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VAN NOSTRAND SERIES IN BUSINESS
ADMINISTRATION AND ECONOMICS



Edited by
JOHN R. BEISHLINE
Chairman, Department of Management and Industrial Relations
Neio York University




JULES BACKMAN”Wage Determination: An Analysis of Wage Criteria
HUGH B. KILLOUGH AND LUCY W. KILLOUGH”International Economics
LEONARD W. HEIN”An Introduction to Electronic Data Processing for
Business
PAUL G. HASTINGS”Fundamentals of Business Enterprise
BETTY G. FISHMAN AND LEO FISHMAN” The American Economy
ANDREW D. BRADEN AND ROBERT G. ALLYN”Accounting Principles
ISRAEL M. KIRZNER”Market Theory and the Price System
MARY E. MURPHY”Managerial Accounting




Additional titles will be listed and announced as published.
MARKET
ÎHEORY
ana the




PRINCETON, NEW JERSEY
Toronto · New York · London
PRICE SYSTEM
By Israel M. Kir¾ner
Associate Professor of Economics
New York University




D· Van Nostrand Co., Inc.
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COPYRIGHT © 1963, BY
D. VAN NOSTRAND COMPANY, INC.

Published simultaneously in Canada by
D. VAN NOSTRAND COMPANY (Canada), LTD.


No reproduction in any form of this book, hi whole or in
part (except for brief quotation in critical articles or reviews),
may be made without written authorization from the publishers.




PRINTED IN THE UNITED STATES OF AMERICA
B'EZRAS HASHEM




TO LUDWIG VON MlSES
Prefiace



D the past few years a number of
URING
competently written textbooks on price theory have appeared. The author's
excuse for adding yet another book to the elementary literature in this field
is that his approach, while in no sense original, presents the subject in an
entirely different light.
The approach adopted in this book views the market as a process of
adjustment. In this process individual market participants are being forced
continually to adjust their activities according to the patterns imposed by
the activities of others. Market theory then consists essentially in the anal-
ysis of these step-by-step adjustments and of the way the information re-
quired for these adjustments is communicated. Equilibrium positions are
not, as in other books, treated as important in themselves. They are rather
seen as merely limiting cases where the market process has nothing further
to do, all activities being already mutually adjusted to the fullest extent.
Despite the importance attached to the implications of the approach
adopted here, users of this book will find relatively few major substantive
departures from price theory as it is usually presented. The principal areas
where major differences will be found arise out of the drastically reduced
attention paid to perfect competition. Presuming the basic course in general
economics, this book is designed for an undergraduate course in intermediate
price theory.
For the rest, an author can hardly hope to have escaped revealing his
own proclivities, biases, and predilections. Determined efforts have been
made to subordinate geometry to economic reasoning. Whatever the author
may have learned from Marshall, Edgeworth, and J. B. Clark, this book
probably will reveal that he has learned more from Menger, Böhm-Bawerk,
and Wicksteed.
Besides his indebtedness to the literature, the author must acknowledge
much kind help received from several persons during the preparation of
v¡i
VÜi PREFACE

this book. To his teacher Ludwig von Mises, above all, he owes his ap-
preciation of the market process. In addition to reading the finished
manuscript, Professor Mises offered many helpful suggestions during its com-
pletion. It is with deep pleasure that the author dedicated this volume to
him upon the attainment of his eightieth year.
The author is grateful to his colleagues at New York University, as well
as to his students, for stimulating discussions on a number of points. To
Professor L. M. Lachmann of the University of Witwatersrand, South Africa,
he is indebted for several valuable insights that were made use of in exposi-
tion. The author's wife has patiently and cheerfully endured, aided, and
encouraged throughout the book's preparation. To all these he is grateful;
none of them is to be held responsible for all that remains unsatisfactory.
ISRAEL M. KIRZNER
Contents



