Market Theory and the Price System. Israel M. Kirzner
in each of these markets are likely to be selling their products in the same lower market. Or again, the market in skilled labor for the production of automobiles is related horizontally to that for steel, because the resources sold in both these markets are combined and sold jointly in the automobile market; and so on.
Clearly, the decisions of buyers or sellers in any such markets will have to be between alternatives that are conditioned, not only by the decisions of competing buyers or sellers in the same market, but also, in part, by the decisions of buyers or sellers in the horizontally related markets. The price of steel to producers of washing machines will be determined partly by the strength of the demand for automobiles; the price that a skilled automobile worker can obtain for his labor will be determined in part by conditions in the steel market; and so on.
It should be clear from our discussion of the complexity of vertical market relationships that horizontal relationships, too, may be far from straightforward. Two markets may be related by different strands of connectedness, some of which may be vertical, others horizontal, in character. For example, sellers in the iron-ore market and sellers in the steel market may both buy the services of unskilled labor in the same labor market.
Several points of great importance ought to be made at this stage concerning the division of the market system into separate “markets.” It must be recognized that any such division is quite arbitrary and is made by the market theorist only as a matter of convenience. Moreover, there are significant problems where the theorist finds it convenient to stress the lack of such watertight divisions. The fact is that in the most important sense, the entire market system is one market. Each market participant is a potential customer for each good offered for sale and a potential entrepreneur in the production of every conceivable product. There is interconnectedness between every single market decision and every other single market decision made in the system. The price paid for a shoeshine at one end of the country is connected, however tenuously, with the prices paid for the rental of high-speed computers at the other end of the country, so long as both points are within a single market system. Nevertheless, there are clearly various degrees of connectedness. The price of computer rentals is obviously more directly sensitive to changes in the attitudes of buyers and sellers of computers than to changes in the tastes or incomes of customers for shoeshines. Thus, the theorist finds it convenient to mark off arbitrarily different “markets” within which the connectedness of decisions is more direct than is the case between decisions in different markets. In pointing to various structural patterns between the markets that make up the market system, the theorist is indicating the less direct, more subtle—but over the long run no less powerful—influences that different markets exercise over one another.
THE ANALYSIS OF HUMAN ACTION IN THE MARKET: THE CONCEPT OF EQUILIBRIUM
With the mutual influences that may be operative between markets well understood, it is desirable to consider what goes on inside a market. This is, after all, the kernel of market theory—the logical tracing through of the consequences within a market of given sets of data that impinge upon it.
A market process can be defined as what goes on when potential buyers and potential sellers are in mutual contact. We have seen that the market system as a whole can be treated as a single market, or that it may be treated for convenience as consisting of a number of interconnected markets. Within any market, however conceived, the theorist recognizes that at any one time each participant has definite attitudes concerning what is being bought and sold. At a given point in time, each participant has a particular eagerness to buy or to sell; for each participant there is on his “scale of values” a unique position assigned to each quantity of the commodity to be bought or sold. When a large number of such potential market participants come into contact with one another, many find opportunities for gainful action. Some buy at the going price, others sell; some find it gainful to bid prices higher than those currently quoted; some find it gainful to offer prices lower than the current prices.
The theorist usually attacks the problem of market analysis in the following way. He takes the attitudes of the various market participants, as they are assumed for any one date, and imagines that these attitudes are maintained continuously over an indefinite period of time. He may then describe a pattern of actions for the various participants that, if actually adopted, would not have to be revised. For example, the theorist may suppose that milk suppliers come daily to market with a continuous and constant supply of milk (concerning which their selling attitude is assumed to continue unchanged), and that prospective milk consumers similarly maintain, from day to day, an unchanged degree of eagerness concerning the purchasing of milk. The theorist may then describe terms on which suppliers might sell and consumers buy milk, that, if actually put into practice, would leave no opportunity for any market participant to improve his position in the future through a change in his actions. This fictional construction of the economic theorist is known as the state of equilibrium. The prices the milk is sold at, and the quantities of milk bought at these prices, are equilibrium prices and quantities.
Should the market participants (whose attitudes are assumed to be maintained without change) take actions that do not correspond to those that characterize the equilibrium market, then pressures will emerge on the participants that will lead them to alter their actions. Should, for example, the sellers of milk offer their milk at a price higher than the equilibrium price, then some sellers will find that milk sales are so low that it would be profitable for them to undercut the existing price. The non-equilibrium price would generate economic forces that would ensure that subsequent prices are different; and so on.
The state of equilibrium should be looked upon as an imaginary situation where there is a complete dovetailing of the decisions made by all the participating individuals. Every single supplier of milk, for example, who has decided that he values twenty-five cents more highly than a bottle of milk (and offers milk to the market at this price), is successful in discovering some consumer who happens to prefer a bottle of milk over twenty-five cents (and is willing to buy milk at this equilibrium price). A market that is not in equilibrium should be looked upon as reflecting a discordancy between the various decisions being made. Some of these discordant decisions cannot be successfully consummated in market action; they do not mesh. If sellers of milk charge too high a price, they will not find sufficient buyers. Decisions will have to be revised until a compatibility is attained between decisions that is the condition of a market in equilibrium.
The theorist who fastens his attention on a particular market upon a particular date is well aware that the decisions being made are different from the decisions that would be made in a market that had attained equilibrium. Whatever the current buying and selling attitudes of the market participants might be, they are likely to be somewhat different than on previous dates. Thus, even if previous market activity had succeeded in achieving equilibrium, from the point of view of the previous market attitudes, the situation is no longer one of equilibrium with respect to the new attitudes of buyers and sellers. But the theorist knows that the very fact of disequilibrium itself sets into motion forces that tend to bring about equilibrium (with respect to current market attitudes). If current attitudes were maintained unchanged (and the theorist is of course well aware that they will do nothing of the kind), then the initial state of dis equilibrium would itself tend to bring about an eventual equilibrium. The very fact that some of the decisions and plans currently being made are incompatible with others, so that some individuals must be disappointed, will force market participants to revise their plans in the direction of closer harmony with the other plans being made in the market. If current attitudes, to repeat, were to continue unchanged, then one might expect the plans of market participants to reach eventual full compatibility. Until then, decisions would be continually revised and adjusted. When equilibrium would have been attained, all plans would be carried out successfully and would be therefore maintained without alteration for as long as the basic attitudes continue unchanged.
The market theorist distinguishes, therefore, (a) a process of adjustment during which the market is in agitation, and (b) a state of equilibrium (the imaginary situation that would be achieved if the adjustments set in motion by the current