The 1934 ordinal revolution: from cardinal utilities to ordinal ‘compensated’ isoquants

Before 1934, Cambridge (Pigouvian) welfare economics relied on the Marshallian concept of consumer surplus and on interpersonal comparison of utilities (Figure 1).

Figure 1.

Independent Utility (V_XA) and cost (C_XA) curves in the Marshallian framework.

The Cambridge welfare relation with respect to the consumption of good X by the part of A, denoting ‘consumer surplus’ (CS_XA) can be summarized as:

(1)\begin{equation} {\rm CS}_{{\rm XA}} = \left[ {V_{XA}^* - C_{XA} } \right] = \left[ {V_{XA}^* - {\rm p}_{\rm X} q_{XA}^* } \right],\end{equation}

where (C_XA = p_Xq*_XA) represents the total cost incurred by actor A to purchase X at market price p_X, while the optimal level of consumption (q*_XA) is reached when marginal satisfaction equals marginal cost (ms_XA = p_X). Thus, CS_XA is a (monetary) measure of the welfare of individual A for the consumption of good X.

From 1934, with the rediscovery of Slutsky (Reference Slutsky1915) article by Hicks and Allen (Reference Hicks and Allen1934) and Schultz (Reference Schultz1935),Footnote ⁴ Cambridge cardinal welfare economics in partial equilibrium was replaced by the EP framework in general equilibrium using generalized utility functions (U_A in Figure 2).Footnote ⁵ Yet, differently from the original EP approach, the Slutsky–Hicks (SH) ordinal revolution shifted the analysis from the original utility function to the ‘expenditure function’ derived from compensated demand curves. In this new SH ‘compensated world’, the utility deriving from the efficient consumption of a good (as was the case among early marginalists), is replaced by the utility deriving from the ‘efficient use of the consumer's purchasing power’ (Mas-Colell et al., Reference Mas-Colell, Whinston and Green1995: 58), or in other words, by the utility of income deriving from the efficient purchase of goods, obviously measured in monetary terms.Footnote ⁶

Figure 2.

(Left) Cardinal independent utility of good X (V_XA). (Right) EP isoquants where the cardinal distance between isoquants matters. The generalized utility of actor A (U_A) is now on the third axis, perpendicular to the page sheet.

To guarantee univocal correspondence between utility in expenditure and utility in consumption, ‘rationality’ entered economic analysis in the form of Samuelson's (Reference Samuelson1938) ‘weak axiom of revealed preferences’, implying the well-known condition of non-intersecting isoquants. Though the latter is usually explained as non-coherent or non-consistent behaviour, non-intersecting isoquants (identifying rational behaviour) imply a much stronger assumption: a consumer cannot potentially receive different utilities in consumption from the same bundle of purchased goods or, stated differently, each point on the expenditure curve must univocally map to a point on the utility curve. Thus, in the SH ‘compensated’ world, actors are really consumers of goods, not users nor administrators.

This is essentially the heritage of the SH ‘compensation effect’, or the SHS ordinal revolution.Footnote ⁷

Rationality, expenditure function and the feasibility of socialist planning

Once non-intersection of isoquants is accepted, the ordinal SHS framework becomes watertight and its extension to normative economics follows immediately. For this reason, while pre-1934 normative economics was substantially Cambridge welfare economics, what has developed since can be renamed ‘welfare economics of the expenditure function’ (WEEF).

