<< . .

. 24
( : 36)

. . >>

follow through the market process in a productive society, taking fuller
account of productive activities and the market phenomena they give rise
to. To a considerable extent we will be able to rely on the analysis of
the simplified market process contained in Chapter 7.
In Chapter 7 each market participant was endowed daily with an

initial bundle of consumer goods. In our present problem each market
participant is endowed in addition with a bundle of productive resources.
The market presents possibilities for each participant, through exchange,
production, and possibly further exchange, to transform his initial en-
dowment into one that is more desirable from his point of view. The
interaction of all participants in the market generates, as we saw in Chap-
ters 2 and 3, sub-markets where various resources are bought and sold,
and also a great deal of entrepreneurial activity linking the various sub-
markets together through production decisions.
The market process determines (a) the prices and quantities of each
of the resources sold, (b) the quantities of each of the resources used in
each branch of production, and (c) the quantities and prices of each of
the products produced and sold. (We are aware, of course, that any num-
ber of intermediate products may be produced and sold, as well as con-
sumption goods.) This market process consists in the concatenation of
decisions on the part of market participants, decisions to buy and sell
resources, decisions to use resources to produce products, and decisions to
buy and sell products. As such, and as we have already seen, the process
is a single one”all the decisions are to some degree dependant upon all
other decisions, and in turn influence further decisions. Any separate
analysis of part of the whole market process is justified only provisionally
in the expectation that such analysis will throw light on the process in its
entirety. We proceed, therefore, in the present chapter, to consider first
the market process as it directly affects the output and prices of only a
single product. We will then consider how the market process directly
affects the employment and prices of only a single productive factor. The
extension of these preliminary inquiries will then enable us in the next
chapter to view and to analyze the market process as an indivisible unity.

In analyzing the market for a single product, we are adopting a
"partial" approach. The only variables into whose value we inquire are
those directly pertaining to the product itself, namely, its price, the method
of production and the quantities of different resources used in its produc-
tion, and the quantities produced by different firms. All other market
phenomena are assumed, insofar as they might affect our own product
market, to be "given" and (at least for most of our inquiry) unchanging.
We ignore, for example, any effects upon other prices that might be brought
about by the process of adjustment in the market for our own product and
that might, in return, exert secondary repercussions upon our own market.
Thus, our problem is to explain the course of the market forces affecting
the price, output, and organization of production of our one product.

We assume prospective consumers to be faced with known and stable
prices that each of the other available products can be bought at. We
assume entrepreneurs to be faced with known and stable prices that each
of the available productive factors can be bought at, as well as with definite,
technologically determined, possible methods of production. We assume
that a large number of entrepreneurs have access to the factors of produc-
tion. Consumers possess, in addition, definite tastes and incomes. We
proceed to spell out the conditions for complete equilibrium in this product
Complete (or "long-run") equilibrium conditions require that a certain
number of firms produce the product, each firm producing a certain quan-
tity, and each firm producing with a certain method of production; that
entrepreneurs sell and consumers buy the product in certain quantities
and for certain prices”all these quantities and prices being such that no
participant or prospective participant in the market should ever find any
reason to alter his actions for the future. As for a definition of the equi-
librium price of the product, we may to a large extent draw upon the
analysis of Chapter 7.1 In equilibrium there can be only a single price
for the product ruling in the market (otherwise entrepreneurs would
eventually discover the discrepancy in prices, and buy the product where
its price is low, and sell it where its price is high, until the discrepancy
should disappear). This price must be such that the quantity of the
product that consumers wish to buy at this price is exactly the same as
the quantity of product that entrepreneurs plan to produce in expectation
of this price. Any other price would mean that, sooner or later, somebody
(producer or prospective consumer) will find that his plans cannot be
executed in the market. Of course, he would have ample reason to alter
his future actions; the market would no longer be in equilibrium.
There are several further relationships implied by these conditions
for the equilibrium price. If the price is to be such that nobody should
see reason to alter his actions for the future, it must inspire, of course, no
entrepreneur in the industry (nor any prospective entrepreneur) to make
any alteration in output volume. This means that equilibrium conditions
require that the relationship between the volume of output, the price of
the product, and the given prices of the various resources make it dis-
advantageous for any entrepreneur to expand production (or to make
plans for eventual expansion of production); but that this relationship
also makes it disadvantageous to cut back production (or to make plans
to cut back production eventually).

iSee pp. 107-116.