1. T H E NATURE AND TASKS OF MARKET THEORY 1
The Individual and the Market. . . The Market System . . . The Founda-
tions of Market Theory . . . The Individual and Economic Behavior . . .
Economic Theory and Economic Reality . . . Market Theory, Economic
Theory, and Economics . . . Summary
2. T H E MARKET: ITS STRUCTURE AND OPERATION 13
The Conditions Under Which the Market Operates . . . Market Roles . . .
The Structure of the Market System: Vertical Relationships . . . The
Structure of the Market System: Horizontal Relationships . . . The Anal-
ysis of Human Action in the Market: The Concept of Equilibrium . . .
Complete and Incomplete Equilibrium . . . The Pattern of Market Ad-
justment . . . The Changing Market. .. The Market System as a Whole . . .
Summary
3. EFFICIENCY, COORDINATION, AND THE MARKET ECONOMY 33
The Economic Problem . . . Society and the Economic Problem . . . The
Problem of Coordination . . . How the Market Solves the Problems of
Coordination . . . The Coordinating Function of Profits in a Market Econ-
omy . . . Summary
4. UTILITY THEORY 45
The Scale of Values . . . Marginal Utility . . . Diminishing Marginal
Utility . . . The Marginal Utilities of Related Goods . . . Marginal Utility-
Some Further Remarks . . . Marginal Utility and the Conditions for Ex-
change . . . Summary
5. CONSUMER INCOME ALLOCATION 63
Marginal Utility and the Allocation of Income . . . The Position of Con-
sumer Equilibrium . . . A Geometrical Illustration . . . The Effects of
Changes . . . The Individual Demand Curve . . . Some Remarks on Ex-
pectations . . . Summary
¡X
X CONTENTS


6. MARKET DEMAND 85
Market Demand . . . The Market Demand Curve . . . Demand Elasticity
. . . Measures of Elasticity . . . Market Demand as Seen by the Individual
Entrepreneur . . . Demand and Revenue . . . Demand and the Prices of
Other Goods . . . Demand as a Market Force . . . Summary
7. MARKET PROCESS IN A PURE EXCHANGE ECONOMY 105
The Nature of Competition . . . A Simple Case of Price Competition . . .
Simple Price Competition Without Perfect Knowledge . . . The Market
for Several Non-Producible Goods: The Problem . . . The Equilibrium
Situation for the Multi-Commodity Market . . . The Multi-Commodity
Market Without Perfect Knowledge . . . Monopoly in a Pure Exchange
Market. . . The Agitation of the Market . . . Summary . . . Appendix
8. PRODUCTION THEORY 142
The Economic Aspect of Production . . . Production by the Isolated In-
dividual . . . Production in Society . . . Production in the Market Econ-
omy . . . Factors of Production . . . Production Functions and Isoquants . . .
The Shape of the Isoquant and the Substitutability of Factors . . . Changes
in Factor Proportions, and Changes in the Scale of Factor Employment . . .
Returns to Scale . . . The Laws of Variable Proportions: The Problem . . .
The Laws of Variable Proportions . . . Economic Implications of the Laws
of Variable Proportions . . . The Least-Cost Combination . . . Graphic
Illustration of the Least-Cost Combination . . . Summary
9. COSTS AND SUPPLY 183
Costs and Rents . . . Opportunity Costs and Supply Theory . . . Prospec-
tive and Retrospective Costs . . . Capital Goods and Cost Theory . . .
Factor Divisibility and Short-Run Per-Unit Costs . . . Short-Run Costs and
Their Effect on Supply . . . Long-Run Costs and Supply . . . Factor Prices
and Supply . . . Summary
10. PARTIAL MARKET PROCESSES”THE DETERMINATION OF PRODUCT
PRICES AND FACTOR PRICES 210
THE MARKET FOR A SINGLE PRODUCT
Long-Run Equilibrium . . . Short-Run Equilibrium in the Single-Product
Market . . . Equilibrium in the Single-Product Market in the Very Short
Run . . . Adjustment to Change in a Market for a Single Product . . .
The Market Process in a Market for a Single Product
THE MARKET FOR A SINGLE FACTOR OF PRODUCTION
Equilibrium in a Factor Market . . . The Market Process in a Market for
a Single Factor of Production.
TOWARD THE GENERAL MARKET PROCESS
Summary
11. T H E GENERAL M A R K E T PROCESS 236
A Preliminary Model . . . The Preliminary Model and the General
Model . . . General Market Equilibrium Conditions . . . A General Market
CONTENTS XI

in Disequilibrium . . . Disequilibrium in the General Market and Entrepre-
neurial Opportunities . . . Entrepreneurial Activity and the General
Market Process . . . Partial Analysis and the Analysis of a General Mar-
ket . . . Toward Further Extensions of the General Market Model . . .
Summary
12. MONOPOLY AND COMPETITION IN THE MARKET 265
The Monopolized Resource . . . The Resource Cartel . . . Restriction of
Supply: A Special Case . . . Combinations of Resource Buyers . . . Monop-
oly in Production . . . The Consequences of Monopoly Output Restric-
tion . . . The Monopolist-Producer as a Resource Buyer . . . Further
Remarks on Monopolized Products . . . The Single Producer Without
Monopoly . . . Some Remarks on the Model of "Pure" or "Perfect" Com-
petition . . . Monopolistic Price Discrimination . . . Summary
13. T H E PRICE SYSTEM AND THE ALLOCATION OF RESOURCES 297
The Possible Levels of "Welfare" Appraisal . . . Misallocation of a Re-
source in a Market System . . . Imperfect Knowledge, the Source of
Resource Misallocation . . . Prices, Profits, and the Reallocation of Re-
sources . . . The Entrepreneur and Resource Allocation . . . Resource
Mobility and the Allocation Pattern . . . Monopoly as an Obstacle to Cor-
rect Resource Allocation . . . Artificial Obstacles to Correct Resource
Allocation . . . Summary
APPENDIX: T H E APPLICATION OF MARKET THEORY TO MULTI-PERIOD
PLANNING 311
Multi-Period Decisions in the Pure Exchange Economy . . . The Inter-
temporal Market . . . Speculation as an Aspect of Intertemporal Mar-
kets . . . Multi-Period Decisions of Producers . . . The Place of Capital
Goods in Production
INDEX 321
The Nature and Tasks
of ÌÆarhet Theory



