Austrian Economics and Models of Rest
G. Stolyarov II
A Journal for Western Man-- Issue XLIII-- November 2, 2005
In his master treatise, Human Action, renowned Austrian school economist Ludwig von Mises presents three economic models for states of rest, critical to analyzing the behavior of real-world markets.
The first of these, the plain state of rest, occurs frequently in actual markets. In a plain state of rest, buyers and sellers have exchanged goods to an extent that satisfies them. For the moment, they see no value in conducting further trades, as the marginal utility of the unit of the good in their possession has come to exceed the marginal utility of the unit of a resource they can trade that good for. The plain state of rest is not permanent, and trading may resume when economic actors become aware of new information. On the basis of this new understanding, their valuations of particular goods might change so as to render trading once again preferable to them.
In contrast to the plain state of rest, the final state of rest is only an imaginary construct. Used to trace the effects of a single initial alteration or disturbance in a market, the model of the final state of rest holds all other factors constant. It assumes that no further alteration in data will occur after the first change. The stable state reached by a market operating under these assumptions will be affected by the initial disturbance alone, and the full effects of this disturbance can thereby be analyzed in separation from all extraneous factors. Although the real market is far too complex for only one change to act on it during a given period of time, the model of the final state of rest can be used to determine which real-world effects are due to which particular causes. In fact, the need for the final state of rest model increases with the number of forces acting on a real-world market; only by isolating the effects of each change can one even begin to fathom the complex causality of an actual economy.
A third model of rest is the evenly rotating economy (ERE), which assumes a final state of rest attained in all markets. Since no unforeseen changes can occur under this model, supply and demand for every commodity will remain the same in perpetuity. All the economic actors thus know in advance precisely how the markets relevant to them will behave in the future. This knowledge of the future is easy to attain in an ERE, because future economic events are merely repetitions of present economic events. In this sense, the ERE implies perpetual economic certainty with regard to the quantities of goods supplied and demanded. The ERE does not rule out all change; the needs and preferences of particular individuals may change and given individuals may be born, age, and die. The model allows for this so long as the total magnitudes of all goods traded always remain the same. For example, for every individual who dies, another individual or multiplicity of individuals would need to assume his set of economic preferences.
As an imaginary model, the ERE is beset by several internal contradictions. Austrian Economics is rooted in the action axiom, and action inherently implies a human being’s pursuit of goals in the face of uncertainty. Had the future been fully known to the acting man and recognized as unalterable by any of his actions, he would have no stimulus and no reason to act. An action implies the capacity to alter the course of the future in accord with one’s purposes. A man living in an ERE, however, will not be able to alter a perfectly known economic future, and will thus have no incentive to act economically to produce the goods that are regularly circulated through the economy. Without action, furthermore, there cannot be any economy at all.
Additionally, the ERE’s lack of uncertainty implies that the economic actors therein will have no need for the use of money. The principal purpose of holding cash reserves is to guard against uncertainty and be prepared to respond to unforeseen future events. If no such events can occur, then the economic actor ceases to have an interest in holding cash reserves. Since this is true of every economic actor in the ERE, this economy must lack money altogether. It becomes instead a highly complex network of direct and indirect barter-exchanges—a fact clashing with the purpose of the ERE as a tool for analyzing the monetary returns on various factors of production.
Despite these shortcomings, however, the model of the evenly rotating economy can be useful in delineating the distinction between interest earned from the use of capital goods and profit gained from entrepreneurial activity. In the ERE, time still passes and every economic actor has a positive rate of time preference—valuing a present satisfaction more than that same satisfaction in the future. A capitalist in the ERE is able to exercise a comparatively low time preference by trading present consumption for capital goods, which are means to greater consumption in the future. The capitalist, preferring more future goods to fewer present goods of like nature, earns the difference in the form of interest. However, since uncertainty is absent from the ERE, so are the arbitrage opportunities that entrepreneurs can use in order to earn profits. Arbitrage opportunities arise from a lack of perfect functional knowledge about supply and demand by at least some economic actors interested in a given good. The entrepreneur’s chance for profit arises when some economic actors have misinterpreted the supply and demand for certain goods and have thereby traded them at prices that would have been different had all relevant information been taken into account. By bidding prices up or down—in accordance with the particulars of the situation—the entrepreneur eliminates this market error, allowing supply and demand to meet and accurate information about them to spread through the new prices. In the ERE, with perfect certainty, all economic actors already possess accurate information about supply and demand. No discrepancies exist for the entrepreneur to correct and thereby earn a profit.
In the real world, interest and profit are often difficult to isolate from one another. If, however, a real-world economy is compared to an ERE where interest is still possible but profit is not, the entrepreneurial profit would be discernible as arising from factors that the ERE would inherently lack.
The three Austrian school models for states of rest each offer useful insights into the state of actual economies. The plain state of rest reflects the aftermath of many real-world market transactions. The final state of rest enables analysis of the effects of particular single economic changes. The ERE serves as a tool for distinguishing interest from profit and exploring the function of each in the real economy.
Note: This essay was approved as an accurate representation of Austrian School economic ideas by Dr. Robert P. Murphy of Hillsdale College, one of the leading contemporary scholars of Austrian Economics.
G. Stolyarov II is a science fiction novelist, independent filosofical essayist, poet, amateur mathematician and composer, contributor to organizations such as Le Quebecois Libre, Enter Stage Right, and the Autonomist. Mr. Stolyarov is the Editor-in-Chief of The Rational Argumentator and a Senior Writer for the Liberal Institute (http://www.liberalinstitute.com). He can be contacted at email@example.com.
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