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Cost and Choice: An Inquiry in Economic Theory; Buchanan, James M.
7 paragraphs found.
Ch. 1, Cost in Economic Theory

Given a supply of a commodity, exchange value was determined by marginal utility, as worked out in a market interaction process. But utility is a subjective phenomenon, and it is not something that can be externally or objectively measured, as can classical cost-of-production. To understand this, let us think of a world of two commodities, each of which is in fixed supply, say, the world of bear and raccoon. Both are "goods," and each good is available in predictably fixed quantity in each period. If we know with accuracy the demand or marginal-utility schedules for all demanders, exchange value can be predicted. Note, however, that this prediction does not emerge as an outcome or result of a rational behavior postulate, at least in the same sense as the classical deer-beaver model. Suppose, given the fixed supplies along with the demand patterns, it is predicted that one bear will exchange for two raccoons. If realized values are observed to be different from those predicted, it is the result only of inaccuracy in the initial data upon which the predictions were made. No equilibrating mechanism is set in motion; there is no sense of error as there is in the deer-beaver model. No corrective process will emerge; values as realized are always "correct"; errors arise only in the data used by the observer. The marginal-utility theory in its elementary methodology here is akin to the simple Keynesian model of income determination. By contrast and despite its flaws, the classical cost-of-production theory is more closely analogous to the Swedish theory of income determination where expectations can explicitly enter the analysis.

Ch. 2, The Origins and Development of a London Tradition

Hayek's specific contribution to the development of cost theory that is contained in his part of the debate on socialist calculation is a peculiarly mixed bag. In his "Introduction" to the famous collection of essays, *28 Hayek foreshadows his later and more explicit methodological emphasis on the necessity of distinguishing between the subjective apparent sense data of the person who chooses in the economic process and the objective data that are available to any external observer. As we shall see, this methodological step is essential to any genuine understanding of cost. It appears, however, that Hayek had not in 1935 incorporated this methodology fully into his own basic theory. In his essay, "The Present State of the Debate," included in the collection, he suggests clearly that cost of production becomes difficult to calculate in a socialist setting primarily because of the absence of the conditions of competitive equilibrium where "cost of production had indeed a very precise meaning." *29 This emphasis, which was also evident in Robbins' work, left the way open for Lerner's effective reply which argued simply for the adoption of a rule for setting prices at marginal opportunity costs, regardless of the state of the world. *30


F. A. Hayek was appointed Tooke Professor of Economic Science and Statistics at the London School of Economics in 1931 and held this chair until 1950. Along with Robbins, he must be credited with providing the source of much of the LSE tradition in cost theory, a tradition that seems to have emerged gradually over these two decades. As suggested above, Hayek's contribution was primarily that of providing the underlying methodological basis for the more explicit works on cost by others. He presented the methodology of subjectivist economics with convincing authority; his essays remain recommended reading almost thirty years after their initial publication. And economic theory, generally, should certainly have avoided some major modern confusions if Hayek's essays had been more widely read and understood.


There seems no doubt that subjectivist economics was explicitly introduced at LSE by Hayek. In a paper of major importance, published in 1937, *31 he laid down the central features of the subjectivist methodology, features that he elaborated in considerably more detail in later works. *32 In his 1937 paper, Hayek gives credit to Mises for the latter's background work, *33 published in German in 1933, but made available only much later (1960) to English-language scholars. Hayek's initial paper provides, in one sense, the "classical" methodology of the subjectivists, a methodology which is central to a theory of cost that is related directly to choice and that is to be contrasted with the theory of cost embodied in neoclassical orthodoxy.

Ch. 3, Cost and Choice

In one sense it might be said that the neoclassical economist has succumbed to the temptation to make his whole theory more general than its methodology warrants. This temptation has been increased by the parallel, and equally confused, logical theory of economic choice, which itself is completely general but which lacks predictive content. This purely logical theory, sharply distinct from the classical in its predictive implications, finds its origins in the subjective-value theorists, but its more explicit sources are Wicksteed, the later Austrians, and the economists associated with the London School of Economics. In full flower, this is the "subjectivist" economics espoused by Hayek and Mises to which I earlier made reference. Some reconciliation between the genuinely scientific theory of economic behavior and the pure logic of choice is required. The achievement of this reconciliation is one of the major purposes of this exploratory study in which the notion of opportunity cost becomes the analytical coupling device.

Ch. 4, The Cost of Public Goods
It is interesting to note that sophisticated cost-benefit analysts recognize the relevance of the distribution of tax shares (or benefit shares), while at the same time they fail to recognize the relevance of the distribution of decision-making power. The oversight of this second distributional effect stems, of course, from the paradigm in which "costs" exist as objectively quantifiable magnitudes, unrelated to the choice process. Among the applied welfare economists who have examined the methodology of cost-benefit analysis, only Roland N. McKean seems to be aware that a problem so much as exists here. See his paper, "The Use of Shadow Prices," in Samuel B. Chase, Jr. (ed.), Problems in Public Expenditure Analysis (Washington, D.C.: Brookings Institution, 1968), pp. 33-65. For a specific discussion of the importance of the distribution of tax or benefit shares, see the paper by Burton A. Weisbrod, "Income Redistribution Effects and Benefit-Cost Analysis," pp. 177-208 in the same volume.
Ch. 5, Private and Social Cost

I should emphasize that this chapter is not designed as a general critical analysis of the Pigovian policy norms. Such an analysis would have required the treatment of many interesting issues that have been ignored here. My purpose has been to utilize this familiar branch of applied economic theory to demonstrate the desirability of clarifying the basic notions of opportunity costs. To those who fully accept and understand the London-Austrian contributions, the internal inconsistencies in the Pigovian logic will be apparent. To those who have been trained in the neoclassical paradigms of opportunity cost, recognition of the inconsistencies may require a working out of elementary examples. It is not easy to question long-accepted precepts, and in the several versions of this chapter, I have found it difficult to prevent the analysis from lapsing into the kind of conventional methodology that I have often used in other works. The result may give the appearance of complexity despite the elementary nature of the points being made. In effect, the incorporation of the London conception of opportunity cost amounts to transforming one of the foundation stones of economic theory. Only when this basic modification is completed can real progress toward changing the superstructure be attempted on a large scale. Meanwhile, only the most exposed aspects of this superstructure—the Pigovian welfare analytics, for example—can be related directly to the particular flaw in one of the theory's cornerstones.