<< . .

. 28
( : 36)



. . >>

own over-all point of view. There must be no other method of production
available to the entrepreneur, involving a difference in product, input pro-
portions, or scale of production that promises greater profits in the long
run.
For general equilibrium to prevail, the prices of all resources and
products must be precisely at those levels necessary to induce such universal
dovetailing of decisions. The price of any resource will be such that the
quantity that owners of the resource wish to sell in the aggregate at the price,
in each period of time, exactly equals the aggregate quantity that entre-
preneurs wish to buy at the price, in order to employ in the execution of
their various long-run and short-run production plans. The aggregate
quantity desired to be sold is found by totaling, for all owners of the re-
source, the quantities each of which are (in the light of all other market
prices) just large enough for the respective marginal units to rank, each
for its relevant resource owner, just lower in subjective importance than
the additional purchasing power obtained through its sale in the market.
This aggregate quantity must in equilibrium equal exactly that which entre-
preneurs wish to buy at the price”an aggregate made up of quantities that
(in the light of technological possibilities and all other market prices) are
each just large enough for the respective marginal units of resource to yield
a value of marginal increment of product that ranks, for each relevant
entrepreneur, just higher than the additional expenditure involved in its
employment.
The price of any product will be such that the quantity entrepreneurs
plan in aggregate to produce and sell in any one period exactly equals the
248 MARKET THEORY AND THE PRICE SYSTEM


aggregate quantity that consumers wish to buy. The aggregate quantity of
a product planned on being produced in any one period is an aggregate
made up of quantities of products each of which (in the light of techno-
logical possibilities and all other prices) are just large enough for the long-
run marginal costs associated with the respective marginal units to rank, for
each relevant entrepreneur, just lower than the corresponding marginal
revenue. This aggregate quantity must be in equilibrium equal exactly
to that which consumers wish to buy at that price”namely, that quantity of
the product found by totaling, for all potential consumers, the quantities
that (in the light of all market prices) are just large enough for the respec-
tive marginal units to rank, each for the relevant consumer, just higher than
the sacrifice represented by the additional expenditure required for these
marginal units.
Entrepreneurial decisions, for general equilibrium to exist, must in
addition satisfy, with respect to each product individually, and with respect
to each factor individually, the remaining conditions for equilibrium dis-
cussed in Chapter 10. No producer must be producing a product for which
his total revenue falls short of his long-run opportunity costs”that is, the
total revenue in his branch of production must not fall short of the total
revenue he could have obtained by applying the same resources in some
different branch of production.2
Under these conditions the flow of resources, products, and incomes
could be maintained without change through any length of time. Each re-
source owner, in the light of the set of prices available to him for the sale of
various resources, and in the light of the prices of the various products, is
able to construct a plan that dovetails perfectly with every other relevant
plan being made in the market. Every consumer earns, in his capacity
of resource owner, an income that, considering the market prices for the
various products, enables him to plan a regular consumption program that,
again, dovetails perfectly with every other relevant plan being made in the
market. The resources made available by the resource owners for produc-
tion are being combined in plants of varying size, in varying patterns of
input proportions, in the production of various different products”the net
result being (a) a stream of output containing the various products in a
precise pattern to fit the aggregate buying plans of the consumers, (b) a
stream of income to resource owners in a precise amount and pattern of
distribution that should make possible the equilibrium set of consumer
plans, and (c) an organization of production such that no entrepreneur can
discover anything to be done with any group of factors in the system, that
might result in the ultimate creation of greater market value than is, in fact,
now being created by the group.

