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Nevertheless, within the scope of the methods of production possible with
the given plant, the entrepreneur will still seek that bundle of variable
inputs that will minimize the current costs of the selected output volume.
Once again, therefore, a factor will be purchased as part of variable inputs
in a quantity such that the marginal increment of product (defined now
with reference to the given plant) associated with the purchase of the last
unit of it should just exceed its marginal cost to the producer.
We are now in a position to define the conditions for complete equi-
librium in our factor market. As usual, the conditions include the require-
ment of a single price for the factor throughout the market. And, again
as usual, it is necessary that the price of the factor be such that the quantity
of factor, which resource owners wish to sell in aggregate at the ruling price,
is exactly the same as that which entrepreneurs will just be willing to pur-
chase at the price. But the implications of this last requirement for com-
plete equilibrium, which are peculiar to the market for a factor, need to be
spelled out.
The equilibrium price for a productive factor, (prices of products and
of other factors being given) must be such that exactly that quantity of
factor is offered for sale (that is, withheld from personal use) as is demanded
to be bought. The quantity that resource owners will offer for sale at this
price will reflect the fact the marginal utility to the seller of the last unit
to be sold of the factor is just lower than that of the additional commodities
MARKET FOR SINGLE FACTOR 229


that he can buy with the increment in revenue derived through sale of his
factor unit. In other words the equilibrium price is just high enough to
make it worthwhile for the last unit of factor (necessary to complete the
equilibrium quantity) to be sold by that seller who is less eager to part with
this unit than are the other sellers to part with the units they do sell.
(Of course, this marginal seller is also less eager to retain this unit for him-
self than are the other resource owners to retain all the units for themselves
that they do not sell at the ruling price.) The quantity that entrepreneurs
will seek to buy at the equilibrium price must be exactly the same as this
equilibrium quantity. This quantity will be bought by the various pro-
ducers of each of the various products. For complete equilibrium not only
should the current rate of plant utilization be optimally adjusted to the
factor prices, but the scale of plant itself also should be so adjusted. The
aggregate quantity of the factor that is purchased at the equilibrium price
will reflect the fact that the value of marginal increment of product asso-
ciated with the last unit of the factor purchased by each producer (measured
with respect to long-range calculations) is just greater than the increment in
expenditure required for this factor unit. This must be the case for all
producers in all branches of production.
If these conditions are fulfilled, no participant in the factor market
has any reason to make plans to alter his activities in this market, all other
things remaining unchanged.11 No resource owner is disappointed in his
plans, nor is there any more profitable way he could dispose of his resource
endowment. Similarly, no entrepreneur will be disappointed in his plans,
nor will he discover any more profitable methods of production. Since his
long-range and short-run decisions are mutually consistent with each other
and with current market conditions, it follows that any increase or decrease
in the quantity bought of the factor will upset the proportions factors are
combined in, in a manner that can only decrease efficiency. The conditions
for equilibrium define the size of plant used by each producer in the produc-
tion of each product using the particular factor; they define also the current
volume of output for each producer of each product where the factor appears
as one of the variable inputs; they define the price the factor is sold at; 12 and
11 This point occurs, of course, at the intersection of the market demand curve for
the factor and the market supply curve of the factor”where these curves, as usual,
reflect the amounts of factor that would be respectively asked to be bought and offered
for sale at hypothetical given factor prices. The analysis in the text explains how actual
factor prices (like actual commodity prices) emerge from the attitudes reflected in the
relevant supply and demand curves.
!2 A special case is where the equilibrium price of a resource is zero. Such a resource
is a free good that yields its owner no income in the market, and in whose use it is not
necessary to economize. Suppose that market participants are endowed with huge tracts
of fertile land so large that even the employment of all the complementary resources
(such as labor and tools) available to the group cannot bring all the land under cul-
tivation, then clearly no price can be obtained for land; competition among landowners
230 MARKET THEORY AND THE PRICE SYSTEM


