In Man, Economy and State, Rothbard says that producers have vertical supply curves for their inventory:
In the first place, the stock of newly produced goods in the hands of the producers is also fixed for any given point in time Say that for the month of December the producers of copper decide to produce 5,000 tons of copper. At the end of that month their stock of newly produced copper is 5,000 tons. They might regret their decision and believe that if they could have made it again, they would have produced, say, 1,000 tons. But they have their stock, and they must use it as best they can. The distinguishing feature of the original producers is that, as a result of specialization, the direct use-value of their product to them is likely to be almost nonexistent. The further specialization proceeds, the less possible use-value the product can have for its producer. Picture, for example, how much copper a copper manufacturer could consume in his personal use, or the direct use-value of the huge number of produced automobiles to the Ford family. Therefore, in the supply schedule of the producers, the direct-use element in their reservation demand disappears. The only reason for a producer to reserve, to hold on to, any of his stock is speculative—in anticipation of a higher price for the good in the future. (In direct exchange, there is also the possibility of exchange for a third good—say cows instead of fish, in our example.)
If, for the moment, we make the restrictive assumptions that there are no class (b) sellers on the market and that the producers have no present or accumulated past reservation demand, then the market supply-demand schedules can be represented as SS, DD in Figure 29. Thus, with no reservation demand, the supply curve will be a vertical straight line (SS) at the level of the new stock.
Rothbard believes that supply curves are vertical for inventories of produced goods because the seller has no use for the good, other than to sell it. There is no reservation demand on the part of grocers, he would say, for bananas.
I have never been satisfied with this explanation. The problem I have with it is that it does not make clear over what time frame a business firm plans to sell. In an auction with one (or more) goods, multiple buyers, and an auctioneer who takes bids, the supply curve is clearly vertical, the price is set by the buyers, and all goods are sold when the bidding stops. But this is not a good description of a retail store.
While it is true that producers have little or no direct use for their inventory, does that mean they try to clear their inventories in a moment, a day, a week, a month, or even longer? Most businesses have some inventories of unsold goods most of the time, suggesting that they are not trying to instantaneously clear their markets. A significant share of the costs incurred by business firms are costs resulting from carrying inventory. If Rothbard is correct, why don’t firms price their inventories to sell out immediately, and by doing so reduce their costs?
While Reading W. H. Hutt’s The Theory of Idle Resources, I found a better explanation of the supply curve for producer inventories. According to Hutt, even for producer stocks of goods, reservation, demand plays a role in price formation. Hutt identified two reasons that business firms may have a reservation demand for their inventories. One is that the buyer of tomorrow may be willing to pay a higher price than the buyer of today. Setting the asking price for a good at a price that would clear the market in one day will probably result in less total revenue than pricing it to sell over a longer period of time.
Yet producers some times price their goods high enough that unsold perishable goods spoil. For durable goods, selling out the entire inventory can usually be done, though it may take some time. Blueberries spoil within a few days while cars do not. But even cars lose some of their value if they are not sold in the current model year. Grocers frequently throw out some of their inventory, spoiled, and car dealers occasionally find themselves with unsold inventory from the previous model year.
Does unsold inventory indicate an error by the seller? Did the seller err in setting his asking price too high? Not necessarily, according to Hutt. Hutt (p. 29), explains that sellers set the asking prices on their inventories in order to sell them over a period of time, and, to intentionally avoid entirely running out of stock.
Consumers’ goods, for instance, are clearly being distributed over time in accordance with consumers’ demand. … we can make use of the same principle through the rule that the balance of a “surplus” of consumers’ goods … is in a state of “pseudo-idleness” when its rate of liquidation is being determined by expectation of the future demand and supply position as modified by the costs of holding. The most important case of this is that of stocks which are in the nature of a “reserve” to meet the vagaries of day-to-day or week-to-week demand. Consider consumers’ goods held in the course of the marketing process, e.g., the stocks kept in a retail shop. The consumer pays for their availability. The mere presence of the goods in that place is the performance of a productive function, sometimes called by writers on marketing “the function of assembly.” Thus, those who occasionally wear silk hats will actually purchase them on unpredictable occasions. Yet they will expect them to be available in the shop when they chance to require them.
