Value & Capital, CHAPTER X -- EQUILIBRIUM AND DISEQUILIBRIUM

In this first section of Chapter X, the author, Sir John Hicks, begins with a summary of the general method he will be using to apply equilibrium analysis to dynamic theory.  As described in Section 4 of the previous chapter, prices will be assumed to be set each Monday.  Everything that has happened up to that time must be treated as data, not subject to change.  In particular, we take as given "the whole material equipment of the community," including finished goods ready for sale, raw materials, and goods at every stage of production in between, along with the physical plant and durable consumer goods already purchased.  "From now on, the economic problem consists in the allotment of these resources, inherited from the past, among the satisfaction of present wants and future wants."

As described in Section 5 of the previous chapter, entrepreneurs and private persons are assumed to draw up plans for their conduct during the current week and in future weeks.  The plans of private persons include quantities of commodities they plan to purchase at present and at future times (and possibly quantities of services to supply).  The plans of entrepreneurs include quantities of inputs to production to be purchased or hired in the current week and future weeks, as well as quantities of outputs to be produced for sale at these times.

As explained in Section 6 of the previous chapter, these plans incorporate expectations about future prices. If the supply and demand in the current week cause the price of some commodity to differ from those expectations, the plans will be revised accordingly.

By assumption, trading happens on Monday and brings supply and demand into equilibrium;  this assumption "is essential in order for us to be able to use the equilibrium method in dynamic theory."  Hicks explains that the current discussion will not focus on the process by which equilibrium prices are formed (referring the reader instead to the end note of the previous Chapter).  "[O]ur method seems to imply that we conceive of the economic system as being always in equilibrium.  We work out the equilibrium prices of one week, and the equilibrium prices of another week, and leave it at that."

Value & Capital, Note to Chapter IX -- THE FORMATION OF PRICES, section 2

The second section of the end note for Chapter IX examines whether Marshall's argument regarding the effectiveness of the trial-and-error process of fixing prices can be extended from the simple "fish market" case Marshall considers to the more general setting that Hicks envisions. The discussion here argues that the effect of "false trading" (meaning trades that happen at prices different from the equilibrium prices) will be to create gains and losses that are "the same in kind as the income effects which may have to be considered even when we suppose equilibrium prices to be fixed straight away."  These income effects have been shown again and again to cause "indeterminateness" in the results derived earlier in the book. (The term "indeterminateness" here appears to mean a lack of precision in the theoretical predictions due to the limitations of the assumptions.)  The text goes on to note that "All that happens as a result of false trading is that this indeterminateness is somewhat intensified.  How much intensified depends, of course, upon the extent of the false trading; if very extensive transactions take place at prices very different from equilibrium prices, the disturbance will be serious."

The discussion goes on to argue that there should not be a large volume of trades happening at "very false" prices.  One of the justifications for this conclusion relies on intelligence in the fixing of prices.  Another justification is explained (perhaps a bit too briefly in the text, in my opinion) by the fact that "gains to the buyers mean losses to the sellers, and vice versa."  There is a footnote reference to p. 64, which is part of Section 2 of Chapter V, where Hicks explains that the income effect of a fall in price tends both to increase demand and to increase supply.  This is because, if sellers are similar to buyers, they will consume some of the commodity they supply, but with lower income they will consume less of it, leaving more to be supplied to the buyers.  Thus the income effect increases both demand and supply, so there is some cancellation of the income effects when it comes to determining excess demand (and hence price at equilibrium).

Hicks concludes the note by explaining that the "arbitrariness" in the practical application of these results is a consequence of assuming the markets to be open only on Mondays, with a relatively long period in which the prices determined that day hold constant.  If we wish to reduce that arbitrariness, he explains that we can do so by thinking of the "week" as being shorter.

Value & Capital, Note to Chapter IX -- THE FORMATION OF PRICES

In this section, the first of two sections comprising the end note for Chapter IX, the author examines Alfred Marshall's argument that (in Hicks's words), "the process of fixing prices by trial and error, necessary when market conditions are changing, need not have any appreciable effect upon the prices ultimately fixed."  The essential step in the argument is the assertion that "a change in price in the midst of trading has the same sort of effect as a redistribution of wealth."  Such a change is illustrated with an example in which an initial "false" price (Hicks's term of convenience for a price other than the equilibrium) is agreed upon for a given commodity:  the false price is chosen to be 10 dollars per pound, whereas the equilibrium price is 6 dollars per pound.  Suppose a person buys 3 pounds at the false price, but the market price soon drops to equilibrium.  This buyer's position is exactly the same as if the price had been 6 dollars per pound all along, but the buyer had been forced to cough up an extra 12 dollars to the seller.  The buyer's demand and seller's supply will be exactly the same in the two scenarios.   The effects of this sort of transfer are income effects, and as noted here, Hicks has repeatedly shown that "income effects can be very frequently neglected."  In Marshall's example the amount spent by the buyer on the commodity in question is assumed to be a small fraction of his resources; thus a price change will not have a large effect on the total value of these resources.  Hicks quotes Marshall as saying that this assumption "is justifiable with respect to most of the market dealings with which we are practically concerned.  When a person buys anything for his own consumption he generally spends on it a small part only of his total resources."  The buyer could be made better or worse off by the initial trading at the false price -- but only slightly in the big scheme of things -- so there will not be a significant effect on his demand for the commodity.  As a result, "the market must finish up very close to the equilibrium price."