they define, for each owner of the resource, the quantity that he will sell.
Once again it is not difficult to see that perfect knowledge on the part
of all participants in the factor market would help them immediately toward
achieving these equilibrium conditions. With all other prices known, with
all possible methods of production known, with the degree to which each
resource owner is eager to retain factors for personal use known, each partici-
pant would know at what price it would be possible for all of them to adjust
their activities so that no disappointments need occur. No entrepreneur
would plan production on the assumption that he will have to offer a price
for the factor any higher than this equilibrium price. He knows that the
lower price is quite sufficiently high to induce the more eager sellers to
supply all that entrepreneurs will demand at this lower price. No resource
owner, in fact, will waste time asking any higher prices, since he knows that
buyers can find all they will want to buy at the lower price. On the other
hand, no resource owner will accept a price for the factor any lower than
the equilibrium price. He knows that the higher price is quite sufficiently
low to attract entrepreneurs to formulate a long-range production plan
calling in aggregate for a quantity of factor that is not less than the entire
factor quantity that resource owners wish to sell at the higher price.
We notice that, as was the case in our analysis of the market for a single
product, it is analytically possible to distinguish cases of incomplete "equi-
librium" in a factor market as well. It is possible, for example, to set up
a model where all decisions to alter the scale of plants are excluded. The
only decisions that producers are free to make, then, are those involving
alteration of "variable" input proportions employed. In such a model it
is possible to talk of "equilibrium" in the factor market, in the sense that
the permitted decisions of both resource owners and entrepreneurs are

would drive down the price to zero. Whenever, in fact, the quantity of a specific factor
is so large that a surplus of it remains after combining it with all the other complementary
versatile factors worthwhile to apply to the branch of production the first factor is spe-
cific to, then the first factor can command no price. As soon as the market demand for
the product (to whose production this factor is specific) increases so much that it be-
comes worthwhile to employ so large a quantity of the complementary factors in its
production as to exhaust the entire available supply of the specific factor, the specific
factor begins to command a price. This price is a rent since the factor is specific; how-
ever, as we see, it is governed by the same analysis that we apply to all prices. Con-
tinued increases in the demand for the product will force up the price of this factor
more than the price of the other factors. Even a moderate increase in the price of the
other factors may suffice to withdraw additional quantities of them from the other
branches of production where they may have been used. But the specific factor is not
used elsewhere in the economy; it commands a rent only because all of it is insufficient
to satisfy the demand for it in production (when free). The perfect inelasticity of its
supply makes its price depend, even more sensitively than that of other resources, on the
price of the product. On the relativity of the terms "specific factor" and "rent," see
p. 187.
MARKET FOR SINGLE FACTOR 231


mutually consistent. Within the range of permitted decisions, there will
be no disappointed plans in such an equilibrium situation. For such a
situation to exist it is necessary that a price for the factor prevail so that
the quantity that resource owners wish to sell at the price exactly equals the
aggregate quantity that producers will wish to employ at the price, with
given plants. This equilibrium price, as before, must be high enough to
provide the power to purchase commodities with a marginal utility just
higher than that of the last factor unit sold, to its seller; the equilibrium
price must also be such as to make the marginal cost of the factor to the
producer, just lower than the value of the marginal increment of product
derived from the employment of the last factor unit bought.

THE MARKET PROCESS IN A MARKET FOR A
SINGLE FACTOR OF PRODUCTION
In the absence of perfect knowledge we may expect factor sales to be
transacted at prices different from the equilibrium price, and production
to be carried on in plants calling for employment of the factors in aggregate
quantities other than that which would be consistent with an equilibrium
price. These buying, selling, and producing activities will result in disap-
pointed plans; the revision of these plans; and a new set of buying, selling,
and producing activities. These changes will constitute the agitation char-
acteristic of all markets that have not yet attained equilibrium. In this
section we sketch the kind of changes that will be generated by the absence
of equilibrium conditions. We will be able to dispense with detailed repeti-
tion of patterns of change that we have become familiar with in Chapter 7
and in the earlier sections of this chapter. We will proceed by considering,
as an illustration, what happens when a factor market initially in equilib-
rium is subjected to a sudden change. We retain our assumption of known
and constant prices of all products and of all other resources.
A factor market is initially in complete equilibrium. Producers have
built plants in the "correct" sizes in the past (so that in aggregate the same
number of new plants each year replace an equal number of old ones with-
out any alterations in sizes) such that the annual aggregate quantity of the
factor purchased by all producers of all products, in response to the market
price of the factor, can be maintained indefinitely if this price continues.
Long-range plans of all producers in all industry call for the employment
of the factor in each industry to the point where its effectiveness per unit
at the margin is just sufficient to justify paying the market price for the last
unit purchased. At the same time resource owners are induced by the
same market price for the factor to sell exactly the amount sought by pro-
ducers at the price; and no resource owner finds himself disappointed in his
232 MARKET THEORY AND THE PRICE SYSTEM


