Value & Capital, Chapter XX, Section 5

In this section, the author reverts to his earlier assumption that the economy being analyzed includes the circulation of money, which does not bear interest.  He then sets up a test of stability for a system in which elasticities of expectations are unity, and the interest rate is fixed, while the price of some commodity, which he calls commodity X, rises by 5%.  If the system is to remain stable, the price rise in commodity X should induce price changes in the other commodities, such that the result is an excess supply of commodity X.  If only some of the other commodity prices are analyzed, there is not a problem.

But when we consider the repercussions on all other markets (but not the market for securities, since the rate of interest is taken as given, and not the market for money, since it is not independent from the rest), then we seem to move into a different world.  Equilibrium can only be restored in the other commodity markets if the prices of the other commodities all rise by 5 per cent. too.

The problem is that under these assumptions, the ratios of prices between given commodities remain unchanged, and therefore "there is no opportunity for substitution anywhere."  As the author describes it, such a system is "in 'neutral equilibrium'; that is to say, it can be in equilibrium at any level of money prices."

As he goes on to explain, if elasticities of expectations are greater than unity, the system is definitely unstable."  The case in which elasticities of expectations are equal to one is therefore a rather important special case.  

Technically, then, the case where elasticities of expectations are equal to unity marks the dividing line between stability and instability.  But its own stability is a very questionable sort.  A slight disturbance will be sufficient to make it pass over into instability.

The author concludes this section by going through a simple argument, based on a rise in demand for a single commodity, to conclude that "when elasticities of expectations are equal to unity, the system is liable to break down at the slightest disturbance."