economics’ method, the conception of the economy, the meaning of competition, the conception of price, the principle of gains from trade, the nature of business costs, the concepts of supply and demand, the theory of price, the role of scarcity, and the theory of aggregate production. Overall, as the result of all the preceding, Objectivism confirms the practicality of capitalism.
Economics is a positive science, not a normative science; that is, economics is descriptive, not prescriptive. Economics can tell us what the effect of a minimum wage law is on employment, but economics cannot tell us whether that effect is good or bad. Good and bad are concepts of evaluation. They presuppose a standard and ultimately a system of morality. Economics is not ethics. Nevertheless, economics is not cut off from ethics. Ayn Rand defined ethics as “a code of values to guide men’s choices and actions” (1964, 2), and some such code, explicit or implicit, underlies everything men do. This includes the work of economists in analyzing an economic system.
Ayn Rand’s ethics of rational self-interest is an ethics of egoism, the view that selfishness is a virtue and the individual should be the beneficiary of his own actions. Her ethics is my ethics. By contrast, for the last hundred years, economists have presupposed the opposite ethics as the base for both generating and evaluating theories: that ethics is altruism, the morality of selflessness and self-sacrifice—the morality of the Judeo-Christian tradition—the morality that dominates our age and that has dominated Western civilization for two thousand years.
The clash between altruism and capitalism is irremediable. Capitalism is the economic system of self-interest. Capitalism depends on self-interest, it encourages self-interest, it sanctions self-interest. At every level and in every detail, the motivation of self-interest is the motivation of capitalism. Consequently, the altruists have loathed capitalism from its beginning in the Industrial Revolution. This loathing is the fundamental cause of “the sweeping market reforms that economists have long advocated” (Mandler 1999, 151).
The primary purpose of economics is to identify, interpret, and explain how a capitalist economy works. Altruism assured economists that capitalism is evil in advance of that knowledge. The evil consequences of this belief permeate all of economics, damning capitalism in both theory and practice. In theory, capitalism never had a chance. Since an evil system cannot work, capitalism was convicted a priori. As for capitalism’s practice, economists’ commitment to the immorality of capitalism blinded them to the facts. Every datum, every event, every phenomenon, every result, every aspect of capitalism was twisted and distorted out of any resemblance to reality in order to make it conform to the altruist agenda. Ayn Rand’s refutation of altruism makes it possible for the first time in history to present the theory and practice of capitalism objectively, untouched by moral distortion. This is the first study of economics to take advantage of that fact, and in the end, an objective perspective is the primary value I have to offer.
A note to the businessmen in my audience: Qua businessman, a man does not need to know economics. If he does know it, his knowledge does not affect his strictly business decisions, such as whether or not to raise his price when his costs increase. But each businessman does need to understand economics if he wants to defend his business against those who want to seize it or shut it down or confiscate his profits. A businessman does not need to understand economics in order to run his business successfully—just in order to keep it. That is the understanding I am offering here.
I would like to suggest to those who know something about economics that they begin by reading the first three appendices. My theory departs radically from standard economics and I have found that people with some background in economics often do not understand me, particularly the fact that I have abandoned supply and demand curves. Appendices A, B, and C present my critique of modern economics and explain why I have taken the direction I have.
I also call the reader’s attention to the Exegesis and Glossary (pp. 333–35). This overview of the various meanings of the concept of value can help one to keep these meanings straight as one reads the text.
The modern context requires that I mention that throughout this book, as well as in this preface, I use the terms “man,” “he,” and “his” in the generic sense, meaning human beings in general. I am unalterably opposed to the current fad of pretending that, after a thousand years of absolute clarity on the subject, the generic use of man somehow excludes women.