This means, first of all, that each entrepreneur must be producing an
output volume for which the aggregate opportunity cost of production is
no greater in the long run than the total revenue obtainable from the sale
of the products; and also that no producer who is not at present producing
the product can see any prospect of producing any quantity of the product
that should yield a revenue greater than the (opportunity) costs of its
production. If these conditions are not satisfied, changes in output will
occur sooner or later. If any producers are incurring losses (that is, if their
long-run opportunity costs of production”the revenue they could acquire
eventually if they transfered their resources to some other branch of pro-
duction”exceed the revenue that they currently receive from their output),
they will sooner or later alter their actions. This might not happen im-
mediately, since many resources may not be transferable, and may thus
involve no immediate opportunity costs (and thus involve no short-run
losses) in their present use. But sooner or later entrepreneurs will retire
from an industry that yields over-all opportunities inferior to those avail-
able in other branches of production. On the other hand, if any outsider
to the industry can perceive prospects of an output that should yield a
revenue in excess of what he could earn elsewhere with the same resources,
he will sooner or later attempt to enter the industry. Neither of these
eventualities is consistent with equilibrium in the product market.
The above required equilibrium relationship means, in addition, that
each entrepreneur will be producing an output volume and facing a de-
mand curve for his product so that the following conditions are satisfied:
(a) the marginal unit produced has added to total revenue an amount ex-
ceeding the corresponding increase in relevant total opportunity costs, and
(b) the next unit that which the entrepreneur just fails to produce would
have added an increment to cost exceeding or equaling what it would add
to revenue. This, we saw in the previous chapter, represents the optimum
volume of output, relevant”mutatis mutandis”for both short- and long-run
decisions. (If potential producers are so numerous that an increase in
output by one of them leaves the price of the product, and hence marginal
revenue, virtually unchanged, it is clear that such an optimum output is
possible only where the relevant marginal costs increase with increases in
output. If marginal costs do not increase with expansion of output, then,
if a certain level of output is selected as satisfactory, still larger outputs
will be still more satisfactory with declining marginal costs, or at least
no less satisfactory with constant marginal costs. Neither of these possi-
bilities is consistent with equilibrium, since there is no good reason why
any entrepreneur should continue producing a given output volume in-
stead of expanding to produce a larger one.)
To sum up, a market for a product will be in complete (long-run)
equilibrium when the following mutually consistent sets of decisions are

being made. (1) Each entrepreneur is producing (in response to the mar-
ket price) an output whose (long-run and short-run) marginal costs bear
the above described relationship to revenues. (2) Each consumer is de-
sirous of buying, at the same market price, a quantity such that the ag-
gregate thus demanded is exactly what producers are¿ in aggregate,
producing. (3) For each producer the market price is no less than the
average long-run costs of production for his volume of output. (4) No
entrepreneur who is not presently producing can find any possibility of
employing resources in this industry more lucratively than in other indus-
tries. These equilibrium conditions define the scale of plant for each
producer, the levels of plant utilization, the output consumed by each con-
sumer, and the market price.
Assuming a unique pattern of decisions does exist for producers and
consumers that would mesh completely in this way, it can be seen that
perfect knowledge on the part of all market participants would help them
immediately toward achieving equilibrium. The logic employed in Chap-
ter 7 is sufficient to prove that the only price bids and offers made by
prospective buyers and sellers are those that they know will not be disap-
pointed and will not involve the sacrifice of more attractive opportunities.
Acting, according to "static" assumptions, on the expectation that basic
market data will never change, those producers willing to do so will then
undertake long-range planning to achieve (at lowest possible cost of pro-
duction) those outputs that it will pay them to offer to the market at what
they know will be the equilibrium price. No other price can prevail,
they can be assured, because this would call for the conscious adoption,
on the part of some producers or consumers, of plans that they realize
must be disappointed. In this way each producer will have constructed
the "correct" scale of plant and will have hired the "correct" quantities
of other factors necessary to achieve his "correct" share of the "correct"
aggregate output. The point is that the long-run equilibrium price for
the product is the one able to induce entrepreneurs to initiate long-range
plans for the production of exactly that quantity that consumers will be
prepared to buy at the same price. Perfect knowledge would make possible
the precise calculation of this price, and also the realization that no plans
will be made by anyone on the assumption of other prices.
In a subsequent section of this chapter we will proceed with our main
purpose”the analysis of the market process in the single-product market
when knowledge is not perfect. Before this, we will consider two situations
where the market for a single product may be in "incomplete" equilibrium.
These are model situations where the decisions being made are consistent
with each other, and do mesh, but only on the hypothesis that specific
kinds of further decisions (which might otherwise be made) are excluded
from the models. In other words these two situations are such that they

would be sel£-perpetuating if certain specified kinds of change are not
allowed to occur in the analysis. In themselves these models of "shorter-
run" equilibria are purely theoretical constructions, but they will prove
helpful in understanding the market process leading to complete, long-run

