Market Theory and the Price System. Israel M. Kirzner

       INTRODUCTION TO THE LIBERTY FUND EDITION

      Market Theory and the Price System was published in 1963 as Professor Israel M. Kirzner’s first (and only) textbook. It was also his second book publication after that of The Economic Point of View, three years earlier. Market Theory and the Price System tackles the common subject of price theory, which was part of the training of young economists at the time (and still is). While Professor Kirzner’s textbook filled a gap in the market by presenting an integrated view of Austrian price theory in contrast to the Chicago approach, the book never became a commercial success, which is not surprising considering the intellectual atmosphere when it was published.

      Israel Kirzner has described his graduate education in economics at New York University (NYU) as one of confusion. One night a week he learned standard price theory through George Stigler’s Theory of Price (1946), and on another night of the week he learned about the market process from Ludwig von Mises and his classic work Human Action (1949).¹ Both approaches were diametrically opposed to the macroeconomics of Keynesianism, which was also taught at the time; thus, by virtue of that opposition alone, the two works seemed to be intellectually aligned. However, there were also subtle differences in emphasis and especially style of presentation that gave Kirzner food for thought.

      According to Kirzner himself, he started out his career as a theorist only to learn that in the eyes of his colleagues he was a historian of economic thought. Kirzner was (and remained to the end of his teaching career at NYU) an economic theorist. He specialized in market theory and the price system. As his work matured, he came to focus primarily on the role that the entrepreneur played in the market economy. Market Theory and the Price System was his first systemic attempt to examine how the logic of action enables us to understand the workings of the market economy.

      The book, originally published in 1963 (with no subsequent editions), had been part of a series of works by the Volker Fund to make sure that economic teaching did not come completely under the sway of Keynesianism.² Published one year earlier, in 1962, Murray Rothbard’s Man, Economy, and State provided a systemic treatise on the principles of economics. In contrast, Kirzner’s work was more or less an intermediate-to graduate-level textbook in price theory. Thus, read in tandem, these books represented an Austrian school of economics alternative to the approach of both the Chicago School of Milton Friedman and George Stigler and the Massachusetts Institute of Technology–Harvard economics of Paul Samuelson. The fate of both books in the marketplace of economics texts in the 1960s is indicative of the state of economic research and teaching at the time. The technical nuances of the approach of Roth-bard and Kirzner were missed.³

      However, even within the Austrian camp, some disagreement arose over the way to present price theory. In a memorandum to the Volker Fund dated December 1961, Rothbard raised critical objections to Kirzner’s book.⁴ Rothbard argued that “What Prof. Kirzner had done is, so to speak, to carry water on both shoulders.” Market Theory and the Price System, by Rothbard’s reading, was fundamentally a Stiglerian work in the refinements of price theory infused here and there with Austrian insights and obligatory qualifications. Rothbard failed to see the subtle argument that was emerging from Kirzner’s analysis of the market system.

      Kirzner’s textbook sought to communicate the basic insights from Philip Wicksteed and the founders of the Austrian School of Economics to a new generation of economic students. As he puts it in the preface: “Whatever the author may have learned from Marshall, Edgeworth, and J. B. Clark, this book probably will reveal that he has learned more from Menger, Böhm-Bawerk and Wicksteed” (1963, vii). The basic idea of the book was to utilize the tools of economics reasoning to explain the market process. Kirzner states his intent clearly:

      The approach adopted in this book views the market as a process of adjustment. In this process individual market participants are being forced continually to adjust their activities according to patterns imposed by the activities of others. Market theory then consists essentially in the analysis of these step-by-step adjustments and of the way the information required for these adjustments is communicated. Equilibrium positions are not, as in other books, treated as important in themselves. They are rather seen as merely limiting cases where the market process has nothing further to do, all activities being already mutually adjusted to the fullest extent. (1963, vii)

      This is what Rothbard ironically misunderstood in his “water on both shoulders” comment.⁵ The equilibrium properties of markets as discussed in Stigler (and also Kirzner) are not logically wrong. However, they hold only when the mutual adjustments through exchange have been fully realized and the plans of the different agents in an economy are perfectly coordinated. Still, this knowledge of the limit theorems of the market system is vital to understanding the tendencies and direction of the processes of adjustment. However, the bulk of economic explanation must be on the continual adjustment of market activity that is guided by relative price movements and the lure of pure economic profit and the penalty of loss. The market economy is defined in Kirzner’s system not by a state of affairs, but instead by an intricate matrix of human interdependencies in the realm of exchange relations and production decisions.

      Central to Market Theory and the Price System is coordination—the critical question of any economic system. It is not just a matter of the allocation of scarce resources, but the coordination of activities such that the most willing demanders and the most willing suppliers have their plans dovetail through mutually beneficial adjustments through exchange. The unique framework Kirzner develops for microeconomic analysis, following Mises and Hayek, opens up for examination error in decision making, entrepreneurial profit, and competition as a process of discovery and learning. As Kirzner explained in an interview in 2006, in the book he was trying to bridge a gap between the neoclassical view of the market and what he understood Mises as saying about the market process. No one at the