2 See pp. 214-216, 228-230.
THE GENERAL MARKET PROCESS 249


An important corollary of these conditions is that no entrepreneurial
profit can exist in equilibrium. We may define the profit earned by an
entrepreneur very broadly for our purposes as the difference between the
revenue received through his employment of a group of factors, and the op-
portunity cost of the factors (that is, the highest revenue being received
through the employment of a similar group of factors elsewhere in the econ-
omy). If a market is to be pronounced in equilibrium, there can be no suc®i
profit. The existence of profit in this sense would mean that those entrepre-
neurs who are now employing the group of factors "elsewhere" will eventu-
ally attempt to take advantage of the opportunities "here" to earn a greater
revenue. Equilibrium can only exist when each similar group of factors
is earning the same revenue in all areas of the market.
This can be made clearer by recalling that any group of factors suffi-
cient for the production of a particular product is, for analytical purposes,
the product. For equilibrium to exist, there can, of course, be only a
single price in the market for each given good or group of goods. In equi-
librium, therefore, there can only be one price for a product, no matter if
this product is in its final form, or whether the product is in the form of the
group of factors necessary for its production. Consequently, the price that
an entrepreneur must pay in equilibrium for his factors of production
cannot be less than the price he receives for his output. This will be true
for all entrepreneurs employing a given factor group: each will be paying
the same price for the factor group, and each will be producing a product
yielding total revenue exactly equal to the cost of the factor group. No
entrepreneurial profit or loss can exist.
This absence of entrepreneurial profits most clearly demonstrates the
proposition that in equilibrium a general market leaves no room for entre-
preneurial activity. It is worthwhile to consider some of the implications
of the absence of entrepreneurial profits. The sum of the prices of a group
of complementary factors of production will be the same in all employments;
and this sum, we have seen, will equal the value of the product of such a
group of factors (this value being again the same for all employments).
Now this, clearly, is (at least in one respect) exactly what would occur if
omniscient resource owners wrere to produce the products themselves without
separate entrepreneurial assistance. In his calculations such an owner of a
group of resources would consider them as equivalent in value to the most
valuable product that the group is able to yield. In weighing the wisdom
of withdrawing a particular bundle of resources from production to con-
sumption (or vice versa), he would balance against its usefulness in consump-
tion, its effectiveness in earning revenue, the latter equal to the value of the
final product. In a general market, with production being carried on by
entrepreneurs, exactly the same calculations will be made if the market is in
equilibrium. The price of a factor group that is just sufficiently high to
250 MARKET THEORY AND THE PRICE SYSTEM


lure them away from direct consumption by resource owners is precisely the
value of the most valuable final product that these resources can produce.
We will soon see, once again, how closely the existence of equilibrium
in a market is bound up with perfect knowledge. As usual the mental con-
struction of a market in complete equilibrium is merely a means to an end.
Our principal purpose is to understand the market process in the absence
of equilibrium conditions. In the general market model, we will find,
entrepreneurial activity is the driving force, and the analysis of this activity
is the key to the understanding of the entire process. For this reason we
place such emphasis on the absence of entrepreneurial profits in equilibrium,
and on the absence of opportunities for entrepreneurs to do anything better
than is in fact being done. All this is different in a market not in equi-
librium.
A GENERAL MARKET IN DISEQUILIBRIUM
Our discussions of conditions in an equilibrium general market make
it easy to see what is meant by disequilibrium in such a market. We will
continue to work with a market where the basic data are unchanged from
period to period. The regular resource endowments continue without
alteration; consumer tastes for the various products undergo no change.
The only changes are those brought about by the market process itself. In
a general market not in a state of equilibrium, market phenomena induce
market participants to make plans that are not completely consistent with
each other. Clearly, this must be the result of the absence of omniscience
on the part of market participants.
In a general market, the absence of equilibrium means that resources
are being used in production processes not best adjusted to the existing
pattern of product prices. Alternatively, absence of equilibrium means that
product prices are not perfectly adjusted to existing production patterns.
Put in still another way, the absence of equilibrium means that the prices of
resources are not completely adjusted to the prevailing patterns of con-
sumer tastes; or alternatively, that the prices of products are not adjusted
to the prevailing pattern of resource availability.
These maladjustments will necessarily make themselves felt sooner or
later. In this way, knowledge of these maladjustments will spread and will
enforce changes in the plans of market participants. For example, the
organization of production may produce "too much" of one commodity and
"too little" of a second, in relation to consumer tastes. The producers erred
in their estimation of the relative significance to consumers of the two com-
modities. The result will be that with given prices expected by the pro-
ducers to prevail for the two commodities, a greater quantity than expected
will be asked of the second commodity, while a smaller quantity than ex-
pected will be asked of the first commodity. The disappointments of both
THE GENERAL MARKET PROCESS 251


