Prices and Entrepreneurial Decision Making
Value is subjective. Prices are objective. Subjective value comes from the mind of the consumer, and influences market prices. When an actor chooses, he must forgo other choices, and he is demonstrating a preference for something, revealing part of the rankings of his values. Since perceived value relative to the actor’s value scale influences prices, then all prices are a result of human actions and choices on the market, caused by the actors' values. Tracing back price changes to human actions on the market is part of what an entrepreneur must do in order to understand the market better. Value travels up the structure of production, from the consumer goods to the producer goods. Tracing the implications of prices changes is part of what an entrepreneur does to understand his market.
Hayek calls prices signals. They are signals that are generated by the market through the market process, which is the interaction between buyers and sellers through their transactions with each other (supply and demand). These signals, in the form of prices and their changes, inform entrepreneurs about what's going on, and guide their actions, and this coordination mechanism is scalable and connects everyone. The market and its prices are all that are needed to coordinate a vast number of people's actions with precision. The entrepreneur doesn't need statistics to make a decision on what to invest in. An entrepreneur that doesn't understand this system is missing out on what's really going on and would be at a disadvantage. Austrian Economics with its deductive method, reveals to us the workings of this price mechanism through its theories and its methodology.
Rothbard said in a lecture (paraphrasing), "An entrepreneur knows more about his specific market than any economist or expert. The reason is that he has skin in the game. A lousy entrepreneur would quickly be eliminated from the market. There is a self-selecting process. The economist or expert has no skin in the game and isn't risking anything when he's wrong about the market." The key insight here is that the entrepreneur knows more than any expert about his specific market and its actors. The entrepreneur gets his information from multiple sources, and forms an outlook on what will happen. The entrepreneur may talk to suppliers, customers, friends, he may hear rumors, read news, from these he would construct a narrative, on top of this can use prices, changes in prices and check it against economic theory to see what's true. From all of this the entrepreneur forms his understanding. This understanding plus other things like intuition, gut feeling, that help the entrepreneur form judgments about the future and judge the best course of action in the present. The entrepreneur has to filter out of the noise what information is the most significant, the factors that will influence the future the most.
In understanding prices and tracing the causes of their changes, an entrepreneur can understand his market better. Prices can inform an entrepreneur about what's happening before journalists and news outlets catch on to it. Prices contain within them information, they are the final outcome of a process of buying and selling by many actors, prices are a kind of average of what all the actors think the price should be. Each good has its own price behavior, which is influenced by the good's physical properties, and other properties such as scarcity, it's perceived value, and finally fluctuations in supply and demand, and the behavior of buyers and sellers. Austrian Economics gives the entrepreneur a correct theory that can help the entrepreneur narrow down on what's happening in the market and gain superior understanding of his market. Knowledge of economics can't guarantee success, but it can bring increased awareness of what's going on underneath the numbers and prices. Eventually helping the entrepreneur gain a better understanding of the market, which means the values of the consumers and the actions of the other actors in the market.
Mises says, "The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of the consumers.” Correctly anticipating the actions of market actors and anticipating future prices and preparing for that future state is what generates entrepreneurial profit.
Mises says, "Monetary calculation is the guiding star of action under the social system of division of labor. It is the compass of the man embarking upon production." Prices determine costs, and not the other way around. Prices are determined in the market. All internal costs should be benchmarked to the market prices in order to have the most accurate cost calculation. Monetary calculation includes retrospective accounting of profit and loss, and prospective accounting with its anticipated costs and anticipated profits. If prices change in the market then not only do the present and future look different, but also the past accounts of profit and loss look different. What worked at one time in the past under the cost structure of that time may not work again with current prices. Accounts give a feeling of certainty in their numbers, but they are static. They are an oversimplified static representation of an inherently dynamic phenomenon.
Austrian Economics can help an entrepreneur have a deeper understanding of his market and of accounting. This can help the entrepreneur in making better decisions out of this better understanding. Here we narrowly focus on prices and costs, but there are many other areas of Austrian Economics that are applicable and will be covered in future articles.