Customers expect business firms to have inventories and are willing to pay higher prices if they can be reasonably sure that the stores or suppliers they use will not be out of stock most of the time. Think about how annoyed you were the last time an item you planned to order at a restaurant was out for the day. The cost of being out of stock, measured in terms of lost goodwill, must be balanced against the costs of unsold inventory.
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Prices send a signal, but not the only signal. There are aspects of business “game playing” which are important.
For example, if a food store is determined to sell all fruit before it rots (and becomes worthless), then the store will have to lower prices at the end of the day. Shoppers will soon learn that slow sales of fruit during the day lead to lower prices at day’s end. Shoppers will be encouraged to delay their purchase to get a better deal, whenever they see a large supply of fruit.
It is trial and error to determine how much fruit must rot to send a signal that your price is firm.
You say perishable, but depreciation might be a better word to describe the process (I also would say that the macro models I was taught in grad school treated depreciation like accounting depreciation, whereas economic depreciation is much messier, more like a Poisson process than anything else).
To be honest, I consider this mostly obvious. Firms don’t make decisions only in spot markets. They make decisions considering multiple periods. If a good will be worthless tomorrow, then firms obviously would behave differently than if the good is worth 50% tomorrow and 0% the day afterward.
I’m not sure how much I got from that.
First, Rothbard makes it pretty clear that speculation plays a role in reservation demand and maintaining inventories. Yeah, a store could sell through its inventory in one day, but it holds out for a higher price, thus creating an upward sloping supply curve.
Second, you are saying inventories are held because consumers want items to be in stock. This isn’t much of a new incite for if the store is out of stock, and there is still demand, then there is said to be a ‘shortage’. Thus, the price the store charged was too low and it sold out of its inventory. The store will always seek purchase and price its inventory such that there is never a shortage nor surplus.
A related reason is different buyers are willing to pay different prices, and they go to the store on different days. If you sell your inventory every day, you have to lower the price to appeal to buyers who want lower prices. If you keep the price higher, somebody will probably pay it the next day.
Isn’t this a perfect illustration of why Mises eschews diagrammatic representations?
I noticed this person’s post and realized he might have misunderstood Rothbard. In that chapter Rothbard is going over Demand to Hold, which is itself the supply held by the producers. The vertical supply curve was intended to show how in the very short run supply is fixed at that quantity, whilst demand to hold is itself a supply held (stock), and the demand of goods held at certain prices. Nice try by this dude, but no cigar. I suggest he listen to Robert P Murphy more.
Robert, I’m not sure if you’re still checking this, but you quote the answer from Rothbard himself. He writes:
Picture, for example, how much copper a copper manufacturer could consume in his personal use, or the direct use-value of the huge number of produced automobiles to the Ford family. Therefore, in the supply schedule of the producers, the direct-use element in their reservation demand disappears. The only reason for a producer to reserve, to hold on to, any of his stock is speculative—in anticipation of a higher price for the good in the future. (In direct exchange, there is also the possibility of exchange for a third good—say cows instead of fish, in our example.)
If, for the moment, we make the restrictive assumptions that there are no class (b) sellers on the market and that the producers have no present or accumulated past reservation demand, then the market supply-demand schedules can be represented as SS, DD in Figure 29. Thus, with no reservation demand, the supply curve will be a vertical straight line (SS) at the level of the new stock.
So he’s saying that if we momentarily assume that the sellers aren’t holding onto the goods for speculative reasons, then the supply curve is vertical.
If I understood your objection, you are saying, “But in the real world sellers might hold on to inventories for speculative reasons.”
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