|Peter Boettke|

The imaginative and penetrating economic thinker Glen Weyl has posted a revised version of his forthcoming paper "Price Theory" to SSRN. This is a very important paper for a variety of reasons, and I cannot deal with it in the detail that it demands in this post. But I want to highlight a very simple point that I think matters a lot for what we want to get out of "price theory" which is the backbone of economic theory more generally.

As Weyl states plainly in his abstract, he defines price theory as "neoclassical microeconomic analysis that reduces rich and often incompletely-specified models into "prices" (approximately) sufficient to characterize solutions to simple allocative problems." In the model, in other words, prices are sufficient to assure that the most willing suppliers and the most willing demanders are perfectly coordinated with each other -- their plans dovetail. Can we identify the "prices" that characterize that equilibrium state of affairs? In Weyl's discussion the contributions of Mises and Hayek can be summed up as the claim that prices are a parsimonious way to communicate the relevant information for allocative efficiency.

Without denying this "economizing" role that prices play in coordinating the plans of numerous and diverse actors throughout the economy, I think it is a mistake to push the argument that prices are a sufficient statistic for a competitive equilibrium. The mistake is that this perspective too easily glosses over the underlying institutional environment that is required for prices and monetary calculation to emerge and serve their function within an economy --- namely private property, freedom of exchange, profit and loss accounting, sound money, fiscal responsibility, etc. --- and it too easily glosses over the guiding role that relative prices play in accommodating change and resulting in the necessary adjustment of economic plans. In other words, the prices as sufficient puts too much emphasis on the role of equilibrium prices, and ignores the role that disequilibrium prices play within a theory of the market process, let alone the institutional infrastructure that enables the competitive market and a functioning price system to operate.

I understand that different models or theoretical frameworks have different purposes, and in many instances the economic theorist is not attempting to understand how prices guide decisions, but instead wants to explore the equilibrium properties of a system and thus how the equilibrium price will reflect that solution. For Weyl's purposes, his depiction is completely unobjectionable and he has done a great service to the economics literature by providing a survey and relating this work to modern trends in theory. However, besides his rather narrow reading of Mises and Hayek, I think there are at least 3 critical sins of omission in this survey: Hayek's 1937 paper on Economics & Knowledge; the work of Armen Alchian on economics forces at work that can be found from his classic paper on evolution and uncertainty to his work on some economics of property rights to his introduction to economic reasoning found in University Economics; and James Buchanan's discussion of "What Should Economists Do?" and the exchange paradigm versus the allocative paradigm in economic theory. I am partial to the Alchian phrase -- economic forces at work, because the prices as sufficient perspective emerges in discussing economic forces after they have worked. Prices are sufficient for a solution, they are not -- to use Buchanan's phraseology --- seen as part of the guides to adjustment in the evolution toward a solution. In Hayek's brilliant 1937 paper, he is clear that such issues such as full and complete information, and optimality conditions such as P=MC or min AC, are by-products of the competitive entrepreneurial market process, not assumptions going into the analysis of the market theory and the price system at the start. In fact, to make those assumptions is to lead the analysis into paradoxes that are problematic for market theory if taken seriously, e.g., the paradox of perfect foresight that was identified by Morgenstern. Again, perfect foresight is a defining characteristic of an equilibrium after all economic activity has been adjusted so that the underlying variables of tastes, technology and resource availability are perfectly reflected in the induced variables of the market --- in that state of affairs, and only in that state of affairs, can prices be said to be sufficient for a solution to a problem of allocative efficiency.

Prices as solutions is a different theory than prices as guides to adjustment which brings about a solution. In my alternative reading of the history of economic thought, I would argue that from Smith to Hayek the critical theoretical task was two fold (a) identifying the underlying institutional environment that enables individuals to better realize the gains from productive specialization and peaceful cooperation, and (b) identifying the role that prices play in guiding the process of exchange and production so that the most willing supplies and the most willing demanders will be brought into coordination with each other. Prices are guiding a process of necessary adjustment, they are, as Hayek wrote in The Use of Knowledge in Society, "a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement."