unavailability of a vital raw material, then many buyers will find that the price they had confidently expected to obtain the commodity at is no longer in effect. If, to take a different possibility, the emergence of some new product abruptly reduces the dependency of consumers upon the commodity we are considering, then sellers will find that their offers to sell will no longer be accepted at the old prices. In short, any kind of abrupt change will immediately increase the degree of disequilibrium existing in the market, and will therefore initiate fairly rapid and extensive adjustments in the plans of buyers and sellers in the direction of the state of equilibrium corresponding to the new state of affairs.
Our discussion of the pattern of adjustment in the market for a single commodity serves to clarify the nature of the market process as it governs activity throughout the entire market economy. We have seen that it is permissible to consider the market system as a whole, as being made up of many separate markets that have definite and powerful strands of relationship. For the market system as a whole to be in equilibrium, it is necessary for equilibrium to exist within each separate market. Within the market for each commodity, buying and selling plans must dovetail so that no disappointment occurs in the execution of any plan made throughout the system.
So long as the market system as a whole is not yet in equilibrium—that is, so long as “general equilibrium” has not yet been attained—some plans are being disappointed. The disappointed buyers or sellers may revise their plans in several ways. They may offer better terms in the same markets, or they may decide to cease (or reduce) activity in these markets and increase activity in fresh markets altogether. Disequilibrium in any one of the separate markets will thus cause adjustments in the plans made first of all by participants in that market, and then secondarily in the plans made by participants in related markets—whether horizontally or vertically related.
In any event the course of the market process is fairly clear, assuming for the moment that consumer tastes and basic production possibilities are maintained unchanged. As each separate market adjusts to bring correspondence in the buying and selling plans directly affecting it, the ripples of disappointed plans spread gradually into the related markets. Each separate market thus adjusts to disappointments in plans due to both its own initial disequilibrium, as well as to the impact of changes in plans brought about by the adjustments being made in related markets.
In the process of adjustment within each separate market, and between the separate markets making up the entire system, a principal role is played by the entrepreneur. Conditions may exist in separate markets so that adjustments can take place to improve the positions of all concerned. The entrepreneur becomes aware of this situation and undertakes the risk of attempting to make the necessary adjustment. It is through his activity that the relationships between separate markets transmit ripples of change. If, for example, on the market for a finished product, its price is in excess of the sum of the prices of all the resources necessary for its production, as prevailing in the separate resource markets, it is entrepreneurial activity that is at once set into motion by the inconsistency, constitutes itself the condition of disequilibrium, and is responsible for the tendency to bring about ultimate equilibrium in the market.
An important change that occurs at any point in the market system as a whole brings about direct alterations in its immediate market vicinity. Entrepreneurial activity transmits the consequences of these changes to related markets. Through the impersonal medium of altered prices, participants in other, possibly remote, parts of the market system are forced to adjust their plans to the changed conditions. The ceaseless agitation that is characteristic of a market economy becomes now for the market theorist a determinate process that is set into motion in a very definite way in response to fundamental changes in the basic data with which the market grapples. Movements of prices; growth of new industries; expansion or contraction of existing firms; the adoption of new methods of production; the search for new resources, techniques, and products; all become explainable for the theorist in terms of the totality of the market process of which they are a part.
In the next chapter we review briefly what the market process achieves. In the later chapters we turn back to examine in greater detail how market forces are transmitted, make themselves felt, and initiate adjustments. In addition we will see more specifically how each participant in the market economy plays a definite role in the whole process.
Chapter 2 surveys the overall operation of a market system.
A market system is characterized by a framework of law that broadly recognizes individual freedom, responsibility, and private property rights. Market theory assumes the use of a medium of exchange.
In a market system individuals may fill the roles of consumer, resource owner, and/or entrepreneur. The chains of cause and effect that are expressed through market forces operate through the typical structural interdependence existing between the decisions made by consumers, resource owners, and entrepreneurs. Vertical relationships between market decisions exist when goods and services are bought for later sale; for example, when resources are bought by entrepreneurs from resource owners to be used in production and sold in the form of the product to consumers. Horizontal relationships exist, for example, when two different products require the use of the same resource in their production; or where a product may be produced with either of two resources that are substitutes for one another.
A market is in equilibrium when all decisions dovetail with each other. Disequilibrium exists when some decisions cannot be executed because they have been planned on the basis of mistaken assumptions concerning the decisions of others. The market process consists in the adjustments that are enforced upon individual decisions by the disappointments experienced in a disequilibrium market. The economic theorist may confine his attention to a limited series of adjustments that may be wrought out within the market system. He will recognize that the situation where all these limited series of adjustments have fully worked themselves out is one of only partial equilibrium. For the entire market system to be in equilibrium—that is, for a general equilibrium to prevail—each of the separate sectors of the market must be in harmony with each of the others. Market theory recognizes the existence of chains of cause and effect between all the market sectors as well as within each of them. The general market process comprises all the adjustments enforced upon the market activities of resource owners, consumers, and entrepreneurs throughout the system by an initial failure of all their decisions to dovetail perfectly with each other.
SUGGESTED READINGS
Menger, C., Principles of Economics, Free Press, Glencoe, Illinois, 1950, Chs. 1, 2.
Stackelberg, H. v., The Theory of the Market Economy, Oxford University Press, New York, 1952, Chs. 1, 2.
Hayek, F. A., “Economics and Knowledge,” in Individualism and Economic Order, Routledge and Kegan Paul Ltd., London, 1949.
EFFICIENCY, COORDINATION, AND THE MARKET ECONOMY
In this chapter we complete our broad preliminary survey of the theory of the market system, its operation and achievements. Chapter
