and relevant depends on whether the second good is or is not a substitute for the first; whether other things were unchanged; and so on.
In carrying out his task of explaining what has happened in the real world, or in predicting the likely consequences in the real world of a particular event, the economist thus combines theory with empirical fact. For these purposes it is frequently quite unnecessary to analyze his final report into its theoretical component on the one hand, and its factual component on the other hand. The skillful economic commentator will combine keen observation of events with statements revealing the theoretical interdependency of these events. A particular case of local unemployment may be linked to a shift in consumer tastes or to the emergence of new, cheaper resource markets elsewhere; an outflow of gold may be linked to particular governmental monetary policies; a particular pattern of industrial organization may be traced back to the tax structure, and so on. It would not be necessary, nor even helpful, in these cases, to separate economic theory from economic fact.
In studying a book such as this one, however, it is imperative that the distinction between theory and fact be kept clear. This book deals essentially with theory. It presents the kinds of logical procedures that must be used to understand the operation of a market economy. It presents the basic tools that the trained economist will use repeatedly in interpreting events in the real world. If these tools are to be used with success, they must first of all be forged as ends in their own right. Economic theory must first be recognized for what it is in and of itself: a body of abstract propositions deduced from hypothetical assumptions.
MARKET THEORY, ECONOMIC THEORY, AND ECONOMICS
We are now in a position to state how the subject matter of this book relates to economic theory as a whole and, even more generally, to the entire discipline of economics.
The theory that we study in this book makes up the core of economic theory, but by no means exhausts it. We investigate here the structure and operation of a market economy in its broadest theoretical outline; and it is within this general body of theory that most other branches of economic theory find their place. We are provisionally able to refrain from paying attention to these other branches of theory only by drastically simplifying the hypothetical market economy we deal with. Once the theory of the simplified market process has been mastered, then more complex and particular market situations can be dealt with by logical extensions of the theory.
In our study, for example, we ignore the possibility of trade between two separate market economies; we therefore do not study the theory of international trade with its impact on the market process within each country. Again, in our study, we almost completely ignore the special role played by the government as an economic agent; we therefore do not study the theory of public finance and the modifications brought about in the market process by governmental taxation, expenditures, or debt. We do not consider, in our study, the numerous complexities that are introduced into the market process by the various possible institutions connected with money; we therefore do not study monetary theory. In the same way (and partly as a result of these simplifications) we do not consider the possibility that market forces might arise that can disrupt periodically the smooth operation of the market process; in other words we ignore the necessity to construct a theory of the trade cycle; and so on.
In our study, therefore, we construct the theoretical framework within which all aspects of the economic theory of a market economy must be set. We follow through the fundamental market forces upon which and through which the impact of any special, additional economic forces will be felt. The theoretical attack upon any particular economic problem in the market must then be carried out against the background of this general and widely accepted theory of the market.
Economic theory thus embraces a range of theorems covering many more problems than are treated in this book. Moreover, as we have seen, the subject economics in turn customarily involves much besides economic theory. The study of an economic problem will typically involve much more than theory, and even for the purely theoretical aspect of such a study, the propositions of general market theory will be only partially satisfactory. The skilled economist must scan the data, using his theoretical competence to suggest or to detect matters requiring further explanation. In seeking such explanation he must apply his theoretical tools to the masses of data he believes to be relevant. It is not the task of market theory to set forth the methods by which the economist can most successfully use the empirical data at his disposal or the methods by which he can most skillfully apply theoretical tools to such data.
Market theory provides the basic tools required for even the most preliminary approach to economic problems. More specialized tools, in the form of the propositions of particular branches of economic theory, may be required to analyze specific problems. These tools, too, depend on the availability and quality of the basic tools we are about to assemble. The scope of market theory, within economic theory generally and within economics as a whole, is indeed narrow. Despite its narrowness, however, it is market theory that nourishes these wider fields. And in this lies its paramount importance.
Chapter 1 clarifies the relationship between the theory of the market and other branches of economics.
Society consists of individuals seeking to act to improve their positions. A market exists where the individuals are in close enough contact with one another to be aware of mutually profitable opportunities for exchange. A market system exists where the individuals in a society conduct their economic activities predominantly through the market.
Economic analysis reveals chains of cause and effect linking together and coordinating the mass of transactions taking place in the market. Market theory investigates these chains of cause and effect. Market theory is made possible by the unique properties of human actions. These properties are embodied in the act of choice among alternatives, an act that the observing mind of the economist can “understand.” Complex market phenomena may then be “understood” by relating them to individual acts of choice.
Economic theory is abstract, selecting only the key features of an economic situation for use in subsequent reasoning. Economic theory is general; its conclusions have validity for a wide range of possible real situations. Market theory provides the general framework for the analysis of a market system. Within this broad framework the various specialized branches of economic theory deal with more complex special cases. The theory in this book thus proceeds by drastic simplification.
SUGGESTED READINGS
Robbins, L., An Essay on the Nature and Significance of Economic Science, The Macmillan Co., London, 1935.
Hayek, F. A., “The Facts of the Social Sciences,” in Individualism and Economic Order, Routledge and Kegan Paul Ltd., London, 1949.
Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949, pp. 1–71.
Stigler, G. J., The Theory of Competitive Price, The Macmillan Co., New York, 1942, Ch. 1.
THE MARKET: ITS STRUCTURE AND OPERATION
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