I am indebted to many friends and colleagues for helpful comments on this project at various stages over the twenty years of its development. Some of them have forgotten helping me, but I remember. They include Robert W. B. Love, Jr., Young Back Choy, Charles Clark, Daniel Drake, Israel M. Kirzner, Walter J. Primeaux, Jr., Warren Samuels, Gary Schuld, Gordon Tullock, Harry Binswanger, Peter Schwartz, and Mike Berliner. Mary Ann Sures, persuaded me to direct my book to the general reader. Anthem Foundation’s grant to St. John’s University reduced my course load from three to two in the fall 2005 semester. John Ridpath gave me line-by-line comments on many chapters. Marlene Podritske greatly improved an early version of the manuscript. Donna Montrezza contributed important grammatical points. Finally, the lion’s share of the line editing fell to Darcy Lorin, who meticulously copyedited most of the present version and saved me from many errors.
My special thanks go to those who read the entire manuscript: to my brothers Robert and Donald who responded as noneconomists to a book written for noneconomists; to Leland B. Yeager, who gave me his usual thoughtful comments; and especially to my most dedicated and relentless editor, M. Kathryn Eickhoff, who read everything and many chapters more than once, who gave me detailed editorial comments on the entire book, and on many chapters more than once, and who brought the invaluable perspective of a business economist to my book and kept me from insulting that venerable group. Finally, my most reliable supporter has been Shrikant Rangnekar, who changed the book’s structure with his observations, who formatted the book for publication, whose enthusiasm for my project has never lagged, and who has been the main force behind its appearance in its present form. I am grateful to all these people, and all of them are innocent of any errors that may remain.
M. Northrup Buechner
New York, NY
November 2010
Appeal to Friends of Reason: How to order a copy of the book
Dear Friends of Reason,
My book is rolling into the world of publication. University Press of America (a subdivision of Rowman & Littlefield Publishers) has assigned it ISBN 978-0-7618-5481-4. It will cost $48.50 for a paperback copy. April is the “press date,” which means that they will start the process necessary to complete publication, and June is the publication month. Objective Economics: How Ayn Rand’s Philosophy Changes Everything About Economics should be out sometime in June.
As a condition of publication, I am required to place the first 100 copies of Objective Economics or purchase them myself. I have to do this before the press date. To help me out, some friends and relatives have purchased advance copies, and I have spoken to the St. John’s University Bookstore and the Ayn Rand Bookstore. Now I am asking for help from friends of reason everywhere.
If you would like to help, you have until March 25 to order an advance copy. Please telephone (1-800-462-6420) or email (customercare@rowman.com) Customer Service at Rowman & Littlefield Publishers and ask for Objective Economics: How Ayn Rand’s Philosophy Changes Everything About Economics. You should not need the ISBN, but please be sure to give them the order code “UPREPUB,” which tells them your order should be counted toward my 100. Then please tell me so I can keep track. If you do this, UPA will mail you a first edition of Objective Economics, hot off the press, as soon as it is published.
Probably Rowman & Littlefield will charge you $48.50 for the book when you make the advance order. Probably you will be able to get it for less than that if you wait until June when it is published. So this gesture is not costless. But a cost is not a sacrifice. A cost is something you give up to get something you value more. A sacrifice is something you give up to get something you value less. The last thing I want is for anyone to make a sacrifice on my behalf. Please, if buying an advance copy of my book is a sacrifice for you, DO NOT DO IT!
But if it is not a sacrifice, I will be very grateful, and I will be happy to sign your copy at the earliest opportunity. If you prefer, I will pay the cost of mailing it to me at St. John’s University.
Thank you for your consideration and support.
