In the next chapter we review briefly what the market process achieves. In the later chapters we turn back to examine in greater detail how market forces are transmitted, make themselves felt, and initiate adjustments. In addition we will see more specifically how each participant in the market economy plays a definite role in the whole process.
Chapter 2 surveys the overall operation of a market system.
A market system is characterized by a framework of law that broadly recognizes individual freedom, responsibility, and private property rights. Market theory assumes the use of a medium of exchange.
In a market system individuals may fill the roles of consumer, resource owner, and/or entrepreneur. The chains of cause and effect that are expressed through market forces operate through the typical structural interdependence existing between the decisions made by consumers, resource owners, and entrepreneurs. Vertical relationships between market decisions exist when goods and services are bought for later sale; for example, when resources are bought by entrepreneurs from resource owners to be used in production and sold in the form of the product to consumers. Horizontal relationships exist, for example, when two different products require the use of the same resource in their production; or where a product may be produced with either of two resources that are substitutes for one another.
A market is in equilibrium when all decisions dovetail with each other. Disequilibrium exists when some decisions cannot be executed because they have been planned on the basis of mistaken assumptions concerning the decisions of others. The market process consists in the adjustments that are enforced upon individual decisions by the disappointments experienced in a disequilibrium market. The economic theorist may confine his attention to a limited series of adjustments that may be wrought out within the market system. He will recognize that the situation where all these limited series of adjustments have fully worked themselves out is one of only partial equilibrium. For the entire market system to be in equilibrium—that is, for a general equilibrium to prevail—each of the separate sectors of the market must be in harmony with each of the others. Market theory recognizes the existence of chains of cause and effect between all the market sectors as well as within each of them. The general market process comprises all the adjustments enforced upon the market activities of resource owners, consumers, and entrepreneurs throughout the system by an initial failure of all their decisions to dovetail perfectly with each other.
SUGGESTED READINGS
Menger, C., Principles of Economics, Free Press, Glencoe, Illinois, 1950, Chs. 1, 2.
Stackelberg, H. v., The Theory of the Market Economy, Oxford University Press, New York, 1952, Chs. 1, 2.
Hayek, F. A., “Economics and Knowledge,” in Individualism and Economic Order, Routledge and Kegan Paul Ltd., London, 1949.
EFFICIENCY, COORDINATION, AND THE MARKET ECONOMY
In this chapter we complete our broad preliminary survey of the theory of the market system, its operation and achievements. Chapter 2 attempted to provide a bird’s-eye view of the way the market transmits economic forces through the system, tending to make the actions of all market participants dovetail more closely in the system. The present chapter demonstrates how these interactions in the market economy enable it to fulfill the basic functions of any system of organization. We are not concerned here with what the market process is or with the patterns of relationships the process consists of, but with how it accomplishes what it is supposed to accomplish. Some remarks are necessary to make clear, at the very outset, the point of view from which such an appraisal can be undertaken.
Social phenomena can be examined from two distinct points of view. First of all, they can be examined merely positively. Chains of cause and effect can be proved to exist; the likely effects of particular changes can be foretold; the probable responsibility of particular prior events for definite current phenomena can be explained. Social phenomena, however, can be examined in addition from a normative point of view. The way prior causes bring about subsequent events can be judged by the success with which the process fulfills definite goals (believed by the investigator to be cherished by someone concerned with the usefulness of the process). A breakdown in a commuter bus service may be seen positively as responsible for highways swarming with an unusual number of private cars. It may be “blamed”—normatively—for the inconvenience experienced by those who use the bus service for a convenient means of transportation.
The economic theorist, too, is able to view his subject matter from both these perspectives. He may simply trace through the operation of market forces. Or he may, in addition, appraise the market from the perspective of one or other aspects of the “economic problem.” Although the concept of an economic problem is most frequently discussed with respect to an entire society, the idea is fundamentally one relating to the individual. For an individual, the economic problem consists in ensuring that the resources at his disposal be utilized in the most effective manner possible—from the point of view of the goals which he has set up. Successful solution of this economic problem requires that the individual apportion resources to promote his various adopted goals in a pattern that will faithfully reflect the hierarchy of importance to him of the various goals. If he desires goal A more urgently than goal B, and the available resources are insufficient for both goals, a “correct” solution of the economic problem requires that he allocate his resources to A rather than to B; and so on.
From the perspective defined by the goal of correctly solving his economic problem, an individual may judge his actions as being either efficient or otherwise. From the point of view of his own chosen goals, considering the varying degrees of urgency that he has assigned to these goals, the individual may frown at a particular course of action as being at variance with his goal program. Such a course of action is “inefficient,” “wasteful,” and “irrational”; it fails to aim at the most important of the chosen goals.
The goal of “efficiency” is not really a separate goal in its own right. Efficiency is nothing else, in the present context, than the consistent pursuit of other goals. Consistency in the pursuit of goals calls for a refusal to apply resources to achieve one goal when this implies forsaking a still more highly cherished goal. Inefficiency is thus synonymous with inconsistency. An inefficient course of action is one that is inconsistent with a given program of goals. A course of action that is inefficient with respect to one set of goals may be highly efficient with respect to a different set. But the point is that, in making plans, individuals have in mind given sets of goals. With respect to this set of goals, they seek a consistent, efficient course of action.
SOCIETY AND THE ECONOMIC PROBLEM
Economists frequently speak of the economic problem facing society. What they usually have in mind is something closely similar to the economic problem faced by individuals. But the legitimacy of this interpretation of the term “economic problem” is by no means clear, and the limitations on its use in this sense must be understood. Discussions that deal with the economic problem facing society assume a group of human beings, on the one hand, having numerous