producers and consumers will alter the relative prices of the two commodi-
ties and revise the production plans of the entrepreneurs.
One very important observation is that a state of disequilibrium in a
general market expresses itself through the creation of profit possibilities.
It is especially illuminating to notice the way this market phenomenon
focuses attention directly on the real nature of general market disequilib-
rium. Whenever a market does not fulfill the conditions necessary for
equilibrium, it would be possible to transfer a block of resources from one
actual employment in the market to some other employment yielding greater
market value (that is, greater revenue) than the actual employment. This
reflects the fact that the decision actually made, with respect to the alloca-
tion of the block of resources, was not completely adjusted to the other
decisions being made in the market at the same time. This decision
erroneously assumed that no superior opportunity existed anywhere in the
market for these resources. In fact, however, a fuller knowledge of the
value that consumers place upon this block of resource (possibly in some
other form) would have led to a different allocation. Thus, the value
placed upon this block of resources by whoever made the "mistaken" deci-
sion is less than its value elsewhere in the market. Only imperfect knowl-
edge on the part of those in the market could have permitted the emergence
of two "prices" for the same "good." Not only the individual who made
the mistaken allocation was in ignorance of the true state of affairs. Every-
body else who would have been in the position to take advantage of the
price differential, but did not do so, was equally ignorant. In this way,
whenever disequilibrium exists in the general market, an opportunity exists
to earn entrepreneurial profit by buying where market value is low and
selling where value is higher.

DISEQUILIBRIUM IN THE GENERAL MARKET AND
ENTREPRENEURIAL OPPORTUNITIES
These considerations reveal the central role that the entrepreneur is
able to play in the market process, as well as the relation between the im-
perfection of knowledge and the existence of a state of disequilibrium.
We have discovered that whereas in equilibrium every "good" sells for
a single price throughout the market (no matter what the form in which
the good may be), in the disequilibrium market more than one price pre-
vails for the same "good" (either when the good is sold in different forms
for different prices, or when the same goods sells for different prices). In-
consistency among the decisions of market participants reveals itself in the
form of more than one price for the same "good." This is an important
discovery, since it links general market analysis of the most complex order
with the analysis of the simplest of conceivable markets. We know that
252 MARKET THEORY AND THE PRICE SYSTEM


in a single-commodity market, for example, equilibrium requires a single
price throughout the market. We now know that equilibrium in the
general market requires precisely the same condition, somewhat more
broadly interpreted. We know, in fact, that all disequilibrium in the
general market may be interpreted as the absence of this single equilibrium
condition.
We recall further, from analysis of the single-commodity market, that
the simplest type of entrepreneurial activity is arbitrage”simultaneously
buying a commodity where its price is low, and selling it where its price
is higher. And we recall that it is precisely this kind of entrepreneurial
activity that tends to wipe out these price differentials”converting a market
initially in disequilibrium into an equilibrium market. Now we have
discovered that all entrepreneurial activity, in the most complex of the
general markets, reduces analytically to precisely the same kind of arbitrage
activity, buying at a lower price to resell at a higher price.
Just as more than one price for a single commodity is possible only
because of imperfect knowledge, so also in the general market the existence
of more than one price for a "good" is possible only through ignorance.
And just as the single-commodity market is brought toward equilibrium
by the spread of knowledge and its exploitation by those entrepreneurs who
find out first, so also in the general market, the market process operates
through the discovery by the more alert entrepreneurs of the existence of
these price differentials, and their subsequent exploitation of these op-
portunities.
All profit opportunities in the general market thus appear as the ex-
pression”in the existence of a lower price and a higher price for the same
"good"”of a fundamental inconsistency among market decisions. It is
the ceaseless search by entrepreneurs for such profit opportunities that
prevents the continuation of existing market activities”in other words, it
is the search for profits that renders such a market state one of disequilib-
rium. Those entrepreneurs will be earning profits who discover these
price differentials before the others. It is their activity that tends to wipe
out these differentials, thus removing the inconsistencies among the de-
cisions being made in the market.