selling plans, nor in any other way under pressure to alter his selling activity.
Into this situation a sudden unexpected permanent change in the basic data
is introduced”in the form of the invention of a new technique for the pro-
duction of several products. The relevance of this invention for the
market for our factor consists in the fact that as a result of this invention the
effectiveness at the margin of our own factor in the production of these
products has been sharply increased. Our task is to investigate the conse-
quences of this change for activity in the factor market.
It is clear that the factor market is no longer in equilibrium. We are
not assuming perfect knowledge in our model, and therefore, as we have
seen, the market prior to the new invention was perfectly adjusted to its
absence: nobody had made plans based on the expectation of the invention.
The plans of producers thus cannot be expected to be maintained indefi-
nitely without change. Sooner or later somebody producing one of the
products that can be produced more efficiently with the new technique will
discover this. He will seek, at the earliest opportunity, to replace the older
methods of production by the newer one. This will involve a reshuffling
of all his variable inputs until he will have achieved (a) what now appears
as the most desirable output level (attainable with the existing plant, that,
while not planned directly for the new technique, cannot be altered in the
short run), and (b) what now appears as the most desirable set of "variable"
input proportions. Under our assumptions as to the constancy of other
prices, the result will be an increase in the quantity this entrepreneur will
seek to buy of our own factor (at least so long as resource owners have not
discovered that they may be able to ask a higher price). As knowledge of
the new technique spreads, it is clear, the old price for the resource ceases
to be an equilibrium price; the aggregate quantity of the factor demanded
exceeds the quantity that resource owners are prepared to sell at the price.
There will be disappointed plans for at least some producers. These disap-
pointments will gradually lead both producers and resource owners to
recognize that higher prices must be offered, and may be confidently asked,
for the resource. The immediate impact of the technological discovery
has thus been an increase in the quantity of this factor employed, together
with a rise in its price. This price rise may be modified by a tendency on
the part of producers who cannot use the new technique to replace our
factor by substitutes as its price begins to rise.
Eventually, further changes may be expected. When entrepreneurs
have the opportunity to revise their long-run plans, they will do so in the
light of the new productive technique and the new higher prices for our
own factor. For each producer, there will now be a different scale of
plant that promises to be the most desirable. A new volume of output
and a new set of long-run input proportions will be selected by each pro-
PARTIAL MARKET PROCESSES 233


ducer in each industry. This will again alter the aggregate annual quan-
tity of the factor sought to be purchased at the previously established new
price for the factor. This may involve a new adjustment in the market
price of the factor. This kind of market agitation will continue for as long
as the factor market has not attained complete equilibrium.