M. Northrup Buechner
Table of Contents of Objective Economics: How Ayn Rand’s Philosophy Changes Everything About Economics
TABLE OF CONTENTS
PREFACE 1
INTRODUCTION 7
CHAPTER ONE
METHOD AND CONTEXT 11
I. The Method of Economics 11
A. Induction 13
B. Other Things Equal 15
C. How to Evaluate This Book 16
II. Laissez-Faire Capitalism 16
Money 19
CHAPTER TWO
OBJECTIVE ECONOMIC VALUE 23
I. The Modern Meaning of Value 23
The Role of Philosophy 24
II. The Objective versus the Intrinsic and the Subjective 25
A. The Intrinsic 26
B. The Subjective 27
C. The Objective 27
III. Intrinsic Value versus Subjective Value 28
A. Intrinsic Value 28
B. Subjective Value 30
IV. Objective Value 31
A. Introduction 31
B. The Standard of Objective Economic Value 31
C. Knowledge and Objective Economic Value 33
Three meanings of value 34
D. Optional Values Are Objective Values 35
E. Nonobjective Values Are Objective Disvalues 35
F. Objective Value versus Subjective Value 36
G. Objective Economic Value 37
CHAPTER THREE
FUNDAMENTAL ECONOMIC CONCEPTS 39
I. Supply and Demand 39
A. The Importance of a Theory of Price 39
B. The Historical Role of the Law of Supply and Demand 40
C. The Meaning of Supply and Demand 41
D. The Law of Supply and Demand 44
II. Goods and Services 45
III. Market 47
IV. Capital and Wealth 48
V. Price 49
A. The Doctrine of Relative Prices 49
B. The Objective Price 51
C. The Opportunity Cost Doctrine 53
D. The Intrinsic Conception of the Real Price 54
Intrinsic price in Adam Smith 55
VI. Competition 56
CHAPTER FOUR
FOUNDATIONAL THEORIES 59
I. The Theory of Consumer Choice 59
A. Hierarchies of Values 60
B. Consumer Choice 63
C. The Diminishing Marginal Value of Money 67
II. The Law of Demand 69
III. The Principle of Gains from Trade 71
IV. The Theory of Objective Business Costs 74
A. Alternative Concepts of Business Costs 74
B. Problems in the Calculation of Business Costs 75
1. Anomalies of cost allocation 77
Labor costs 77
Materials costs 78
Machine costs 79
Handling and carrying costs 79
Administrative costs 79
Advertising and promotion costs 80
2. Erroneous cost calculations 80
3. Costs calculated by reference to the selling price 81
4. Summing up 82
C. The Theory of Objective Costs 82
CHAPTER FIVE
INTRODUCTION TO THE THEORY OF OBJECTIVE PRICES 85
I. The Three Theories of Price 85
A. The Intrinsic Theory of Price 85
B. The Subjective Theory of Price 86
C. Marshall’s Theory of Price 88
D. The Objective Theory of Price 88
II. Background Considerations 89
A. Case 1 90
B. Case 2 90
C. Case 3 91
III. How Prices Are Created 92
A. Preliminary Comments on Terminology 92
B. The Markets of a Free Economy 93
C. The Five Methods of Price Creation 94
CHAPTER SIX
SOMEONE SETS THE PRICE 97
I. Introduction 97
The Calculation of Profit 98
II. Demand 99
Socially Objective Value 99
III. Unit Costs 101
A. Average Cost Pricing 101
B. Variable Cost Pricing 102
C. Marginalism 102
D. The Required Relation of Cost to Price 103
E. The Structure of Unit Costs 104
IV. Competition 108
A. The Prices Currently Charged by One’s Competitors 108
B. The Quality of One’s Product Relative
to Competing Products 108
C. Price Leadership 109
V. Additional Issues 109
A. Expectations 109
B. Complications 110
VI. The Long-Run, Profit-Maximizing Price 110
A. The Meaning of Long Run and Profit Maximizing 110
B. The Long-Run, Profit-Maximizing Facts 111
C. Short-Run Profit Maximization Is a Nullity 112
D. The Alternatives to Long-Run Profit Maximization 113
1. No standard 113
2. Alternative standards 115
E. Creation of the Long-Run, Profit-Maximizing Price 117
F. Altruism versus the Profit Motive 118
CHAPTER SEVEN
THE OTHER METHODS OF PRICE CREATION 121
I. Negotiated Prices 121