For this first case, decisions are needed on the part of producers and
consumers that should be mutually consistent, on the hypothesis that no
changes shall be made in the size or in tlie number of plants where produc-
tion is carried on. We do not have to inquire therefore into the decisions
of producers as to the scale of plant they should employ. For the present
problem these decisions are not variables that we seek "equilibrium" values
for. Along with the prices and quantities available of all the other prod-
ucts, and of factors of production, they are data that are held unchanged for
our analysis, and that form the framework within which our short-run
equilibrium situation is to be constructed.
Such a short-run equilibrium requires that producers produce a certain
output (each with his given scale of plant) and sell it for a certain price,
such that the aggregate output will equal exactly the quantity of product
that consumers would want to buy at this price. (There must be of course
only a single price for the product if the market is to be in any kind of
equilibrium.) The price we seek, then, for the product is the one that
will induce producers to produce in aggregate (with given plant size)
exactly that output that consumers will buy at the price.
The only opportunity costs of production that are relevant to the
short-run model are those incurred for the variable factors used in pro-
duction. The costs incurred in the past for the plant (including any
contractual obligations for the current period incurred for the plant in
the past) are irrelevant, as we have seen in the previous chapter, for
short-run decisions. It will pay an entrepreneur with a given plant to
keep on producing in the short run even though his average revenue is
lower than average long-run costs, so long as average revenue is greater
than average short-run (variable) costs. With this reservation an entre-
preneur will therefore always carry production to the point where the
marginal unit produced just adds to revenue an amount in excess of the
addition to short-run costs.2

2 For the special case where entrepreneurs face perfectly elastic demand curves, the
best output position will be that where the (rising) short-run marginal cost curve
intersects the demand curve. The demand curve indicates for all outputs the (same)
marginal (and also average) revenue. We have seen, therefore, that the short-run
marginal cost curve becomes part of the supply curve of such an entrepreneur. Such an

For equilibrium, therefore, the following mutually consistent sets of
decisions must be made. (1) Each of the given entrepreneurs is producing
(in response to the market price of the product) an output whose short-run
marginal costs are related to marginal revenues in the manner described.
(2) Each consumer is desirous of buying, at the same market price, a
quantity such that the aggregate thus demanded is equal to the aggregate
output. It will be observed that short-run equilibrium conditions may
still be fulfilled even though entrepreneurs outside the industry perceive
exceptional profit possibilities in this industry. Moreover, short-run equi-
librium may exist even though some entrepreneurs are producing an output
such that the price of the product does not help recoup the "fixed" costs
incurred in the past in setting up the plant. Clearly, this "equilibrium"
might be rapidly disturbed were the hypothetical short-run interdiction
on changes in plant size and number to be lifted. These short-run equi-
librium conditions define the level of utilization by each entrepreneur
of his given plant, the output consumed by each consumer, and the market
The second of the hypothetical situations where the market for a
single product may be in incomplete equilibrium is often termed the "very
short run." In the very short run the hypothesis is made that no decisions
shall be made that should increase the available stock of the product. All
available output is the result of past production decisions. (Thus, we
have a situation similar to those analyzed in Chapter 7 where market par-
ticipants found themselves endowed with non-producible commodities.
In the present context, however, we will assume that the producers can
make no personal use whatsoever of their product; their past production
entrepreneur will thus operate so that his marginal cost equals the market price of his
product, as in the diagram. Short-run market equilibrium will require a market price




Figure 10”j
(a) low enough to enable all the entrepreneurs to achieve this position without some of
them being left with unsold goods and (b) high enough for the entrepreneurs to achieve
this position without resulting in an aggregate output less than what consumers in
aggregate would buy at the price.
3 The reader, as an exercise, may care to convince himself that perfect knowledge
would lead to immediate attainment of short-run equilibrium conditions in a market for
a single good.

decisions were made purely with the intention to sell the output in the
The conditions for equilibrium in such a market cannot prescribe,
therefore, any limitations for the production decisions of producers, since
these decisions are excluded altogether. The only decisions that are per-
mitted, on, the present hypothesis (and which must be mutually consistent
if equilibrium is to exist), are those of the producers concerning the
quantities of output to sell and the price to ask, and those of the consumers
concerning the quantities to buy and the prices to offer. We continue
to exclude decisions based on pure speculation so that, since producers have
no use personally for their product, it is evident that each of them will
be willing to sell all available units of product, no matter how low the
market price.
It is therefore easy to spell out the conditions for equilibrium in such
a case. The product, as always in equilibrium, must be selling at the
same price throughout the market. The price, once again, must be such
that the quantity of product that consumers, in aggregate, wish to buy
at this price is exactly equal to the quantity that producers wish to sell at
the price. But we have seen that producers will be willing to sell the
entire stock of the product, no matter how low the price. It follows,
therefore, that the equilibrium price must be that at which consumers
will wish to buy exactly the quantity available. The price must be at a
level such that the least eagerly sought-after unit of product that would
be bought at the price will just exhaust the entire stock.
For equilibrium to exist in the very short run, it will be observed,
it is not necessary that price cover any kind of costs. Moreover, since
producers are prepared to sell the entire stock at any price, it follows that
the active determinant of what the equilibrium price should be is ex-
clusively the demand situation.4 The conditions for equilibrium in the
very short run define the output bought by each consumer and the market
price. It has already been proved in Chapter 7 that in such a market,
equilibrium conditions would be immediately fulfilled if all participants
in the market possessed perfect knowledge.