Three different applications of WEEF can be identified.Footnote ⁸

First is the ‘social welfare function’ approach (Bergson, Reference Bergson1938; Samuelson, Reference Samuelson1947: chapter 7; Reference Samuelson1950; Reference Samuelson1956), which developed from Barone's 1908 paper, first translated to English by Hayek (Barone, Reference Barone and Hayek1935). This contribution was eventually refined by Lange (Reference Lange1942) to provide a solution to the problem of the optimal centralized allocation of resources. What is usually referred to as ‘the socialist debate’ falls within this category (Bergson, Reference Bergson and Ellis1949; Hayek, Reference Hayek1940). Second is the Kaldor–Hicks–Scitovsky ‘compensation test’, also defined as ‘New-Welfare Economics’. Key works are Kaldor (Reference Kaldor1939), Hicks (Reference Hicks1939) and Scitovsky (Reference Scitovsky1941), all of which represent a defence and a correction of Pigou's original approach to taxation within a ‘compensated framework’. Last are the works in partial equilibrium on monopoly power and the optimal pricing of utilities (Hotelling, Reference Hotelling1938; Lerner, Reference Lerner1934).

By the early 1940s, the new ordinal approach could place Pigou's welfare economics on a much safer basis, justifying normative conclusions on the optimal allocation of resources in general equilibrium while avoiding the inter-personal summation of utilities. Thus, by the beginning of the 1940s Russian socialist planning had become (at least theoretically) feasible and fully justified, as shown in the works of Lange (Reference Lange1942) and Lerner (Reference Lerner1944) (see Bergson, Reference Bergson and Ellis1949).Footnote ⁹

I now return to Coase. First, it should be underlined that all three developments of the ‘welfare economics debate’ influenced Coase's ideas to some degree, and not solely the central planning debate (Coase, Reference Coase1988a: chapters 1 and 6).Footnote ¹⁰ Second, Coase developed his paper between 1932 and 1934 (Coase, Reference Coase1988b: 19), thus before the SHS ordinal revolution, and apparently initially sharing the normative position of Lerner and Lange, while opposing Mises, Robbins and Hayek's positivist approach (Coase, Reference Coase1988b: 8; Reference Coase1993: 248–249).

Still, a clear contradiction arises here, since Coase never clearly adopted the Paretian ordinal approach, in sharp contrast with Lerner and normativists in general. For example, in the ‘Marginal Cost Controversy’ Coase adopts a critical position towards the Hotelling–Lerner interpretation of marginal cost rule (Coase, Reference Coase1988a: 16–19; Medema, Reference Medema1994: chapter 3). The same is true for his position towards the Kaldor–Hicks compensation test (1988a: 159–163). This contradiction is also highlighted by Bylund (Reference Bylund2014).

As we shall see, the answers to these contradictions lay in the way the two terms composing the ISP (ΔC_AB < TC_k) are interpreted by early Austrians (subjectivists) and ordinalists.

The role of opportunity costs in Weser's imputation theory and the birth of asset specificity

From equation (2) it is possible to distinguish between different types of goods, based on the value of the resource's opportunity cost for actor A.

Consistent with Wieser (Reference Wieser1930 [1889]: book V) we can distinguish ‘cost goods’ (mc_XA > 0) from ‘monopoly goods’ (mc_XA = 0), defined by the author as the ones that ‘are specific elements of individual industries’ (1930: 108; emphasis original). In effect, Wieser's ‘monopoly good’ is nothing but Williamson's ‘asset specificity’. To see this, note that GS_XA is simply:

(2′)\begin{equation} {\rm GS}_{{\rm XA}} = \left( {V_{XAm}^* - V_{XA\left( {m + 1} \right)}^* } \right),\end{equation}

where [V*_XAm(mc_XAm)] is the overall value of the good employed up to the marginal service ‘m’, and (V*_{XA(m + 1)} = ms _{XA(m + 1)}CP_XA) is the foregone value obtained by redeploying the good in its second-best service.

Thus, GS_XA is a measure of the degree of specificity of good X for actor A, when the marginal employment is given by the service Am. This is consistent with both Williamson's definition of specificity,Footnote ¹⁴ and the way mainstream OE defines ‘asset specificity’ (Holmström and Roberts [Reference Holmström and Roberts1998: 76]; Segal and Whinston [Reference Segal, Whinston, Gibbons and Roberts2013: 117]).Footnote ¹⁵ If a completely dedicated good has no value outside the specific employment as is the case for Williamson's ‘asset specificity’, then (ms _{XA(m + 1)} = mc_XA = 0), which is Wieser's monopoly good. Thus, GS_XA is a measure of ‘good-specificity’ for actor A, which is the correct reinterpretation of Marshallian's surplus when actors administer capacity-goods.

