Value & Capital, CHAPTER XVI, Section 3

This section begins by identifying three categories of influences on price-expectations.  The first is non-economic influences such as "the weather, the political news, people's state of health, their 'psychology.'"  The second category is economic influences that are "not closely connected with actual price-movements."  The author describes this category as ranging all the way from "market superstitions" on one extreme, to market-related news such as crop reports on the other.  Although the author says that we must never forget the existence of these first two categories of influences on prices (which he calls "autonomous causes"), he does not consider them topics for analysis.  The third category, which he begins to discuss in more detail, includes actual experience of prices, both past and present.

For this third category, the author notes that past prices and current prices affect expectations "in very different ways, and so it makes a great deal of difference which influence is the stronger."  The extreme case is that in which the influences of past prices are "completely dominant" and any change in a current price is therefore "treated as quite temporary."  The other cases are those in which the influences of current prices could have different degrees of intensity.

The author lists various cases that characterize the possibilities for influence of current prices on expectations.  He does this by first defining "a measure for the reaction we are studying."  This measure is the elasticity of expectations, which he defines, for a commodity X, as "the ratio of the proportional rise in expected future prices of X to the proportional rise in its current price."  The case of elasticity of 0 corresponds to the case of no influence, described earlier.  If the elasticity were 1, "a change in current prices will change expected prices in the same direction and in the same proportion."  (As a further example, if the elasticity of expectations for some commodity is 0.75, and its current price rises by 20 percent, then we would expect future prices to be only 15 percent higher, instead of 20.)  The author also considers more extreme cases;  for instance, an elasticity of greater than 1 would mean that "a change in current prices makes people feel that they can recognize a trend, so that they try to extrapolate."  Conversely, a negative elasticity makes people feel that a price change is "the culminating point of a fluctuation" (and hence that future prices will be lower than before).

The author concludes that "the second pivotal case (that in which the elasticity of expectations is unity) is of such importance that we ought to make a practice of working out that case whenever it is relevant."  He closes out the current section by previewing that the upcoming discussion will cover the working out of this case.