Lesson 3 of 7
Simulating a market
Lange's answer was not a dodge. A planning board posts prices, managers follow two rules, and surpluses and shortages move the prices. Stated as he stated it.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Lange's move is a distinction: a price as an exchange ratio on a market, and a price as an index of the terms on which alternatives are offered. He grants the second is needed and denies it requires the first.
- His planning board does not compute prices. It posts them, watches inventories, and adjusts, which is the same trial and error he says a market performs.
- Managers get two rules: combine factors to minimise average cost, and set output where marginal cost equals the posted price.
Oskar Lange's essay appeared in the Review of Economic Studies in 1936 and 1937 and was reprinted in 1938 in a volume edited by Lippincott alongside an older paper by Fred Taylor. It is the most cited reply to Mises and it is not a dismissal: Lange opens by saying the socialists owe Mises a debt for forcing them to take economic accounting seriously.
Who sets a price, and how it moves
A competitive market
- Parties agree a price between themselves.
- A surplus or a shortage shows up to whoever holds the stock.
- Each participant treats the price as given and reacts.
- Adjustment happens wherever the discrepancy appears.
Lange's central planning board
- The board publishes a list of accounting prices.
- Managers treat those prices as fixed parameters.
- Surpluses and shortages are reported upward.
- The board raises or lowers the price and the search repeats.
Both columns are trial and error. They differ in who adjusts and how fast.
The distinction the whole reply rests on
Lange argues that Mises confused two senses of the word price. In the narrow sense a price is the ratio at which two things exchange on a market. In the wider sense a price is an index of the alternatives available: the terms on which one thing can be turned into another.
Only the wider sense, he argues, is needed for rational allocation, and the wider sense is fixed by the technical possibilities of transformation, which a socialist administration knows as well or as badly as any capitalist entrepreneur does. He adds a sharper point: if Mises is right that economic laws require private ownership to operate, then economics is a theory about one set of institutions only, which sits badly with the Austrian insistence that economic theory is universal.
The two rules, and who they are addressed to
Lange's manager is a public official, not a profit maximiser. In place of profit, two rules.
The first rule says to choose the combination of factors that minimises average cost, which puts the marginal product per unit of money equal across factors. The second says to set output where marginal cost equals the price of the product. Addressed to a plant manager, the two rules together do what profit maximisation does in a competitive firm. Addressed to the director of a whole industry, the second rule also decides whether the industry should expand or contract, since it makes the industry's own marginal cost the test for building or replacing plant.
Consumer goods and labour keep a genuine market in his scheme: people choose what to buy and what work to do, and those prices are set the ordinary way. It is the prices of capital goods and other non-labour resources that become accounting prices fixed by the board.
What Lange said the real difficulty was
He did not claim the scheme was frictionless. He argued that Hayek and Robbins had moved from the impossibility claim to a practical one, which he treated as progress, and that the practical question was whether the board's search converges fast enough.
His own stated worry was not calculation at all. It was bureaucracy: the danger, on his account, was the administrative apparatus rather than the arithmetic. That is a concession worth carrying into the next two lessons, because the criticism that followed was aimed exactly at the machinery he was least worried about.
Check yourself
What distinction does Lange's reply rest on?
- Between consumer goods and capital goods
- Between a price as a market exchange ratio and a price as an index of available alternatives
- Between short-run and long-run costs
Show the answer
Answer: B.
He argues only the second sense is required for rational allocation, and that it is available to a planning board through the technical possibilities of transformation.What are the two rules Lange's managers are given?
- Maximise output, then minimise employment
- Minimise average cost in the choice of factors, and produce where marginal cost equals the posted price
- Match last year's output, adjusted for the plan target
Show the answer
Answer: B.
Both rules appear in part three of the essay, the second addressed to plant managers and to industry directors for different purposes.What did Lange name as the more serious danger in his own scheme?
- That prices would be impossible to compute
- The bureaucratic apparatus, rather than the calculation itself
- That consumers would not be free to choose
Show the answer
Answer: B.
He treats the calculation problem as answerable by trial and error and locates the real difficulty in administration, which is a concession his critics did not make for him.Sources
- Lange, 'On the Economic Theory of Socialism', published in the Review of Economic Studies in 1936 and 1937 and reprinted in Lange and Taylor, On the Economic Theory of Socialism, edited by Lippincott, 1938: part one on Mises and the two senses of price, part three on the trial and error procedure, the central planning board, the two rules given to managers, and his own statement that the bureaucratic apparatus is the graver danger.
- Taylor, 'The Guidance of Production in a Socialist State', American Economic Review, 1929, reprinted in the same volume. Named as Lange's own footnote names it, crediting it with indicating how a socialist economy would solve the problem by trial and error; Taylor's paper itself was not read for this lesson.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The steel example is invented to show one round of the adjustment. It reports no real market and no real plan.
- This lesson states the reply and does not evaluate it. The evaluation is the next lesson, and it is one side of an argument that did not end.