Not surprisingly, the first economist to employ the concept of asset specificity to explain how production is organized within a social system was one of Wieser's students: Gottfried Haberler (Reference Haberler1936 [1933]: chapter XII). Haberler employed the concept developed by his teacher in ViennaFootnote ¹⁶ to explain when trade, under the DCC, breaks down, namely, when there are specific factors of production that can only be employed by some countries (see also Haberler, Reference Haberler1950).Footnote ¹⁷

In conclusion note that the economic problem in value theory (equation (2)) puts in relation two demand-driven values; there is no supply-driven price appearing in it. The original claim by Austrians that demand is the only primitive in economics is thus vindicated.

The ISP in the subjectivist, cardinal framework

In the case where the new productive activity k lies within the set of capabilities (or rights) of firms A and B, both firms may consider redeploying their resource X in the new more valuable activity k if: (mr_Xk > mr_XA) and (mr_Xk > mr_XB). The redeployment of resource X to k will therefore generate a surplus (or profits) of π_XA = (mr_Xk − mr_XA)CP*_XA for A, or π_XB = (mr_Xk − mr_XB)CP*_XB for B, where the new marginal costs of production now correspond to the marginal revenues that the firms were obtaining in the previous use of X.

Hence, the Coasean ISP now becomes:

\begin{equation*} \left[ {\left({\rm mr}_{{\rm XA}} CP_{XA}^* - {\rm mr}_{{\rm XB}} CP_{XB}^* \right) < {\rm TC}_{\rm k} } \right]. \end{equation*}

Here TC_k is commensurable with the actors’ subjective opportunity costs (mr_XAand mr_XB) for the implementation of activity k. TC_k then represents ‘property-right’ TC, consistent with the definition previously provided, and is independent from good X market price that, in fact, does not appear in the ISP relation. In other words, what is exchanged is the performance of the single activity k.

In this case, production costs (ΔC_AB) consist of a capacity term (CP*_Xf) and the opportunity-cost term (mr_Xf). ΔC_AB is then an economic variable deriving from the firms’ subjective and idiosyncratic capabilities, rights and opportunities. In other words, here we are dealing with institutionally embedded productivities, where TC is never sufficient (and may be unnecessary) to explain the ISP. The heterogeneity of actors’ preferences, capabilities, opportunities and rights, ensuring (mr_XACP*_XA ≠ mr_XBCP*_XB), is the necessary (and potentially sufficient) assumption. Note that in value theory a good is productive because it is specific (low mr_Xf) and efficient (low CP*_Xf). Thus, everything else equal, activity k will be undertaken by the least powerful actor (lowest mr_Xf), which is the one employing X at the highest degree of specificity (V_Xfk − V_Xf).

When actors can purchase, and therefore administer, capacity-resources (or multi-service resources for their property to be a bundle of services, or use rights), a change in the status of the actors, deriving from a different allocation of legal rights in the use of resource X, might fundamentally change the way in which activity k is allocated between the firms, for the simple reason that the actors’ subjective opportunity costs might change in turn. Thus, changes in the external environment may affect actors’ respective levels of resource specificity (V_Xfk − V_Xf), influencing the way in which production is organized between A and B.

In sum, when productivity (mr_XfCP*_Xf) is an (institutionally embedded) economic characteristic of a good defined over scope, and not a dis-embedded technological characteristic defined over scale (as a ratio in quantities), the ISP is never independent from the external socio-institutional (legal) context.

