<< . .

. 29
( : 36)



. . >>

for sale of the first resource is greater than what producers plan to use.
The relatively high price of the first resource, as compared with the second,
has led producers to plan production with methods substituting more of
the second resource for the first, and to plan to produce more of those
products requiring relatively heavy inputs of the second resource, and
less of those products requiring relatively heavy inputs of the first resource.
The relatively high price of the first resource may be inducing resource
owners to substitute quantities of the second resource in direct consump-
tion in place of quantities of the first.5
Some of the resource owners who have made plans to sell the first
resource, and some of the producers who have made production plans
calling for employment of the second resource, will find themselves disap-
pointed. This is, of course, the direct result of the inconsistency between
the decisions in the resource markets and will set into motion the appro-
priate corrective market forces. But the inconsistencies directly perceived
in the resource market also imply indirect inconsistencies in the decisions
made at the level of the product market. Consumers, we assumed, have
been making consumption plans fully adjusted to the production plans
that entrepreneurs have been making on the basis of their expected ability
to buy all of each of the two resources that they might wish to buy at the
expected prices. Since some of the plans of the producers are disappointed,
some of the plans of consumers, too, are going to be disappointed (since

¯ This will not necessarily be the case. For some resources especially, economists
>
have learned to expect a "backward-sloping" supply curve. The high price obtained
for the first resource may make it worthwhile for its owners to sell less of it, since the
smaller quantity sold can command a "sufficient" range of purchasing power.
THE GENERAL MARKET PROCESS 257


these latter plans presuppose successful fulfillment of the former). The
inconsistent plans of the producers are reflected here in the derived, in-
consistent plans of the consumers.
This situation provides opportunity for entrepreneurial profits. As
soon as some alert entrepreneur senses what is happening in the market
for the two resources, he will immediately offer to buy quantities of the
first resource at prices loiuer than the market prices prevailing initially.
He will be able to secure these low prices, since resource owners will have
been forced by their disappointments to revise downward their estimates
of the price of the first resource. The alert entrepreneur will then apply
his supply of the first factor to the production of those products that, re-
quiring heavy inputs of the first factor, had been sold in the product market
at correspondingly high prices. No consumers, until now, have been dis-
appointed in their plans to buy products requiring heavy inputs of the
first factor (since we have assumed the existing product prices to be com-
pletely adjusted to the output plans of the producers, and no producer
who planned to buy the first factor has been disappointed). The price of
the products requiring heavy inputs of the first factor, therefore, has no
reason to fall. Thus, the alert entrepreneur who discovers the new lower
price the first factor can now be obtained at is able to gain profits. Similarly,
the discovery by the alert entrepreneur of the new lower price of the first
factor (relative to that of the second, especially in view of the higher price
that will certainly be charged very shortly for this second factor) may
open up for him opportunities for profit through the substitution at the
margin of units of the first factor in place of units of the second, in the
production of those products using both factors.
These profit possibilities have been made possible by the existing faulty
allocation of resources. The "erroneous" market prices for the two re-
sources had guided producers into substituting the second resource for the
first in production, and into producing products requiring heavy use of
the second resource in place of products requiring heavy use of the first”
although, in view of the real factors underlying the market, a different pat-
tern of production would have been more efficient. In view of consumer
tastes, technological possibilities, and the willingness of resource owners
to sell factors, the initially planned production pattern "wasted" the first
resource and used the second resource too heavily.
As more and more entrepreneurs move in to exploit the profit pos-
sibilities thus created, they set into motion tendencies in price movements
that both reflect the improving pattern of resource allocation and render
more limited the possibilities for further profits. On the one hand, as
entrepreneurs buy more of the first resource, and buy less of the second,
they are directly easing the pressures that had been forcing the price of
the first resource to fall, and that of the second to rise. At the same time,
258 MARKET THEORY AND THE PRICE SYSTEM


