Market Theory and the Price System. Israel M. Kirzner
quantity that prospective buyers are prepared to buy at this price (or above it), some of the would-be buyers will be disappointed and will be induced to revise their bids.
Thus, the agitation of the market proceeds under the impulse of very definite market forces. Prices offered and bid would be continually changing—even with constancy assumed in the basic production and consumption attitudes of the market participants—as would-be buyers or sellers find themselves forced to offer more attractive terms to the market. A would-be buyer might offer a higher price than before because his previous offer did not fit in with the plans of any prospective seller. Apparently all sellers aware of this previous offer found more attractive alternative ways of disposing of their commodities. A seller would be forced to lower his price because buyers found more attractive uses for their money—either elsewhere in this market, or in some other market altogether.
The general direction toward which agitation in the market is tending should be clear. If unlimited time were allowed for a market to reach its own equilibrium position—that is, if we assumed no change to occur indefinitely either in consumer valuation of the commodity or in producers’ assessment of the difficulty of its production—it is easy to imagine what would finally emerge. There would be a single price prevailing in the market; all sales would be effected at this price. Individuals would offer to sell the commodity at this price, and the quantity that they offer for sale would be exactly sufficient to satisfy those other individuals who are offering to buy the commodity at the prevailing price. No would-be buyer is disappointed in his plans to buy, and no would-be seller in his plans to sell.9
Much of our discussion thus far has concerned the attitudes of individuals at a given point in time, or over a period during which these attitudes are assumed not to change. The analysis of the market under these artificial conditions makes it possible, in addition, to grasp the course of the market process as it would operate in the absence of these restrictive assumptions. Let us consider again the pattern of adjustment discussed in the previous section.
If we permit change to occur in the urgency with which prospective buyers are anxious to acquire the commodity sold in the market, or if we permit change to occur in the conditions governing the production and supply of the commodity to the market, a number of new elements enter into the situation. It is clear, first of all, that with respect to the attitudes of buyers and sellers toward the commodity as of each moment, a different equilibrium situation occurs toward which the market would tend if the attitudes of that moment were maintained indefinitely. Since attitudes are permitted to change, it follows that the market process, the ceaseless agitation of the market, is being continually pulled toward a different equilibrium position. Would-be buyers and sellers who were disappointed in their past market activity—or who, even if not disappointed in the past, do not wish to be disappointed in the future—must revise their bids or offers to make them more attractive to the current market. A quite different importance is now attached to the skill of anticipating future market conditions. Disappointment of plans made by would-be sellers will spur them to undertake production only by their assessment of future demand conditions.
But the basic pattern of market adjustment is applicable in this changing market as well. The disappointments engendered at any one time by the existing absence of equilibrium will help to guide subsequent plans to anticipate the correct future conditions. Since the changes in market data can be expected to proceed only gradually, the success or failure of past plans can provide a fairly reliable indicator of how these plans must be revised in the future. Thus, market forces are still able to direct the agitation of the market in the direction of a uniform market price, and of a correspondence between the quantities offered and demanded in the market at given prices.
Where a considerable change in the basic market attitudes has occurred with abruptness, the consequences are not difficult to understand. The change will make itself felt initially by severely disappointing the plans of buyers and sellers who had been unable to foresee the change. If, for example, the supply of the commodity has been abruptly halted by the sudden unavailability of a vital raw material, then many buyers will find that the price they had confidently expected to obtain the commodity at is no longer in effect. If, to take a different possibility, the emergence of some new product abruptly reduces the dependency of consumers upon the commodity we are considering, then sellers will find that their offers to sell will no longer be accepted at the old prices. In short, any kind of abrupt change will immediately increase the degree of disequilibrium existing in the market, and will therefore initiate fairly rapid and extensive adjustments in the plans of buyers and sellers in the direction of the state of equilibrium corresponding to the new state of affairs.
Our discussion of the pattern of adjustment in the market for a single commodity serves to clarify the nature of the market process as it governs activity throughout the entire market economy. We have seen that it is permissible to consider the market system as a whole, as being made up of many separate markets that have definite and powerful strands of relationship. For the market system as a whole to be in equilibrium, it is necessary for equilibrium to exist within each separate market. Within the market for each commodity, buying and selling plans must dovetail so that no disappointment occurs in the execution of any plan made throughout the system.
So long as the market system as a whole is not yet in equilibrium—that is, so long as “general equilibrium” has not yet been attained—some plans are being disappointed. The disappointed buyers or sellers may revise their plans in several ways. They may offer better terms in the same markets, or they may decide to cease (or reduce) activity in these markets and increase activity in fresh markets altogether. Disequilibrium in any one of the separate markets will thus cause adjustments in the plans made first of all by participants in that market, and then secondarily in the plans made by participants in related markets—whether horizontally or vertically related.
In any event the course of the market process is fairly clear, assuming for the moment that consumer tastes and basic production possibilities are maintained unchanged. As each separate market adjusts to bring correspondence in the buying and selling plans directly affecting it, the ripples of disappointed plans spread gradually into the related markets. Each separate market thus adjusts to disappointments in plans due to both its own initial disequilibrium, as well as to the impact of changes in plans brought about by the adjustments being made in related markets.
In the process of adjustment within each separate market, and between the separate markets making up the entire system, a principal role is played by the entrepreneur. Conditions may exist in separate markets so that adjustments can take place to improve the positions of all concerned. The entrepreneur becomes aware of this situation and undertakes the risk of attempting to make the necessary adjustment. It is through his activity that the relationships between separate markets transmit ripples of change. If, for example, on the market for a finished product, its price is in excess of the sum of the prices of all the resources necessary for its production, as prevailing in the separate resource markets, it is entrepreneurial activity that is at once set into motion by the inconsistency, constitutes itself the condition of disequilibrium, and is responsible for the tendency to bring about ultimate equilibrium in the market.
An important change that occurs at any point in the market system as a whole brings about direct alterations in its immediate market vicinity. Entrepreneurial activity transmits the consequences of these changes to related markets. Through the impersonal medium of altered prices, participants in other, possibly remote, parts of the market system are forced to adjust their plans to the changed conditions. The ceaseless agitation that is characteristic of a market economy becomes now for the market theorist a determinate process that is set into motion in a very definite way in response to fundamental changes in the basic data with which the market grapples. Movements of prices; growth of new industries; expansion or contraction of existing firms; the adoption of new methods of production;