The ISP according to the objectivist, ordinal paradigm

In neoclassical price theory, ‘use-stage’ and ‘purchase stage’ conceptually correspond. At equilibrium, both firms are on the Edgeworth contract curve (the equilibrium will be Pareto optimal) and the marginal productivity of good X in all uses for all users will be identical to its market price: mr_XA = mr_XB = mr_X = p_X. This is simply the ‘Barone–Bergson’ allocative rule applied to the market for X (see Lerner, Reference Lerner1944: 75–77). Thus, the economic problem reduces to the optimal quantity of productive services (q_Xf) to be purchased by each firm. In conclusion, the competitive relation (mr_X = p_X) now only depends on exogenous (dis-embedded) factors such as firms’ production technologies, and the social endowment of good X.

In the case where a new (more valuable) activity k becomes available for resource X, firms will adjust the quantity of their respective stocks Q_XA and Q_XB, thus shifting the marginal equality towards a new social equivalence: (mr_Xk = p_Xk). The resulting marginal relations for A and B respectively become:

\begin{equation*} \left[ {{\rm \pi }_{{\rm XA}} = ({\rm mr}_{{\rm Xk}} - {\rm p}_{{\rm Xk}} ){\rm Q'}_{XA} } \right],\end{equation*}

\begin{equation*} \left[ {{\rm \pi }_{{\rm XB}} = ({\rm mr}_{{\rm Xk}} - {\rm p}_{{\rm Xk}} ){\rm Q'}_{XB} } \right].\end{equation*}

The endogenous economic variable is now the quantity purchased by the two firms (their scale of operations) that will shift to the new optimal scale in production (Q′_Xf).

In this case, Coase's ISP becomes [(p_XQ′_XA − p_XQ′_XB) < TC_k], or:

\begin{equation*} \left[ {p_X \left( {{\rm Q'}_{XA} - {\rm Q'}_{XB} } \right) < {\rm TC}_{\rm k} } \right].\end{equation*}

Note that TC_k now affects the purchase of a certain stock of the variable service (p_XQ′_XAor p_XQ′_XB) and is therefore commensurable with (it adds to) its market price p_X. Hence, consistent with the definition provided in section 5, TC_k now represents ordinal frictions that affect the optimal quantities purchased, thus affecting the scale of operation.From the previous relation, we can distinguish two situations:

First (Q′_XA = Q′_XB). In this case, firm A internalizes transaction k if and only if (TC_k > 0), from which the usual conclusion: firms exist because markets fail. Hence, in the case of identical technological productivities we have that TC is always necessary and sufficient to explain the allocation of activities between firms.

Second (Q′_XA ≠ Q′_XB). In this case ΔC_AB is a technological parameter (K) deriving from scale and scope economies. This is the case of different technological productivities and firm A internalizes transaction k if and only if (TC_k > K): TC are always necessary, but not sufficient to enquire the ISP. This is the case considered by TCE (Williamson, Reference Williamson1985: 92; Reference Williamson1988).

In both cases, marginal cost, denoting a firm's productivity, is a technological and dis-embedded parameter of the production process, defined as the optimal quantity of the variable factor to be purchased with respect to another factor. Ultimately, this is the reason why industrial organization ‘tells us almost nothing about the organization of industry’ (Coase, Reference Coase and Fuchs1972a: 59): firms do not administer capacity resources, rather they all share the same objective (dis-embedded) opportunity cost (p_Xk) and this is why the economic analysis at the firm level remains over scale. This is equivalent to the suggestion that allocation problem (and therefore ‘administration’) remains at the social level (discussed in section 7.1).

In this case, the economic constraints defining cost, scarcity and therefore value, can either be explained by the existence of frictions (or barriers) in the market, or by an insufficient social endowment of the good with respect to the actors’ needs.Footnote ²¹ In both cases, the constraint is ‘elsewhere’ in the social system, and not firm-specific, consistent with Stigler's definition of ‘cost’ (Reference Stigler1966: 105; emphasis added): ‘the cost of any productive service to use A is the maximum amount it could produce elsewhere’.