ENTREPRENEURIAL ACTIVITY AND THE
GENERAL MARKET PROCESS
In this section we will discuss the various kinds of market forces that
may be set into motion by entrepreneurial activity as a result of particular
disequilibrium conditions.
1. Simplest of all will be the market agitation initiated by the discovery
of more than one price for the same physical resource, or the same physical
THE GENERAL MARKET PROCESS 253


product. We have analyzed this already in Chapter 7. Entrepreneurs
who find out this price discrepancy will simply buy the product or resource
at the low price from those who do not know that any higher price can
be obtained for it, and will sell at the higher price to those who do not
know that it can be obtained at any lower price. In so doing entrepreneurs
are wiping out a lack of coordination between decision makers. Among
those who were aware only of the lower price, there were presumably
some who might have sold more of the product or resource than they are
prepared to sell at the lower price. Similarly, among those who knew
only of the higher price, there were presumably some who might have
bought a larger quantity had they known of the lower price. Entrepre-
neurial activity leading to a single intermediate price will remove this lack
of coordination.
Of course, in considering a general market, we understand that the
adjustment in the prices of the particular resource or product will affect
market activity with respect to other products or resources as well. The
nature of these secondary adjustments will depend on the particular rela-
tionships between the products or the resources. In general, the adjust-
ments will follow the pattern we discuss below in the next few paragraphs.
2. A second possibility for entrepreneurial activity may be created by
inconsistencies affecting most directly the decisions being made with respect
to two different products. Ignoring the possibility of more than one price
for the same physical resource, or the same physical product, there may
be an absence of coordination among the production, selling, and buying
decisions affecting two different products. This kind of inconsistency has
already been noticed in this chapter, and it is, in addition, similar in some
respects to cases considered in Chapter 7.
It may be possible, for example, that both consumers and entrepreneurs
have each independently misjudged the relative significance that consumers
attach to two particular products. As a result of this error consumers
have adjusted their buying plans, and producers their production plans,
according to the expectation of a price for the one product that is "too
high," and a price for the second product that is "too low." Since all
concerned make the same error, their price expectations prove initially
correct. (We may imagine that the prices of the various resources, too,
have become completely adjusted to the entrepreneurial plans constructed
according to these expectations.) These production decisions are clearly
inconsistent with each other in the light of prevailing consumer tastes.
These production decisions would be mutually consistent only if the rela-
tive prices of the products would induce each consumer to allocate his
income among the various available products in such a way that in ag-
gregate, consumers wish to buy precisely those quantities of each of the
two products that producers have planned to produce. But if the market
254 MARKET THEORY AND THE PRICE SYSTEM


price of the one product is too high, and the price of the other product
too low, the terms of "exchange" between the two products are such that
disappointments must necessarily occur. These terms of "exchange" be-
tween the two products will in general induce consumers to allocate income
so that more of the second product is consumed in place of the first product
than would have been the case with "correct" relative prices for the two
products.3 As a result producers of the first product discover that they
have produced "too much" of it (that is, they find they cannot sell at the
prevailing price all they have produced in expectation of this price); while
producers of the second product discover that they have produced too
little (that is, they are unable to satisfy all consumer orders made at the
ruling price for their product).
It should be observed that the inconsistency among production de-
cisions and consumption decisions relevant to the two products implies
still further inconsistencies in decisions relevant to the resources allocated
to these products. Although we have imagined resource prices to be
completely adjusted to the plans of producers, the lack of coordination
between the latter plans implicitly makes the decisions regarding the
buying and selling of resources also internally inconsistent with each other
in the light of consumer tastes. Thus, the adjustments that eventually
will be brought about through the discovery of the fundamental incon-
sistencies in decisions with respect to the products will also exercise an
influence upon the resource markets.
It is not difficult to perceive the opportunities for entrepreneurial ac-
tivity created by these market inconsistencies. The entrepreneur who
gathers the earliest information concerning the disappointed plans of the
producers of the first product, and the disappointed plans of prospective
consumers of the second product, is in a position to gain profits by exploit-
ing his superior knowledge. He will refrain from producing the first
product and will expand his output of the second product for which he
will be able to ask and obtain a new higher price. In this way (assuming
both products to use the same inputs) he will transfer resources from
an employment where marginal revenue will be less than marginal cost
(since he knows the price of the first product will fall, so that the equality
between marginal revenue and marginal cost previously expected with the
originally planned output will not be achieved), to an employment where
marginal revenue will be greater than marginal costs (after the rise in
price for the second product).
Similarly, where the first product has been produced with resources
different from those used for the second product, the more alert entre-
preneurs will cut down their purchases of the resources used for the first
3 Where the two products are complementary goods, the direct consequences of the
market error may be more complicated than is spelled out in the text.
THE GENERAL MARKET PROCESS 255