is devoted to the study of
HIS BOOK
the theory of the market system. In this first chapter we attempt to obtain
a clear notion of what is meant by a market; what is meant by a market
system; and how economic theory can throw light on the nature of market
processes. Our discussion will clarify the relationship between market
theory and other branches of economics. Moreover, it will indicate the
importance of the economic theory of the market for an adequate under-
standing of the world we live in.

THE INDIVIDUAL AND THE MARKET
Society consists of individual human beings. Each human being is eager
to act to improve his position, whenever this appears possible. In order
to satisfy his desires, a man may act on his own (as, for example, when he
paints his house by himself), or he may fulfill his ends indirectly through
exchange (as when he pays another man to do the painting). Where an
exchange transaction takes place freely, the two individuals involved have
both acted to fulfill separately their respective goals.
In a predominantly free society, individuals are in most respects at
liberty to act as they choose. That is, in such a society an individual is
generally at liberty to take advantage of any opportunity (as he perceives
the existence of such an opportunity) in order to improve his position (as
he understands the idea of improving his position). He is free to act in
isolation, and he is free to engage in acts of exchange with other individuals
(whenever he and some other individuals both perceive the opportunity
of mutual benefit through trade). As we shall find, such opportunities for
1
2 MARKET THEORY AND THE PRICE SYSTEM

mutually advantageous exchange arise constantly in society. Moreover, the
exploitation by individuals o£ these opportunities opens up yet further
opportunities of the same kind, both to the individuals themselves and to
others in the society. A market exists whenever the individual members
of a society are in sufficiently close contact to one another to be aware of
numerous such opportunities for exchange and, in addition, are free to take
advantage of them. A market economy exists wherever the ramifications
of the market become so widespread and the opportunities it offers so nu-
merous and attractive that most individuals find it advantageous to carry on
their economic activities predominantly through the market rather than on
their own.
The market economy is thus to be distinguished, on the one hand, from
the autarkic economy, where individuals carry on their economic activity
isolated from one another, being unaware or unwilling to take advantage of
opportunities for exchange. On the other hand, it is to be distinguished
from the centrally controlled economy where economic activity of individ-
uals is directed by a central authority so that, although transfers of goods
among individuals may be ordered by the central authority, individuals
are not free to take advantage of exchange opportunities which they them-
selves may perceive. It is unlikely that any one of these three types of
economies will exist historically in its theoretically purest form. To some
extent, limited market activity is likely to arise even in the most primitive
and autarkic of societies, whereas even the most rigid of centrally controlled
economies leaves room, legally or illegally, for some market-type activity
between individuals. Finally, even the most fully developed market econ-
omy is incapable of making it advantageous for individuals to seek the
satisfaction of all their wants exclusively through the market. (Most men,
for example, turn to the market for a haircut but not for a shave.)
In the developed market economy, the conditions of production have
become adjusted to the market requirements. Over a period of time, indi-
viduals acting through the market have succeeded in setting up an organ-
ization of production and exchange which, in turn, has widened the market
until it has embraced the bulk of all economic activity in the society. In
such a system, as in any system where the individual is relatively free to
act as he pleases, men seek to improve their positions with the means at
their disposal. But, whereas the isolated individual can improve his posi-
tion only by adjusting himself to, and manipulating, the conditions imposed
by nature, in the market economy the individual acts to take advantage
also of the conditions and opportunities made available by the market.
The salient fact that emerges from this discussion is that any descrip-
tion of market activity means the description of individual activity, but
also that the activity of each participating individual in the market is
conditioned by the actions of other participating individuals (either in the
THE NATURE AND TASKS OF MARKET THEORY 3

past or as anticipated in the future). It is this insight, we will discover, that
is the basis for the economic analysis of the market system and of the
processes that take place in the market.