TOWARD THE GENERAL MARKET PROCESS
We have in this chapter considered separately two areas within a mar-
ket system. Wefirstexamined the processes that would be generated within
the market for a single product, which could be imagined as insulated
from the rest of the market. We then examined a similarly insulated
market for a single productive resource. The juxtaposition of these two
cases should have emphasized the artificiality of the assumptions regarding
their "insulation" from the rest of the market. At the same time this
juxtaposition should have suggested the direction that the analysis must
be extended to if it is to provide a glimpse of the concatenation of decisions
running throughout the entire market system. It must have been re-
marked, for example, that when a new invention increased the marginal
effectiveness of one input, with respect to the production of several products,
we might have expected (if released from the assumed constancy in product
prices) a tendency toward a lowering of the prices of these products, with
subsequent further adjustments. We will explore the more general market
process in the following chapter.
At this point we merely pause to recognize that our analysis shows the
way market forces would operate in each limited area of the market, if
each of these areas were insulated from the rest and considered in turn.
When we drop these "insulating" assumptions, it becomes apparent that
for equilibrium to exist in any one area, it is necessary that conditions be
fulfilled that relate directly to other areas. Moreover, it becomes apparent
that in the absence of equilibrium in any one area, the market forces set
into motion will impinge on other areas as well. Agitation in the market,
proceeding from an initiating cause in one area, will take the form of rip-
ples of change moving from one area to another and, of course, initiating
secondary waves of change having an impact also upon the area the agi-
tation originated in. We turn in the next chapter to this more complex
problem.
SUMMARY
Chapter 10 commences the analysis of the way the decisions of both
consumers and producers interact in the market place to determine the
prices of resources and products, the quantities of resources used in each
234 MARKET'THEORY AND THE PRICE SYSTEM


production process, and the quantities of products produced. In this
chapter the task is approached by first analyzing the market process as it
directly affects a single product, and then analyzing the corresponding
market process affecting a single productive factor.
In the analysis of the single-product market, stable prices for all factors
and all other products are assumed to be known. Equilibrium conditions
can be spelled out for the market. These define the scale of plant for
each producer, the level of utilization of each plant, the output consumed
by each consumer, and the product price. Perfect knowledge can be shown
to lead to the fulfillment of such a pattern of dovetailing decisions.
By mentally arresting specified types of changes, it is possible to spell
out various "incomplete" patterns of equilibrium. In particular it is of
interest to work out the pattern of dovetailing decisions that can be achieved
with given plants (short-run equilibrium) and given products (equilibrium
in the very short run). The relevance of these situations of incomplete
equilibrium is found in the time sequence of the market processes leading
up to complete equilibrium. The analysis of these processes makes up the
core of the subject under investigation. The thread running through
these processes is the consistent revision by producers and consumers of
their plans, until all sources of plan incompatibilities among them are re-
moved.
In the analysis of the single-factor market, stable prices for all other
factors and for all products are assumed to be known. Equilibrium con-
ditions can be spelled out for the market. These conditions define: the
size of plant used by each producer in the production of each product using
the particular factor; the current volume of output for each producer of
each product in which the factor appears as one of the variable inputs; the
price of the factor and the quantity of it sold by each of its owners. Once
again perfect knowledge is implied in the fulfillment of these conditions.
Imperfect knowledge implies disappointed plans that will lead to plan
revisions on the part of resource owners and producers. These plan re-
visions, too, may be expected to follow a typical time sequence, with some
adjustments being made only after maladjustment has prevailed persistently
for a long time.
The principal limitation on the usefulness of the analysis of market
processes treated in this chapter arises from the assumed "insulation" of
these processes from the full interaction with the rest of the adjustments
that will be generated throughout the entire market system by any initial
maladjustments in the areas under direct examination.
PARTIAL MARKET PROCESSES 235


Suggested Readings
Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949,
pp. 324-336.
Wicksteed, P. H., Common Sense of Political Economy, (Reprint-1933 ed.), Rout-
ledge and Kegan Paul Ltd., London, 1949, Bk. 1, Ch. 9.
Wicksell, K., Lectures on Political Economy, Routledge and Kegan Paul Ltd., Lon-
don, 1951, Vol. 1, pp. 196-206.
Machlup, F., The Economics of Sellers' Competition, Johns Hopkins University
Press, Baltimore, 1952, Chs. 9, 10.
11