In conclusion, it is easy to see that in a framework where all actors have their respective marginal opportunity costs ‘on the market’ (corresponding to the price p_X), adaptation will necessarily only happen on the market, by means of market transactions.

Ordinal microeconomics, rationality and the creation of the black box

The previous discussion can be summarized as follows: if actors’ opportunity costs in the use of a resource are but objective parameters (not idiosyncratic to the actors’ subjective socio-institutional status), then TC become the necessary condition to explain and understand the ISP. Not surprisingly, this is also the necessary condition for the ordinal SHS framework to hold: only if subjective opportunity costs in use coincide with the objective opportunity cost in exchange, will the expenditure curve be inverted into a utility curve and ordinal isoquants become a sufficient tool to conduct the welfare analysis of a socio-economic system. Accordingly, it should be noted that ‘objective opportunity costs’ is also the sufficient precondition to postulate Samuelson's weak axiom, and therefore the presence of ‘rationality’ and rational behaviour. After all, rationality itself must be an objective parameter of a social system for it to make any sense at all.Footnote ²²

However, if this is not the case, WEEF breaks down, together with ordinal SHS microeconomics. In this scenario, TC (and the performance of the market mechanism in general) are never sufficient (and might be unnecessary) to explain the ISP and the role of institutions in economic analysis. This is the case of intersecting isoquants, usually interpreted as the result of irrational or inconsistent behaviour. In truth, this simply means that natural value (value in use) and exchange value (market price) do not coincide, or: (mc_Xf ≠ p_X). This returns us to Adam Smith's paradox of value.

But then, what makes (mc_Xf = p_X) for every actor f, thus guaranteeing: (i) rational behaviour (Samuelson's weak axiom), (ii) the univocal inversion of Hicks’ compensated demand functions into non-compensated ones (the univocal mapping of the expenditure curve into the utility curve), and therefore (iii) market frictions as necessary and sufficient elements to explain the ISP in the ordinal SHS framework? The answer is quite simple: under SHS, actors do not own, control, nor transact any resources at all. Variable (and mono-purpose) services are transacted, purchased and allocated, but there is no distribution of resources.

To see this, it is sufficient to isolate the only fundamental relation in economic theory that really describes the ‘relationship between ends and scarce means which have alternative uses’ (Robbins, Reference Robbins1935: 16):

(5)\begin{equation} CP_{XA} = q_{A1} a_{XA1} + q_{A2} a_{XA2} + \ldots + q_{Az} a_{XAz} ,\end{equation}

where CP_XA is the capacity constraint of resource X controlled by actor A (the scarce mean), q_Ai represents the quantity of ‘end i’ that actor A wants to satisfy (the total satisfaction that A wants to derive from i), while the coefficients a_XAi represent the capacity of resource X to satisfy end ‘Ai’. If the employment of X is sequential (cumulative), relation 5 translates into Figure 3, where marginal satisfactions (respectively, opportunity costs) are given by: (1/a_XAi).

In Paretian WEEF the previous relation is never associated with the economic problem of the producers. In fact, it is never assigned to any actor as the reference to ‘A’ is missing. It is sufficient to look at Barone (Reference Barone and Hayek1935: 250; equation (1)) to see that relation 5 in WEEF becomes: (CP_X = q ₁a _X1 + q ₂a _X2 + . . . + q_za_Xz) where scarcity is now the social endowment of resource X (CP_X), usually represented by the length of the X-axis of the Edgeworth box. Thus, producers do not control X, nor any other resource, but merely purchase the services a_Xi rendered by it. Most importantly, the marginal coefficients a_Xi do not denote subjective preferences, but are technological parameters deriving from the producers’ production functions (Barone, Reference Barone and Hayek1935: 250; equation (3)). The allocation of good X thus happens at the social level and is technology driven. Similar remarks were already made by Hayek (Reference Hayek1935: chapter 5).

