Thursday, June 30, 2011

Rothbard's Cluster of Errors

Rothbard says:

"why is there a sudden general cluster of business errors?"

He goes on:

"How, then, do we explain the curious phenomenon of the crisis when almost all entrepreneurs suffer sudden losses"

and later confidently announces:

"In the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors at the same time."

But of course Rothbard is wrong. The large cluster of errors exists because many businessman and workers have the same set of cognitive biases that creates the phenomenon of sticky wages. With a large pool of qualified unemployed workers, a rational world would advice all workers to accept lower wages. Instead, wages fall slower than prices and many businesses go under.

Eventually something happens which reverses the process. (An increase in aggregate demand or perhaps an eventual "catch up" of declining wages in respect to prices). Businesses become profitable and we enter the boom period.

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