Market Theory and the Price System. Israel M. Kirzner
his position). He is free to act in isolation, and he is free to engage in acts of exchange with other individuals (whenever he and some other individuals both perceive the opportunity of mutual benefit through trade). As we shall find, such opportunities for mutually advantageous exchange arise constantly in society. Moreover, the exploitation by individuals of these opportunities opens up yet further opportunities of the same kind, both to the individuals themselves and to others in the society. A market exists whenever the individual members of a society are in sufficiently close contact to one another to be aware of numerous such opportunities for exchange and, in addition, are free to take advantage of them. A market economy exists wherever the ramifications of the market become so widespread and the opportunities it offers so numerous and attractive that most individuals find it advantageous to carry on their economic activities predominantly through the market rather than on their own.
The market economy is thus to be distinguished, on the one hand, from the autarkic economy, where individuals carry on their economic activity isolated from one another, being unaware or unwilling to take advantage of opportunities for exchange. On the other hand, it is to be distinguished from the centrally controlled economy where economic activity of individuals is directed by a central authority so that, although transfers of goods among individuals may be ordered by the central authority, individuals are not free to take advantage of exchange opportunities which they themselves may perceive. It is unlikely that any one of these three types of economies will exist historically in its theoretically purest form. To some extent, limited market activity is likely to arise even in the most primitive and autarkic of societies, whereas even the most rigid of centrally controlled economies leaves room, legally or illegally, for some market-type activity between individuals. Finally, even the most fully developed market economy is incapable of making it advantageous for individuals to seek the satisfaction of all their wants exclusively through the market. (Most men, for example, turn to the market for a haircut but not for a shave.)
In the developed market economy, the conditions of production have become adjusted to the market requirements. Over a period of time, individuals acting through the market have succeeded in setting up an organization of production and exchange which, in turn, has widened the market until it has embraced the bulk of all economic activity in the society. In such a system, as in any system where the individual is relatively free to act as he pleases, men seek to improve their positions with the means at their disposal. But, whereas the isolated individual can improve his position only by adjusting himself to, and manipulating, the conditions imposed by nature, in the market economy the individual acts to take advantage also of the conditions and opportunities made available by the market.
The salient fact that emerges from this discussion is that any description of market activity means the description of individual activity, but also that the activity of each participating individual in the market is conditioned by the actions of other participating individuals (either in the past or as anticipated in the future). It is this insight, we will discover, that is the basis for the economic analysis of the market system and of the processes that take place in the market.
To the casual observer, market activity seems to be a bewildering and uncoordinated mass of transactions. Each individual in the market society is free to buy what and when he pleases, to sell what and when he pleases, to produce or to consume what he pleases, or to refrain altogether from any or all of these activities. Transactions may involve any of innumerable commodities or services, they may involve any of a wide range of quantities and qualities, and they may be concluded at any of a wide variety of prices.
Economic analysis reveals that this seeming chaos in the activity of market participants is only apparent. In fact, analysis shows that the exchanges that take place are subject to definite forces at work in the market. These market forces guide the individuals participating in the market in their decisions. Each market decision is made under the stress of market forces set up by the decisions, past or expected, of all the market participants. During any given period, therefore, the decisions made by individual market participants constitute an interlocking system embracing the entire scope of the market. This network of decisions constitutes the market system. The end results of all these decisions make up the achievements of the market system; and the tasks which society may seek to fulfill by permitting a market economy are the assigned functions of the market system.
The importance of the market system and of its analysis is not simply the discovery that decisions are made under constraints set up by other decisions. Market system analysis, we will discover, reveals a remarkable feature in the operation of these constraints, and it is chiefly this feature that invests market theory with its importance. The real significance of the market system lies in the fact that the mutual interplay of these constraints makes up a unique process through which the decisions of different individuals (who may be quite unknown to one another) tend to be brought progressively into greater consistency with each other.
Consistency and correspondence between the decisions made by different market participants are of the first importance in any successful execution by the market of its functions. If all potential members of the labor force decided to train themselves as skilled watchmakers, a catastrophic aberration of individual decisions would exist. After all, a decision to become a watchmaker depends on the confident assumption that some other people will be barbers, tailors, etc.
The free interplay of individual decisions in the marketplace constantly generates new forces modifying and shaping the delicate, sensitive, and interlocking decision network that makes up the system. It is the task of market theory to trace the consequences of these market forces, paying particular attention to the degree in which they constrain independently made decisions into mutually corresponding and concordant systems.
THE FOUNDATIONS OF MARKET THEORY
The construction by economists of the body of propositions that make up market theory is founded upon their consciousness of the existence and the nature of economic law. The recognition of “laws” in economic affairs implies the understanding that apparent chains of causation prevail in social events, just as in the physical world. Acts of individuals in the market are perceived as taken in consequence of definite acts, prior or anticipated, of other individuals. What goes on in the market at any one time is to be ascribed to what has gone on in the past, or to past anticipations as to what will go on in the future. Market phenomena do not emerge haphazardly in a vacuum; they are understood to be uniquely “determined” by market forces.
While the essential concept of a law of economics is thus quite parallel to that of a law of physical nature, the two kinds of law have little further in common. Laws of physical nature are inferred from the observation of sequences of physical events. Economic laws, as we shall see, are founded on our understanding of the influence that a given event will have upon the actions of individuals.
To be sure, the laws of physical nature are also operative in the spheres of human activities. A heater raises room temperature, and ice lowers the temperature in the ice box; human beings are more comfortable at some temperatures than at others, and food keeps better at some temperatures than at others. These physical, physiological, or biological laws must be considered in any attempt to “explain” why men buy heaters or ice. The recognition of economic law involves the insight that, even after the physical, physiological, and psychological sciences have been utilized to the utmost in tracing the influences that have helped determine an economic “event,” there still remain significant elements that have not been traced back to prior causes. These elements, in the absence of an economic theory, would have to be considered as undetermined by any causal forces. The recognition of economic law means the perception of determinate causal chains constraining the course of events insofar as these are left undetermined by physical, physiological, or psychological laws.
Consider, for example, the consequences upon the price of