The same is true in Bergson (Reference Bergson1938: 314–315) and, more generally, in all works consistent with the WEEF approach. Hence, there is no transfer of ownership or control rights in ordinal microeconomics since there is no distribution of goods among the actors; there is a mere transfer of use-rights of socially available and non-appropriable resources. Firms do not transfer, nor administer resources because they do not own any. Ultimately, the lack of appropriable resources is the reason why there is no ‘power’ in ordinal WEEF, and the social status of actors, together with their rights and capabilities in use, become irrelevant.

Thus, it is the Paretian approach that fosters the constant confusion between (i) allocation and distribution, (ii) uses and users, and (iii) neoclassical frictions and property-rights TC. In a world where resources are not privately controlled and actors can only purchase variable services to satisfy their needs, services’ opportunity costs become objective, making any allocation across users also an allocation across uses and vice versa; the result is that the conceptual distinctions discussed in section 5 become practically impossible.

An appropriate normative analysis would thus enquire how socially scarce resources are distributed to alternative users. The latter will then decide how to allocate the scarce capacities they control to alternative uses, according to their respective (socially-embedded) use rights and capabilities (their respective social power). However, ordinal welfare economics, and therefore neoclassical (SHS) price theory, skips this step and instead directly enquires how socially scarce resources are allocated to alternative uses at the social level. Yet, social allocation is legitimate only if one of the following holds: (a) all users are endowed with the same set of rights/capabilities (so that they necessarily share the same subjective opportunity costs), (b) users can only employ the good in one single use (partial equilibrium analysis), or (c) resources are non-appropriable.

If only one of these scenarios holds, natural value in use corresponds to value in exchange, making price theory necessary and sufficient to derive normative conclusions on the allocation of scarce resources within a community. Not surprisingly, while (b) corresponds to the Cambridge/Chicago partial-equilibrium approach adopted in industrial organization (Friedman, Reference Friedman1949; Stigler, Reference Stigler1968), (c) is examined by Paretian WEEF in general equilibrium.

The present discussion can be summarized as follows: the existence of firms’ boundaries depends on the existence of resources’ boundaries.

With no capacity constraints at the single actor-good level, (denoting control or power over the resource) the allocation problem occurs at the social level and firms’ decisions are necessarily by-passed by the economic problem. In this case, it becomes impossible to justify the subjective economic problem of the firm and the black-box is thus introduced into economic theory. In this case, TC remains the sole necessary (and maybe sufficient) element to explaining the ISP (section 6.2).

Conversely, when control (or power) is introduced into the scenario, the ‘boundaries of a good’ are internalized within the boundaries of an economic actor. Then the allocative economic problem shifts from the social level [CP_X(q_ia_Xi)] to the actor-level [CP_XA(q_Aia_XAi)], and actor A ceases to be a black-box. However, this shift generates a potential misalignment between actor A opportunity cost (ms _{XA(m + 1)} = mc_XA) and good X market price p_X. If (mc_XA ≠ p_X), A can then ‘adjust her utility’ internally, redeploying the resource she already owns (or controls). This internal adjustment decouples the utility curve from the expenditure curve, and thus can be interpreted as a ‘rotation’ of actor A isoquants in the Edgeworth box. In this case, the SHS ordinal approach (and Samuelson weak axiom of rational behaviour) breaks down, depriving the market mechanism of the ‘veto power’ concerning the ISP (section 6.1).

To conclude, note that ‘income’ (I_A) is the only resource administered at the individual level in the SHS framework. Actor A ‘scarce budget’ is in fact defined by the well-known relation:

(5′)\begin{equation} I_A = q_{A1} p_1 + q_{A2} p_2 + \ldots + q_{Az} p_z .\end{equation}

However, as the opportunity cost of the pecuniary resource I_A is always defined by an objective market price (p_i), we reach the important conclusion that financial institutions exist because financial markets fail.