The relevance of these situations of incomplete equilibrium for the
understanding of the market process (as it takes place in a world without
omniscience) may be grasped by considering the following case. Imagine
For a diagram illustrating this case, and for some further discussion, the reader is
referred to the last portion of the Appendix to Ch. 7, especially to the discussion sur-
rounding Fig. 7-7.

a market for a particular product where the decisions of the various par-
ticipants are made according to the following schedule. (1) Once every
five years, a date is set aside on which all entrepreneurs have, if they wish,
the opportunity either (a) to enter the industry by building a plant (for
those entrepreneurs who have not been in the industry during the pre-
ceding five years); or (b) to build a new plant (for those entrepreneurs who
have been in the industry during the preceding five years) in any size they
see fit; or (c) to leave the industry altogether (by closing down their plants
and having no longer to shoulder any fixed charges upon them). (2) On
the first day in each month each owner of a plant decides the daily rate
of production for the month. This decision is made in the light of the price
of the product expected to rule in the market during the month. Once the
decision has been made, it cannot be altered until the following month.
The monthly decision determines for the whole month the quantity of fac-
tors that shall be employed each day, and provides for a steady daily output
that shall be produced each day, before the daily buying and selling activity
commences, ready for sale to the market. (3) Although during the course
of a month a producer has no way of altering the current rate of output
until thefirstof the following month, each producer daily revises his estima-
tion of the current market price for the product. Before the commence-
ment of trading each day, each producer plans the selling offers that he will
make during the day, in the light of his current estimate of market condi-
tions. (4) Before each trading day each consumer makes his estimate of the
market price for the product for that day, and formulates his buying plans
for the day accordingly.
Suppose this market is initially in a state of complete long-run equi-
librium. Each entrepreneur in the industry is operating with a scale of
plant, at a level of utilization, that permits aggregate output to be sold
at the equilibrium price. No entrepreneurs in the industry have any
reason to offer to sell tomorrow for lower prices than today, nor to demand
higher prices. No entrepreneurs have any reason to increase the rate
of output for the following month, nor to decrease it. No entrepreneur
has any reason, when the date for plant alteration arrives, to do anything
except to build the same size plant that he has owned previously. No one
presently outside the industry feels any attraction to enter it, when it will
be possible to do so. No consumers have any reason to alter their buying
plans for the following day. All decisions, therefore, those made by con-
sumers and those made by producers, those made from day to day, those
made from month to month, and those made only once in five years, are
completely consistent with each other. Into this situation introduce now
a sudden, permanent, unexpected increase, occuring one night in the early
part of a month, in the intensity of demand for the product (represented
graphically by a shift to the right of the entire market demand curve).

We must inquire into the effects that this change will generate upon the
market activity of all participants, all other relevant factors remaining un-
It is clear, first of all, that the market is no longer in equilibrium. If
entrepreneurs go to market on the day immediately following the change
in demand with the same selling plans as for the previous days, there will
have been by the end of the day many disappointed consumer plans. Con-
sumers will have come to market with plans to purchase greater quantities
(at previously ruling prices) than before. The daily output, previously
just sufficient to satisfy consumers at the (previous) equilibrium price, is
now insufficient. Some consumers will have discovered that they must
offer higher prices in order to fulfill their plans. Entrepreneurs will dis-
cover that they may expect higher prices and in the succeeding days will
make their selling plans on this expectation, refusing to sell for the pre-
vious low price.5
When the first of the following month is at hand, and producers must
decide on the rate of output of the next month, their estimates of the
product price for the month will have risen from those of the first of the
preceding month. Each entrepreneur will realize that whatever the rate
of output he had been previously satisfied to maintain, he is now able to
improve his position by stepping up the daily output rate for the month.
The first unit of the product, which previously just was not worthwhile to
add to the daily output, for example, now promises to add more to revenue,
should it be produced, than it would add to current costs. The reason
why this unit of output had previously been the first submarginal one was
that its marginal (short-run) cost just exceeded the addition that it brought
about in revenue. Now, however, the entrepreneur can expect a higher
price for the product, one that causes the marginal revenue from this unit,
and also from some further units as well, to exceed the corresponding
short-run marginal costs.6

<< . .

. 24
( : 36)

. . >>