Value & Capital, CHAPTER X, Section 3

This section discusses several possible causes of disequilibrium in a dynamic economic system.  One of them comes about when individuals differ in their expectations of prices. But the text argues that unless the expectations are "very definite" there are unlikely to be serious effects (in fact, the text calls this "perhaps the least important" cause of disequilibrium).

A second possibility arises when individuals' plans are inconsistent (even though their price expectations might be consistent).  In particular, when planned supply for some commodity (meaning the total quantity that all sellers plan to sell) is greater than planned demand (the total that all buyers plan to buy), the new price must be lower than it had been expected to be.  The text says this case "is evidently a potent cause of disequilibrium; it is perhaps the most interesting cause of all." 

A third possible cause is incorrect foresight by individuals as to their future preferences, or their estimates of the outputs of production processes.  When these preferences or production outputs are realized, some individuals "will find themselves unwilling or unable to buy or sell those quantities of goods they had planned to buy or sell."  As in the previous case, the new prices will be different from those that had been expected.  Further, as the text notes, "the imperfect foresight of some persons will put others too into disequilibrium."

The text argues that these three possible causes are the only ones that could arise when price expectations are definite.  A fourth possibility arises from the fact that, in real life, price expectations are uncertain.  The discussion notes that the effect from this possibility is not disequilibrium in the sense of instability, but disequilibrium in the sense of being an "imperfect equilibrium."  The explanation goes as follows:

when risk is present, people will generally act, not upon the price which they expect as most probable, but as if that price had been shifted a little in a direction unfavourable to them.  Now this means that even if no disequilibrium in any of the above senses is present ... still the most perfect adjustment of resources to wants may not be reached. ... [T]heir sense of risk may have prevented entrepreneurs from producing those quantities of output, which they would have produced if they had been more confident that their anticipations were right.  In this way, the efficiency of the system may be very seriously damaged, without any of the types of disequilibrium mentioned above coming into question.

The discussion notes next that this lack of confidence is a possible, though not a necessary, source of waste.  "Putting insufficient faith in good judgments is a source of inefficiency; but skepticism about bad judgments may be better than implicit trust."  The section then closes with the intriguing comment that "we shall find as we go on that there are reasons for suspecting that the economic system loses more by mistrust than by over-confidence."

Value & Capital, CHAPTER X, Section 2

This section explores the senses in which the dynamic economic system is either in or out of equilibrium.  In one sense, it is always in equilibrium, because one may think of current supply and demand as being equal in competitive conditions.

Stocks may indeed be left in the shops unsold; but they are unsold because people prefer to take the chance of being able to sell them at a future date rather than cut prices in order to sell them now.  The tendency for the current price to fall leads to a shift in supply from present to future.

The discussion goes on to note that in another wider sense, the economy is always out of equilibrium to some extent.  Beginning with the observation that prices established on the first day of trading will govern the plans and the allocation of resources throughout the intervening time until new prices are determined, the implication is that the second set of prices may differ from the first one.  The discussion argues that constancy of prices should not be required for equilibrium in an economy subject to change;  rather the more important test is whether the second set of prices realized in the economy "are the same as those which were previously expected to rule at that date."  In other words, "In equilibrium, the change in prices which occurs is that which was expected."  Hicks goes on to describe such an economy, in which preferences and resource quantities are what they were expected to be, and plans need not be revised because "no one has made any mistakes" as being "like the sun in Faust."  Here Hicks gives a quote in German without translation.  Fortunately, we have Google Translate to help us get an (approximate) English version, which is "Her predecessed journey she accomplished with thunder."

No economic system exhibits perfect equilibrium over time, as Hicks notes.  He makes the intuitive claim that equilibrium is "usually approached most nearly when conditions are nearly stationary; when people expect prices to remain steady, and they do remain steady."  Conversely, acute disequilibrium (in the sense that "expectations are cheated and plans go astray") is most likely "in times of rapid price-movement."

There are two final points worth noting from this section;  both are topics treated briefly, but both seem significant.  The discussion about the degree of disequilibrium notes that "the expectations of entrepreneurs are in fact not precise expectations of particular prices but partake more of the character of probability distributions."  Therefore "the realized prices can depart to some extent from those prices expected as most probable, without causing any acute sense of disequilibrium."  The second point is that the divergence between expected and realized prices, despite offering some "latitude" in applying the concept of equilibrium, represents economic loss.

Whenever such a divergence occurs, it means (retrospectively) that there has been malinvestment and consequent waste.  Resources have been used in a way in which they would not have been used, if the future had been foreseen more accurately; wants, which could have been met if they had been foreseen, will not be satisfied or will be satisfied imperfectly.

The next section will begin to explore how disequilibrium arises.

Historical note:  The New York Times this morning (22 February 2017) contains the obituary of Kenneth Arrow.  Professor Arrow was mentioned in the second post of this blog.  I am considering blogging on Arrow's 1950 paper, "A Difficulty in the Concept of Social Welfare" as my next topic after finishing the blogging of Value and Capital.