Ronald Coase, socialist planning and the role of accounting in the ISP

I now attempt to make sense of Coase's path-breaking contributions through the lens of the ordinal–cardinal debate. Among all possible interpretations, one thing is quite clear: Coase's original approach to the ISP was probably subjectivist and cardinal.

Still, more decisive than the debate between ordinalists and cardinalists (after all Coase was not an economist), were Coase's (Reference Coase1990: 3) studies in accounting. As he recalled: ‘[a]t any rate, in the 1930's I was working on both accounting and the theory of the firm’. In fact, the way in which accountants model cost is genuinely cardinal and subjectivist, and certainly not ordinal (objectivist).

This is true for one simple reason: accountants deal with appropriable, three-dimensional resources and treat opportunity costs as those costs deriving from the employment of already-purchased goods. In other words, accountants keep value in use distinct from value in exchange, and usually deal with the former. This is the essence of Coase's (Reference Coase, Buchanan and Thirlby1973) accounting works.

For these reasons, the appropriate way to model ‘whether employee A should move from X to Y’, is quite certainly the cardinal, subjectivist approach [(mr_Xf − mc_Xf)CP*_Xf] and not the ordinal [(mr_Xf − p_X)q_Xf]: The single workman will render the service in department X at the expenses of department Y, according to his limited time, energies, capabilities, or rights. The competitive relation is constrained by the ‘productive capacity’ of the workman and there is no ‘elsewhere’, as both services are genuinely subjective (firm-specific). After all, this conclusion reflects the considerations expressed in Coase (Reference Coase1990).

However, to approach the economic problem of the firm in this way is not consistent with how ordinalists (such as Lerner and Lange) justified socialist planning starting from the mid-30s (when Coase's ideas were already well developed). Conversely, Coase's conclusions become much closer to Hayek's position (Reference Hayek1935: chapter 5; Reference Hayek1937, Reference Hayek1945), as already noted by Bylund (Reference Bylund2014).

In brief, the level of analysis of the allocation problem is what matters, together with the way in which an actor's opportunity cost is modelled. Thus, if the opportunity costs of all actors employing a productive factor always correspond to the latter's objective market price, then central planning and decentralized exchange are simply the two extreme mechanisms arising from different levels of transaction cost (0 ⩽ TC_k < ∞). After all, this is the essence of the ‘competitive solution’ in socialist economics, as already noted by Barone (Reference Barone and Hayek1935: 274), Bergson (Reference Bergson and Ellis1949: 432), Lerner (Reference Lerner1944: chapter 6), Scitovsky (Reference Scitovsky1951: 305) and, especially, Schumpeter (Reference Schumpeter1954: 987). Thus, for social planning to work, market prices must remain the sole necessary and sufficient informative variable of the system.

Instead of the usual contraposition between markets and organizations (reflecting Williamson's [Reference Williamson2010: 679] distinction between coordinated and autonomous adaptations), I suggest an alternative market-administration dichotomy between: (i) adaptation by means of market transactions (the market), and (ii) adaptation through internal redeployment of the goods (administration). The former occurs when the second best option perceived by the single decision maker in the use of a resource is the market price (p_X), while the latter occurs whenever the value deriving from the internal redeployment of the good (the subjective opportunity cost mc_XA) is perceived as the second-best alternative. After all, this dichotomy reflects Adam Smiths’ distinction between exchange value and use value and holds if and only if (mc_XA ≠ p_X).

It is important to note that a single actor can very well administer the goods she owns or control, even in a complete decentralized system. Administration (in use) does not necessarily imply social planning or, more generally, ‘coordinated’ or ‘centralized’ administration at the organizational or social level. Administration simply suggests ‘adaptation outside the market’ by means of internal resources’ redeployment. This makes the ‘market–administration’ dichotomy more general than the ‘market–firm’ one.