The General Market Process



I N THE present chapter we seek to un-
derstand how the competitive market process works in a system where no
prices are considered as "given" or constant. In such a system the prices
of all factors, and of all products, are variables that take on values de-
termined by the market process itself. For such a system to be in equilib-
rium, all market decisions must mesh completely; the economist cannot
be satisfied to seek consistency only among a selected group of decisions
against the background of a "given" set of other decisions that remain
external to the analysis. When an autonomous change occurs somewhere
in the system affecting the fundamental data on whose basis certain de-
cisions are made, the economist must trace the impact of this change upon
all subsequent decisions. Until now we have been proceeding step by
step, confining ourselves primarily to partial analyses. In this chapter we
will discuss, after a preliminary foray into one more hypothetically re-
stricted market, the problem of the general market process in a market
where both factors and products can be bought and sold at prices freely
determined by market forces.
For most of this chapter we will be working with a system organized
on the following lines. There are a large number of resource owners.
Each resource owner finds himself endowed daily by nature, without cost,
with some bundle of resources whose content does not change from day
to day. The composition of this bundle differs from one resource owner
to another, but each resource appears in the daily endowment of many
resource owners. (None of them have monopoly power over any resource.)
Each of these resource owners is free either to retain his resources for his
own consumption purposes or to sell any quantity of them for what he can
get for it. There are also in the system a large number of prospective
entrepreneurs who may find it worthwhile to buy resources in the market,
236
THE GENERAL MARKET PROCESS 237


convert them into finished products, and sell these products for what they
can bring in the market.1 Finally there are the consumers. (These in-
dividuals, in addition to being consumers, are also resource owners, en-
trepreneurs, or both.) Consumers buy products in the market with in-
comes that they earn as resource owners or entrepreneurs.
The fundamental data that must ultimately determine the course of
the market process are (a) the daily endowments of resources, and (b) the
tastes of consumers. These are assumed to be given and unchanging
throughout the analysis unless inquiry is specifically directed toward the
consequences of a change in these data. On the one hand, consumer
tastes play a role in determining the quantity of resources that will be
sold to the market at any given price since, as we saw in the preceding
chapter, a unit of a resource will be sold only if its price is high enough
to outweigh its marginal utility in consumption to the resource owner. On
the other hand, of course, consumer tastes (along with consumer incomes)
play a major role in determining the quantity of each of the products that
consumers will buy at given prices. The composition and quantity of
the resource endowments will determine (along with the tastes of resource
owners as consumers) the quantity of the various resources that will be
sold to the market at given prices. At the same time the composition and
quantity of resource endowments play a major role in the determination
of consumer incomes.
The central problem is to understand the way market forces determine
the decisions that will be made (a) by each resource owner concerning the
sale of each unit of each of the resources in his daily endowment; (b) by
each of the prospective entrepreneurs concerning the purchase of the var-
ious resources, their organization into various productive complexes, and
the choice of products to be produced; and (c) by each of the consumers con-
cerning the purchase of the various available products. These decisions
will determine the prices of each of the factors and of each of the products,
the quantity of each factor employed, the method of production used for
each product, the quantity of each product produced, and the quantity of
each of the available products purchased by each consumer. Consistency
between all these decisions means that the resulting market phenomena will
be maintained indefinitely within alteration. Inconsistency between any
sets of decisions will be revealed through disappointments and will be fol-
lowed by revisions in future decision making. Inconsistencies will thus
generate ripples of change affecting wide areas of decision making. Our
problem is to understand how the market forces generated by the revelation
of these inconsistencies determine subsequent market phenomena. First
we take up a preliminary model.

For the sake of simplicity we continue to refrain from taking explicit notice of in-
termediate products, the produced means of production.
238 MARKET THEORY AND THE PRICE SYSTEM



A PRELIMINARY MODEL
In this preliminary analysis we simplify the statement of the problem
outlined in the previous section by making a major modification in the
institutional framework of the system. For the purposes of the present
section, we deal with a system different from that dealt with in the rest of
this chapter, in that production can be carried on by a market participant
only with resources that were in his initial endowment, not with resources
bought from others. Resources can be bought only for direct consumption.
During the rest of this chapter (after the present preliminary model) we will
be dealing with the system, outlined above, where resource owners do sell
resources to entrepreneurs who then produce products for sale to consumers.
In this section, however, each resource owner, if his resources are not to be
left idle, or to be used directly in consumption, must himself combine the
resources that he possesses, in order to produce products that he must then
consume himself or sell to other consumers. This case differs from the
hypothetical systems considered in Chapter 10 in that in the present problem
the prices of all products are determined by the market process that we wish
to investigate, with no market decisions imagined to be imposed externally.
Our case differs from the multi-commodity case considered in Chapter 7 in

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