THE MARKET SYSTEM
To the casual observer, market activity seems to be a bewildering and
uncoordinated mass of transactions. Each individual in the market society
is free to buy what and when he pleases, to sell what and when he pleases,
to produce or to consume what he pleases, or to refrain altogether from any
or all of these activities. Transactions may involve any of innumerable
commodities or services, they may involve any of a wide range of quantities
and qualities, and they may be concluded at any of a wide variety of prices.
Economic analysis reveals that this seeming chaos in the activity of
market participants is only apparent. In fact, analysis shows that the ex-
changes that take place are subject to definite forces at work in the market.
These market forces guide the individuals participating in the market
in their decisions. Each market decision is made under the stress of
market forces set up by the decisions, past or expected, of all the market
participants. During any given period, therefore, the decisions made by
individual market participants constitute an interlocking system embracing
the entire scope of the market. This network of decisions constitutes the
market system. The end results of all these decisions make up the achieve-
ments of the market system; and the tasks which society may seek to fulfill
by permitting a market economy are the assigned functions of the market
system.
The importance of the market system and of its analysis is not simply
the discovery that decisions are made under constraints set up by other de-
cisions. Market system analysis, we will discover, reveals a remarkable
feature in the operation of these constraints, and it is chiefly this feature
that invests market theory with its importance. The real significance of the
market system lies in the fact that the mutual interplay of these constraints
makes up a unique process through which the decisions of different indi-
viduals (who may be quite unknown to one another) tend to be brought
progressively into greater consistency with each other.
Consistency and correspondence between the decisions made by differ-
ent market participants are of the first importance in any successful execu-
tion by the market of its functions. If all potential members of the labor
force decided to train themselves as skilled watchmakers, a catastrophic
aberration of individual decisions would exist. After all, a decision to be-
come a watchmaker depends on the confident assumption that some other
people will be barbers, tailors, etc.
The free interplay of individual decisions in the market place con-
4 MARKET THEORY AND THE PRICE SYSTEM

stantly generates new forces modifying and shaping the delicate, sensitive,
and interlocking decision network that makes up the system. It is the
task of market theory to trace the consequences of these market forces, pay-
ing particular attention to the degree in which they constrain independ-
ently made decisions into mutually corresponding and concordant systems.

THE FOUNDATIONS OF MARKET THEORY
The construction by economists of the body of propositions that make
up market theory is founded upon their consciousness of the existence and
the nature of economic law. The recognition of "laws" in economic affairs
implies the understanding that apparent chains of causation prevail in
social events, just as in the physical world. Acts of individuals in the
market are perceived as taken in consequence of definite acts, prior or
anticipated, of other individuals. What goes on in the market at any one
time is to be ascribed to what has gone on in the past, or to past anticipa-
tions as to what will go on in the future. Market phenomena do not emerge
haphazardly in a vacuum; they are understood to be uniquely "determined"
by market forces.
While the essential concept of a law of economics is thus quite paral-
lel to that of a law of physical nature, the two kinds of law have little
further in common. Laws of physical nature are inferred from the obser-
vation of sequences of physical events. Economic laws, as we shall see, are
founded on our understanding of the influence that a given event will have
upon the actions of individuals.
To be sure, the laws of physical nature are also operative in the spheres
of human activities. A heater raises room temperature, and ice lowers the
temperature in the ice box; human beings are more comfortable at some
temperatures than at others, and food keeps better at some temperatures
than at others. These physical, physiological, or biological laws must be
considered in any attempt to "explain" why men buy heaters or ice. The
recognition of economic law involves the insight that, even after the physi-
cal, physiological and psychological sciences have been utilized to the
utmost in tracing the influences that have helped determine an economic
"event," there still remain significant elements that have not been traced
back to prior causes. These elements, in the absence of an economic theory,
would have to be considered as undetermined by any causal forces. The
recognition of economic law means the perception of determinate causal
chains constraining the course of events insofar as these are left unde-
termined by physical, physiological, or psychological laws.
Consider, for example, the consequences upon the price of ice of a
sudden sharp reduction in the quantity available for sale. The most com-
plete application of the physical sciences (while it might throw a great deal
THE NATURE AND TASKS OF MARKET THEORY 5

of light on why such a reduction in the supply has occurred, or upon the
possible alternative ways consumers might be able to do without ice) can
in itself tell us nothing about why subsequent ice purchases are carried out
at higher prices. Our explanation of the higher prices being the conse-
quence of the reduced supply thus invokes the concept of economic laws,
which we understand as explaining the result of the particular change that
has occurred when other aspects of the situation have remained unchanged.

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