A. Facts Affecting the Negotiated Price of
an Individual Item 122
B. Facts Affecting the Negotiated Price of a Contract 123
II. Sealed Bid Prices 125
A. Why Price by Sealed Bids? 125
B. Deciding Whether or Not to Bid 126
C. Deciding What Price to Bid 127
III. Auction Prices 128
A. Auctions to Individuals 128
B. Auctions to Businesses 131
IV. Brokered Prices 132
V. Someone Sets or Negotiates the Wage 134
CHAPTER EIGHT
THE THEORY OF OBJECTIVE PRICES 139
I. The Extent to Which Market Prices Are Objective 139
II. Nonobjective Prices 140
A. Someone Sets the Price 140
B. Negotiated Prices 142
C. Sealed Bid Prices 143
D. Auction Prices 143
E. Brokered Prices 144
F. Nonobjective Markets 144
G. Conclusion 145
III. Market Prices and Objective Prices 145
IV. Evaluation of the Theory 146
A. The Answers to Three Questions 146
B. A Causal Explanation 147
C. A Universal Explanation 148
D. An Explanation of How Prices Reflect Economic Facts 148
E. The Theory of Objective Prices Is Not Circular 149
F. Price Is the Value versus Price Measures the Value 150
V. Objective Economic Value 150
CHAPTER NINE
THE FACTORS OF PRODUCTION 153
I. The Original Factor of Production 153
II. The Law of Demand for Factors of Production 155
A. The Rate of Profit on Investment 156
B. Relative Importance to the Businessman 159
III. The Worker Markets 160
A. The Market Demand for Workers 160
B. The Market Supply of Workers 162
C. Worker Pools 163
D. How Wages Rise 164
E. How Wages Fall 165
F. Supply and Demand and Relative Scarcity 166
G. Executive Compensation 168
III. Conclusion 170
CHAPTER TEN
CHANGES IN OBJECTIVE PRICES I
THE EFFECT OF CHANGES IN FACTS ON SET PRICES 173
I. Background Premises 173
On the Origin of Changes in the Facts 175
II. Changes in Average Cost 176
A. Increases in Average Cost 176
1. An industry-wide increase in average cost 176
a) Price elasticity of demand 177
b) The cost classification of industries 178
2. The effect on profits of increases in price 181
a) Demand is inelastic 181
b) Demand is elastic 181
(1) A constant cost industry 182
(2) An increasing cost industry 182
(3) A decreasing cost industry 182
3. Restoring an industry’s profits 183
4. An increase in average cost unique to the
businessman 184
B. Decreases in Average Cost 184
1. An industry-wide decrease in average cost 184
2. The effect on profits of decreases in price 184
a) Demand is inelastic 185
b) Demand is elastic 185
(1) A constant cost industry 185
(2) An increasing cost industry 185
(3) A decreasing cost industry 185
3. Why prices fall 186
4. A decrease in average cost unique to the businessman 187
III. Changes in Demand 187
A. Increases in Demand 187
1. An industry-wide increase in demand 187
When the supply of a good does not equal
the demand 191
2. An increase in demand unique to the businessman 193
B. Decreases in Demand 193
1. An industry-wide decrease in demand 193
a) When all industries in the chain of production
are able to reduce supply 193
b) When an industry in the chain of production
is unable to reduce supply 194
c) When the supply of a good usually does not
equal the demand 196
2. A decrease in demand unique to the businessman 197
IV. Long-Run Results 197
A. When the Rate of Profit Rises 197
B. When the Rate of Profit Falls 199
Comment on the preceding in relation
to modern economics 201
V. Changes in Competition 202
A. An Increase in Competition 202
1. Price competition 202
2. Quality competition 204
Producer sovereignty 204
B. A Decrease in Competition 207
VI. Conclusion 207
CHAPTER ELEVEN
CHANGES IN OBJECTIVE PRICES II
THE EFFECT OF CHANGES IN FACTS ON OTHER PRICES 211
I. Negotiated Prices 211
A. Changes in Average Cost 212
1. An increase in average cost 212
2. A decrease in average cost 212