with the shift from the production of products requiring heavy inputs of
the second resource toward products requiring heavy inputs of the first,
a tendency is brought about for the price of the former products to rise, and
for that of the latter products to fall.
We recognize, especially with respect to entrepreneurial activity set
into motion by inconsistencies in the resource markets, that corrective ad-
justment may take considerable time to be completed. Even alert entre-
preneurs may find themselves unable to exploit their earlier knowledge
of market conditions, due to past decisions. They may be saddled with
plants that cannot easily be converted from the production of one product
to another, or from one method of production to another, or from one scale
of output to another. What appear to be profits in the long-run view
may not be profits in the short-run view (due to the differences in the
respective opportunity costs). But eventually market forces will bring
about the adjustments outlined above. Of course, in the general market
we are dealing with, adjustments of this kind must be expected to bring
about alterations in the conditions of related markets as well. These al-
terations, too, although they are likely to be of a smaller order of magnitude,
will bring about adjustments that may be analyzed by one or other of the
examples being considered here.
4. A fourth possibility for entrepreneurial activity may exist even
where all resource and product prices are completely adjusted to the
production and consumption plans that have actually been made. This
possibility arises from the fact that these plans may not reflect the op-
portunities that "really" exist. Producers may be ignorant of particular
inventions that might lower their costs; consumers may be ignorant of
the way a new product may suit their given tastes.6 In such cases resources
are being used to produce goods that are less valuable than the goods that
could be produced with the same resources, if the existing knowledge was
fully exploited.7
Definite opportunities for entrepreneurial activity arise from cir-
cumstances of this kind. Disequilibrium conditions emerge as soon as
someone perceives the profit possibilities inherent in the situation. He
will then exploit these possibilities by applying the new invention to pro-
6 Clearly, a question of semantics is involved here. If one chooses to define tastes as
referring only to those commodities that the consumer knows, then by definition a prod-
uct that is still unknown, cannot be described as an unseized consumer "opportunity."
Nevertheless, the wider interpretation of "tastes" is in keeping with common usage.
7 Of course, the purist may point out that there are always unknown technological
possibilities that future generations will discover. From this point of view a market
system might be described as always in a state of disequilibrium, with respect to the
infinity of knowledge that is beyond human reach. A more workable approach, how-
ever, is to define relevant technological knowledge as that which is possessed by someone
in the system. Disequilibrium then exists, with respect to this knowledge, so long as it
has not yet been placed at the service of the market.
THE GENERAL MARKET PROCESS 259


duction (or by introducing the new product to the consumer market).
The innovator (this term is used to distinguish him from the inventor)
will then be able to produce products more cheaply than others, without
having to sell these products at a lower price, or he may be able to produce
a new product selling for a price greater than its full per-unit costs of pro-
duction.
The market agitation set in motion in this way will gradually tend to
subside as profit opportunities are exploited away. As knowledge of the
new production possibilities spreads, the prices of resources, and of prod-
ucts, will adjust until equilibrium is restored, with no further opportunity
for profitable entrepreneurial activity.
With respect to all these different kinds of inconsistencies among de-
cisions, and the entrepreneurial activity they give rise to, we must not
forget that entrepreneurs may not only gain profits but may also incur
losses. In fact, whenever a market is not in equilibrium, some entrepre-
neurs are clearly foregoing (unintentionally, of course) more desirable oppor-
tunities for less desirable ones. Thus, in the broad sense, entrepreneurial
loss is always present in a disequilibrium market. Entrepreneurial losses
are incurred when producers make "wrong" decisions; that is, whenever
they use resources for purposes other than those that the market ranks as
most important. Entrepreneurial mistakes are due, of course, to mistaken
assessments of market conditions. Even in a market where, like the model
we are dealing with, the basic data”resource availability and consumer
tastes”do not change, there is ample room for entrepreneurial mistakes.
Entrepreneurial mistakes are responsible for any subsequent disappoint-
ments in the plans of all market participants. However, the market con-
tains a built-in device that operates to minimize the likelihood of
entrepreneurial mistakes. This device is precisely the fact that such mis-
takes are inescapably accompanied by losses”that are, by definition, some-
thing entrepreneurs seek to avoid.

