Market Theory and the Price System. Israel M. Kirzner
mastered, then more complex and particular market situations can be dealt with by logical extensions of the theory.
In our study, for example, we ignore the possibility of trade between two separate market economies; we therefore do not study the theory of international trade with its impact on the market process within each country. Again, in our study, we almost completely ignore the special role played by the government as an economic agent; we therefore do not study the theory of public finance and the modifications brought about in the market process by governmental taxation, expenditures, or debt. We do not consider, in our study, the numerous complexities that are introduced into the market process by the various possible institutions connected with money; we therefore do not study monetary theory. In the same way (and partly as a result of these simplifications) we do not consider the possibility that market forces might arise that can disrupt periodically the smooth operation of the market process; in other words we ignore the necessity to construct a theory of the trade cycle; and so on.
In our study, therefore, we construct the theoretical framework within which all aspects of the economic theory of a market economy must be set. We follow through the fundamental market forces upon which and through which the impact of any special, additional economic forces will be felt. The theoretical attack upon any particular economic problem in the market must then be carried out against the background of this general and widely accepted theory of the market.
Economic theory thus embraces a range of theorems covering many more problems than are treated in this book. Moreover, as we have seen, the subject economics in turn customarily involves much besides economic theory. The study of an economic problem will typically involve much more than theory, and even for the purely theoretical aspect of such a study, the propositions of general market theory will be only partially satisfactory. The skilled economist must scan the data, using his theoretical competence to suggest or to detect matters requiring further explanation. In seeking such explanation he must apply his theoretical tools to the masses of data he believes to be relevant. It is not the task of market theory to set forth the methods by which the economist can most successfully use the empirical data at his disposal or the methods by which he can most skillfully apply theoretical tools to such data.
Market theory provides the basic tools required for even the most preliminary approach to economic problems. More specialized tools, in the form of the propositions of particular branches of economic theory, may be required to analyze specific problems. These tools, too, depend on the availability and quality of the basic tools we are about to assemble. The scope of market theory, within economic theory generally and within economics as a whole, is indeed narrow. Despite its narrowness, however, it is market theory that nourishes these wider fields. And in this lies its paramount importance.
Chapter 1 clarifies the relationship between the theory of the market and other branches of economics.
Society consists of individuals seeking to act to improve their positions. A market exists where the individuals are in close enough contact with one another to be aware of mutually profitable opportunities for exchange. A market system exists where the individuals in a society conduct their economic activities predominantly through the market.
Economic analysis reveals chains of cause and effect linking together and coordinating the mass of transactions taking place in the market. Market theory investigates these chains of cause and effect. Market theory is made possible by the unique properties of human actions. These properties are embodied in the act of choice among alternatives, an act that the observing mind of the economist can “understand.” Complex market phenomena may then be “understood” by relating them to individual acts of choice.
Economic theory is abstract, selecting only the key features of an economic situation for use in subsequent reasoning. Economic theory is general; its conclusions have validity for a wide range of possible real situations. Market theory provides the general framework for the analysis of a market system. Within this broad framework the various specialized branches of economic theory deal with more complex special cases. The theory in this book thus proceeds by drastic simplification.
SUGGESTED READINGS
Robbins, L., An Essay on the Nature and Significance of Economic Science, The Macmillan Co., London, 1935.
Hayek, F. A., “The Facts of the Social Sciences,” in Individualism and Economic Order, Routledge and Kegan Paul Ltd., London, 1949.
Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949, pp. 1–71.
Stigler, G. J., The Theory of Competitive Price, The Macmillan Co., New York, 1942, Ch. 1.
THE MARKET: ITS STRUCTURE AND OPERATION
In this chapter and in the next, we survey the market, its overall operations and achievements. Later we will analyze, separately, the different functional sectors that compose the market, and how these various sectors interact within the market. Here, we will contemplate the forest in its entirety, before scrutinizing the separate trees, and then examine the consequences for the other trees of the existence and growth of each separate tree.
THE CONDITIONS UNDER WHICH THE MARKET OPERATES
We are considering the theoretical operation of a market system. The model of the market we will be working with can be characterized by the set of ideal conditions governing the model, which we construct for the purpose.
In a market system each member of the society is free to act, within very wide limits, as he sees fit. Moreover, the system operates within a framework of law which recognizes individual rights to private property. This means that each individual is free at each moment to employ the means available to him for the purpose of furthering his own ends, providing only that this should not invade the property rights of others. At the same time each individual can plan his activities with the assurance provided by the law, first that the means available to him at any one time are secure against appropriation by others, and, then, that he will not be prevented by others from enjoying the fruits of his productive activities.
The system recognizes the rights of individuals to enter into arrangements with one another which they believe will be of mutual benefit. Individuals may act cooperatively either by pooling their resources to produce jointly, or by each agreeing to specialize in one kind of production and to exchange parts of their production, or by the one agreeing to furnish productive services to the other in return for finished products or their equivalent. Our ideal system may be thought of as, in one way or another, ensuring the smooth fulfillment of such cooperative arrangements. Contracts are made in good faith, and contractual obligations are fulfilled to the letter.
Members of the system, being human beings, at any one time have likes, dislikes, and preferences; each follows his own moral standards. Each member acts to fulfill “his own” purposes: but these purposes are not necessarily “selfish” ones and they may be directed toward alleviating the pain of others; and so on. Each member has more or less imperfect knowledge of the facts surrounding his field of action; each, in some degree, possesses curiosity, intelligence, determination; each has potential or actual talent for some or other activities, depending on his (natural or acquired) physical and other qualities.
Members of the system need not be aware of the entire scope of the market system or of the theory of its operation, but we may assume them to be generally content to seek to achieve their purposes within the framework of the system as they find