B. Changes in Demand 213
1. An increase in demand 213
2. A decrease in demand 213
C. Long-Run Results 214
1. An increase in supply 214
2. A decrease in supply 214
3. Conclusion 214
II. Sealed Bid Prices 215
A. Changes in Average Cost 215
1. Industry-wide changes in average cost 215
2. A change in average cost unique to the contractor 215
B. Changes in Demand 215
An industry-wide change in demand 215
C. Long-Run Results 216
D. Changes in Competition 217
1. Price competition 217
2. Quality competition 217
E. Conclusion 217
F. The Meaning and Measure of Scarcity
When Pricing Is by Sealed Bid 218
III. Auction Prices 218
IV. Brokered Prices 219
A. The Role of Supply and Demand in Stock Markets 220
1. The law of demand for stocks 220
2. The rule of supply for stocks 222
3. Supply, demand, and the price of stocks 222
4. Excess demand and excess supply 224
5. Fundamental analysis versus technical analysis 226
6. Relative scarcity and the price of stocks 227
B. The Bond Market 228
C. The Role of Supply and Demand
in Commodity Futures Markets 228
V. Conclusion 232
CHAPTER TWELVE
SCARCITY AND PROFIT 235
I. Absolute Scarcity 235
II. Relative Scarcity 237
A. The Meaning of Relative Scarcity 237
B. The Subject Matter of Relative Scarcity 238
C. Increases in Relative Scarcity 239
1. Demand increases relative to supply 239
2. Supply decreases relative to demand 239
D. Decreases in Relative Scarcity 240
1. Demand decreases relative to supply 240
2. Supply increases relative to demand 241
E. Relative Scarcity and the Cost of Production 241
III. Relative Scarcity and the Theory of Objective Prices 242
IV. Derived Demand 243
V. The Distribution of the Factors of Production 248
VI. The Economic Significance of Profit 250
The Theory of Economic Growth 252
VII. The Moral Justification of Wages and Profits 254
CHAPTER THIRTEEN
TOTAL SPENDING AND PRODUCTION 257
I. The National Income and Product Accounts 257
A. Income Received for Production
Equals the Value Produced 259
B. Income Received for Production
Equals the Value Added 261
C. Total Value Added Equals Value of the Final Product 261
D. The Double-Counting Argument 262
E. Total Spending Equals Spending on Final Products 263
II. Intrinsic Value in the National Income
and Product Accounts 263
III. National Income Based on Objective Value 265
A. Total Spending 267
B. Objective Value in the National Income
and Product Accounts 270
APPENDIX A
THE THEORY OF PRICE IN MODERN ECONOMICS:
A CRITIQUE 273
I. Market Structure 273
II. Pure Competition 274
III. Monopolistic Competition and Oligopoly 276
IV. Modern Economics’ Theory of Price for Oligopoly 277
A. Game Theory 278
B. Modern Economics’ Conception of Price Theory 279
V. Pure Monopoly 280
Patents and Copyrights 281
VI. Overview of Modern Economics’ Theory of Price 282
VII. Conclusion 283
APPENDIX B
THE METHOD OF MODERN ECONOMICS:
A CRITIQUE 285
APPENDIX C
MARGINALISM IN MODERN ECONOMICS:
A CRITIQUE 293
A. The Law of Utility 294
B. The Fallacy of Marginal Cost Pricing 296
C. Marginal Revenue Product and
the Law of Demand for Factors 298
D. The Origins of a Business 299
E. Conclusion 301
APPENDIX D
THE MEANING OF SCARCITY IN MODERN ECONOMICS:
A CRITIQUE 303
The Consequences 306
APPENDIX E
THE EFFECT OF CHANGES IN COST ON SET PRICES:
EXPANSION OF THE ARGUMENT IN CHAPTER TEN 307
A. Increases in Average Cost 307
1. A constant cost industry 309
2. An increasing cost industry 310
3. A decreasing cost industry 310
B. Decreases in Average Cost 312
1. A constant cost industry 314
2. An increasing cost industry 314
3. A decreasing cost industry 314
ENDNOTES 317
EXEGESIS AND GLOSSARY 333
REFERENCE LIST 337
INDEX 343
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