The Real Calculation Problem

In economic theory it is held that the market, without external shocks, reaches equilibrium prices where supply meets demand. Those that talk about this equilibrium price effect use adjectives like “efficient”, “optimum”, “correct”, “valid”, even “objective”. The standard position in all neoclassical economics is that equilibrium prices established by the market facilitate the perfect ongoing distribution of resources, a situation that is very very hard to reproduce without a free market, and very very hard is the same as impossible in economics. This idea is asserted with more or less venom depending on which school is involved but the basic idea is foundational to mainstream as well as most fringe schools. Some call this the “calculation problem”, the problem being that proper prices can’t be calculated, only derived by the market.

I think there is a far more fundamental calculation problem: Prices.

Price is a funny word in economic theory. It ostensibly means “exchange ratio” and is modeled as such. This leads to the miraculous observation that a massive proportion of consumer goods happen to have a “exchange ratio” of one penny under the pound, but this is perhaps because “prices” are really an internal variable, a kind of force of nature, and what we think of as prices are some kind of outward manifestation wobbled by human judgment. We can only hold price as an abstraction.

It’s nice to have the view that there are these prices everywhere, on everything, as if there’s a big book of real prices somewhere that guides us all in making the correct economic decisions. You can partially accept this if you take prices as labels on things, because price tags are everywhere. Trouble is that the price tags are irrelevant because, as mentioned, they are just outward manifestations, judgements or wishes about what a real price might be. It seems pretty clear that prices (i.e. the ones economics like to talk about) only exist at the moment of a transaction. A lot of things aren’t for sale, so don’t have prices in any technical sense, only factors that influence future real prices. Even those things that are for sale can’t be said to have a definite price until they are bought, then they instantly lose their definite price. It’s a bit like a probability density function in Quantum Mechanics, the price can be anything but at the moment of transaction the function collapses and the price briefly becomes definite. This definite price is only correct for that one transaction, that one distinct event, and instantly goes out of date. Even worse, the collapsing of that price can change the future prices for everything else to any extent. This can happen for any number of reasons; for example, people trading a thing can give the impression that, you know, people want it, pushing up supply, or demand, or both.

If we wanted to track the price of a thing, say coffee beans, even if we could record every transaction that ever happened, instantly, that would give us only out-of-date data on a subset of coffee beans. An important set of coffee beans (the ones yet to be sold, or even yet to be grown) don’t even feature in that data set. Who is gathering this data? Data itself is a commodity so how does everyone get access to the total set? If the acquisition is a private institution then there are plenty of opportunities for distortion of the measurement of prices without breaching any free-market principals. If a company is selling price data it is itself interacting with price data even if it isn’t tracking price data on price data. This is a problem for pure market models: does the valid market include whatever is gathering the price data or is it valid only without that entity? If it is included then… how are it’s prices tracked (and therefor set)?? If it isn’t included then valid markets can never exist because they’d require a lack of a price gathering agent which would be required to track prices at all. Or perhaps the price data agent would give the data away… pricing below the equilibrium price, interfering with clearing, causing perpetual non-equilibrium prices, which is invalid/inefficient/evil/socialist.

This isn’t dealt with in neoclassical economic theory, instead real prices are some kind of fundamental force to which all of the everyday prices, on the whole, over time, or on average, or whatever, converge; it doesn’t matter what those prices actually are, the market will get them right. As I have said, even if the market does generate correct prices we still have to measure them, and face a significant challenge in doing so and even if we succeed we would distort the prices being measured.

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