PARTIAL ANALYSIS AND THE ANALYSIS OF A
GENERAL MARKET
From the analysis used in the preceding sections, it will be noticed
that although we are dealing with a general market (where all prices and
quantities are free to move), the market process in such a market can be
envisaged as the picture obtained from superimposing upon one another
a number of separate processes characteristic of some one partial market
not in equilibrium. With respect to the conditions for general market
equilibrium, this was not the case. Equilibrium in the general market
(while of course requiring equilibrium also in each of its distinguishable
sub-markets) cannot be considered simply as a quilt made up of discrete
260 MARKET THEORY AND THE PRICE SYSTEM


patches of partial equilibrium. General market equilibrium implies a
definite harmony between the various distinguishable sub-markets. But
the process by which a general market moves, when equilibrium conditions
are absent, may be considered as a combination of discrete partial processes.
In fact, understanding the matter in this way is rather important for an
adequate comprehension of the adjustment process in a disequilibrium
market.
The essence of any adjustments, of any entrepreneurial activity initi-
ated by disequilibrium conditions, is the making of "corrective" decisions
by entrepreneurs in the light of new knowledge of the state of the market.
Two characteristics of such decisions may be noticed. First, such decisions
are made "spasmodically" in the sense that the required knowledge is not
acquired continuously. Second, such decisions each may be considered
made with respect to relatively small segments of the general market. The
first characteristic implies that although disequilibrium conditions are
likely to be manifest separately in many distinguishable sub-markets, never-
theless, the entrepreneurial decisions being made in each of these sub-mar-
kets are not made completely simultaneously. Thus, it is feasible to imagine
a general market adjusting itself step by step, each step taken in one sub-
market bringing about alterations in the data relevant to the conditions
for equilibrium in related sub-markets, and thus modifying the subsequent
step-by-step process of adjustment. The second characteristic, that de-
cisions are made with regard to small segments of the whole market, is a
corollary of the limitations of the human mind, including that of entre-
preneurs. An entrepreneur will make decisions affecting prices where he
perceives the opportunity for profit. He will operate against the back-
ground of other prices that he takes as given and that he does not seek to
exploit.
Taken together these two characteristics of entrepreneurial decision
making imply that adjustments in a general market will be made one at
a time in limited areas of the market, that adjustment in one area will
impinge on other areas and will eventually be reflected in the adjustments
subsequently made. These subsequent adjustments may of course affect,
in turn, still other areas as well as the area where the very first adjustment
was itself made. The point is that these intricate webs of adjustments,
working in all directions and impinging back again upon areas where
these very adjustments had their roots, are woven piecemeal, not in any
continuous, grand pattern simultaneously harmonizing all areas of the
market. Appreciation of the complex chains of relationships simultane-
ously required for a state of general market equilibrium is useful principally
in giving an idea of the multitude of separate adjustments set in motion
by a state of disequilibrium, and of the power of an entrepreneurial de-
THE GENERAL MARKET PROCESS 261


cision in one area of the market to set off intricate and wide ranging
ripples of change felt eventually thoughout the market.