factor and will expand their purchases of the resources used for the second.
A tendency is thus caused toward a fall in the prices of the former resources
and a rise in the prices of the latter resources. Profits are gained by these
nimbler entrepreneurs because they perceive that they can obtain a high
price for the second product. They see that resources hitherto thought
able to create the greatest market value at the margin when allocated to
produce other products (for example, the first product, perhaps) will in
fact create the greatest market value when applied at the margin of pro-
duction of the second product. Continuation of previous plans for the
production of the first product must involve losses, they perceive earlier
than others, at least on the marginal units produced. Their search for
profits and fear of losses induces them to alter their decisions in the pattern
described.4
Entrepreneurial activity will continue in this fashion for as long as
the relevant decisions have not been shaken down into full mutual con-
sistency. Prices of the products, quantities produced of the products, and
prices of the resources affected must all be such as to eliminate plan dis-
appointments. In a general market at any one time we may expect numer-
ous groups of products (and these groups containing probably more than
two products in each group) that will have the kind of inconsistency dis-
cussed here. In all such cases the market will be in agitation set off by
entrepreneurial discovery of the profit possibilities thus presented.
3. A third possibility for entrepreneurial activity may be created by
inconsistencies in market plans revealed most glaringly in the decisions
affecting two different productive resources. We have seen, of course, that
imperfection of knowledge in the market for products implies inconsis-
tencies among decisions in the resource markets as well, and we have also
seen that the resulting market forces will bring about corresponding changes
in the decisions made in the resource markets. But there may be incon-
sistencies that have their root directly in resource market decisions.
Let us suppose that all resource owners and all entrepreneurs err in
their assessment of the relative ease with which two different productive
factors can be made available to the market; or that they err in their as-
sessment of the relative usefulness of the two factors in the various branches
of production open to the market as a whole. As a result of these errors,
all concerned (correctly) expect prices for the resources that are "too high"
for the first resource and "too low" for the second resource.
Presented with these market terms upon which the one resource can
4 The discussion in these paragraphs illustrates what were described in Ch. 2 as
"horizontal relationships" existing among different sub-markets. The reader may work
out for himself possible further developments that might follow7 (working horizontally)
on the course of events described here. The reader may wTork out, for example, the
consequences for the market prices of products that are used complementarity Avith one
or other of the two products referred to in the text.
256 MARKET THEORY AND THE PRICE SYSTEM


be substituted for the second, producers in aggregate ask to buy too much
of the second resources and too little of the first, in comparison with the
quantities of the two resources that their owners (in the light of the market
terms upon which they can replace the one resource by the other in direct
consumption) are offering for sale. We may assume that product prices are
completely adjusted to the expected and initially realized resource prices,
so that no entrepreneur sees any opportunity of improving his position from
what he expects to gain by means of his production plans made in the light
of the ruling resource and product prices.
Nevertheless, the resource prices are inconsistent with equilibrium
conditions. Producers are induced by the relative prices of the two re-
sources to produce definite quantities of various products requiring these
resources, with methods of production calling in each case for an input
mix with definite proportions of the various available resources. Resource
owners are induced by the relative prices to sell definite quantities of the
two resources. The aggregate quantity offered for sale of the second re-
source falls short of what producers are planning to use, while that offered

<< . .

. 28
( : 36)



. . >>