TOWARD FURTHER EXTENSIONS OF THE
GENERAL MARKET MODEL
Our analysis of the general market has been facilitated by the retention
of several simplifying assumptions. Although the model of a general mar-
ket discussed here has been free of many of the more restrictive assumptions
retained in earlier chapters, we are still some distance away from a model
that can be applied directly to anything likely to be encountered in a real
world. In this section we point briefly to the way our model may be
extended to eliminate some of its more glaring simplifications.
One of the more important of our simplifications has been the assumed
absence of monopoly power throughout the market. In particular, no
resource was monopolized, and no monopoly in the production of any one
product was assumed. In the next chapter we will explore the implica-
tions of the relaxation of this no-monopoly assumption.
A second of our simplifications has been to ignore intermediate prod-
ucts. We have been arguing as if the resources endowed by nature to
resource owners are directly combined and yield finished products for
consumption in a single operation. In a real world we are likely to find
that many products can be used not only for consumption but also as fac-
tors of production, while other products may be useful only as factors of
production. We have already noticed some of the implications of this
in Chapter 2. It is not difficult to perceive that the introduction of inter-
mediate products into the model does not upset the essential logic of its
analysis. The principal modification that it would entail is the introduc-
tion of new levels for entrepreneurial decision making. Producers pro-
ducing finished consumer products with produced inputs will use these
input prices in calculating their costs of production. The producers of
these produced inputs will be making decisions with respect to a higher level
of factor prices, and so on. Market interrelationships between various
levels of production can be analyzed with the same set of logical tools we
used in explaining the relationships between factor markets and product
markets. The consequences of inconsistencies in the decisions directly
affecting the consumer product market will initiate entrepreneurial ac-
tivity that will eventually affect all the related higher markets, with vary-
ing degrees of indirectness.
A more complex problem that has been assumed away thus far in our
analysis is that introduced by the duration of productive processes. We
have been assuming that in a productive process the product emerges simul-
taneously with the application of the inputs (or, at least, that any duration
262 MARKET THEORY AND THE PRICE SYSTEM


of production introduced no complications). In any kind of real world
the product to be sold is available for sale only at some definite period
of time after the productive factors are employed. Thus, every process
of production involves investment to a lesser or greater extent. Where
long-run decisions are made, they will usually involve long-term invest-
ments. We will return in an appendix to a brief survey of how the prob-
lems necessarily introduced by investment can be incorporated into a
general theory of the market process.
The final complication that we will refer to is brought about by dy-
namic changes in the basic data of the market. Included are changes in
the endowments of resources provided to the society by nature”these
changes being in the size, composition, and ownership of the endowed
resource bundles; also changes in the tastes of consumers. (So far we have
assumed away all kinds of these changes, including those that an anthro-
pologist or social psychologist would ascribe to the operation of the market
process itself.) However, in earlier chapters we have alluded sufficiently
to the effects of changes in the data upon partial markets for it to be ap-
parent how these dynamic changes must be treated in the general market
model as well. A change in tastes or resource availability must be treated
as something that introduces an immediate set of inconsistencies among
decisions otherwise consistent (if the market had previously been in equi-
librium); or (if the market had previously not been in equilibrium), as
introducing a new set of decisions with respect to which the market process
must seek mutual consistency. The speed of adjustment of the market to
the new changes will depend on the rapidity with which entrepreneurs
gain knowledge of the changes, translated into profit possibilities. The
only way, as we have seen in the introductory chapters, to analyze the
economic processes of a changing world, is to realize that all action is under-
taken with respect to the tastes and available resources relevant to a
particular date. All market interrelationships flow from such action.
Eventual changes in the basic data will be translated by the market into
changing patterns of market action, each pattern traceable to the data
of a particular date. Where different sets of relevant market data bring
about adjustments with various speeds of reaction, we may expect that at
any one time the market process may be a complex set of overlapping
programs of action, each set, perhaps, referring to the data of a different
date. All this vastly complicates, but does not essentially alter, the anal-
ysis developed in this chapter.

SUMMARY
Chapter 11 continues the analysis of the market process until it em-
braces a system where no prices are given or constant. The chapter pro-
THE GENERAL MARKET PROCESS 263


ceeds in two steps. A market is considered where there are a large number
of owners of different resources. Each of these resources can be used to
help produce a variety of different products. No prices or quantities of
resources or products sold are assumed to be determined externally to the
analysis. However, in the first of the two steps, we confine attention to
a system limited by the requirement that production be carried on only
with resources owned initially by the producer himself; resources can be
bought only for consumption. After this preliminary case, in the second
of the two steps, a market is analyzed where production may be carried
on with the help of purchased factors of production as well.
In the first of the two steps, analysis explains the determination in the
market of (a) the quantity of each resource consumed directly by each con-
sumer, (b) the quantity of each product produced, (c) the method of pro-
duction of each product, and (d) the prices in the market of each resource
and product. Analysis proceeds on lines analogous to those followed in
Chapter 7, where a multi-commodity pure exchange economy was consid-
ered. There a market participant converted his initial commodity bundle
into the most desirable possible alternative bundle available through ex-
change. Here he converts his initial resource bundle into the most desir-
able possible commodity bundle through production as well as exchange.
The principal complication setting the present analysis apart from that
of Chapter 7 arises out of the versatility of resources in production. De-
tailed analysis reveals how, in the absence of perfect knowledge, the market
process would enforce revisions in these more complicated plans of market
participants toward greater consistency between the decisions being made
at different points in the economy.
In the second of the two steps, production may be carried on with
resources acquired in the market. This alters the character of the market
for resources, widens very considerably the scope for production possibilities,
and makes possible the emergence of a distinct producer-entrepreneur
whose activities promote the spread of relevant market information and
the smoothness of the market process.
In this general model of a market system, the conditions for equilibrium
can be described in detail, analogous to those that determined the equilib-
rium position for the preliminary model analyzed in the earlier portion of
the chapter. It is easily shown that here again, equilibrium implies
complete knowledge throughout the market. Imperfect knowledge, on
the other hand, implies disequilibrium, which expresses itself through the
creation of profit possibilities available to those who discover them first.
Detailed analysis reveals the various different kinds of entrepreneurial
opportunities that may be offered by a general market in disequilibrium,
and the way the exploitation of these opportunities tends to correct the
initial inconsistencies existing between the various decisions being made.
264 MARKET THEORY AND THE PRICE SYSTEM


In this way the market process enforces particular production possibilities,
more and more consistent with the underlying data, resource supply, and
consumer tastes.
The analysis proceeds on a step-by-step basis justified by the nature
of the chains of cause and effect relationships involved in the market. An
understanding of the more serious complications from which the analysis
in this chapter has abstracted will lead to the most useful employment of
it in applications to a real world.


Suggested Readings
Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949,
pp. 258-323, 388-394.
Leftwich, R. H., The Price System and Resource Allocation (rev. ed.), Holt, Rine-
hart and Winston, New York, 1960, Ch. 17.
12

JMonopoly and Competition
in the General Market



W E HAVE been examining until now
market processes where the relevant market forces operated principally
through competitive pressures. We saw how the price that each resource
owner obtains for the resources he sells (or the price that each producer
obtains for the products he produces and sells) is determined by what he
deems necessary to offer the market in order to outstrip his competitors.
In the present chapter we consider what can be expected to happen in a
general market where the supply of particular resources (or the production
of particular products) is concentrated in the hands of single market par-
ticipants. Most of the cases we will examine are simpler analytically than
many we have considered in earlier chapters. Nevertheless, monopoly
and related problems should be treated at this stage, because they bring
about modifications in the general market model where they are embedded.
In introducing these problems we must be aware of the considerable
terminological confusion that surrounds them. The terms "monopoly"
and "competition" are used in the literature to denote a number of different
market situations. Moreover, economists frequently use these terms quite
differently from laymen. These terms have in turn led to numerous further
terms and combinations of terms in attempts to distinguish numerous
special market situations from one another. We will attempt in this chap-
ter to deal with relatively simple cases specifically relevant to the framework
of analysis developed in earlier chapters, and we will try to avoid fruitless
terminological disputes. As a result, several of the cases that we will
consider possibly will not fall neatly into the terminological pigeonholes
that have become popular in the specialist literature on the subject.
265
266 MARKET THEORY AND THE PRICE SYSTEM


THE MONOPOLIZED RESOURCE
Suppose that starting from a given day, in the model of the general
market considered in the preceding chapter, a particular resource hitherto
present in the endowments of many participants, regularly appears (in
the same aggregate quantity as previously) in the initial endowment of only
one market participant. How would this affect the various prices, volumes
of output, and methods of production on the general market? 1
The favored resource owner now finds himself in a situation quite

<< . .

. 29
( : 36)



. . >>