Value & Capital, CHAPTER XVI, Section 2

In this section, the author briefly reviews the changes that were needed "to convert the static theory of the firm into a dynamic theory of the production plan."  He then describes the most direct and straightforward translations, into the dynamic setting, of "[t]he standard propositions, which define the behavior of a firm in static conditions."  Finally, he summarizes the shortcomings of these direct translations, thus setting up the discussion to come in succeeding sections.

The first of the two "amendments" needed to the static theory of the firm was that "Outputs and inputs due to be sold (or acquired) at different dates have to be treated as if they were different products or factors."  The second was that "actual prices have to be replaced, not merely by expected prices (when that is necessary) but by the discounted values of those expected prices."

The standard propositions that define a firm's behavior could be directly converted from the static case to the dynamic as follows.  To examine the effect of a change in the price of commodity X expected to take place t weeks in the future, the analysis can consider this to be a change in the price of commodity Xt and then apply the static rules.  In the case of a rise in the expected price of Xt, these rules imply that

there must be an increase in the planned output Xt.  This may come about either through an increase of inputs or through the diminution of other outputs, or both.  The inputs may be current or only planned;  the diminished outputs may be of the same kind but differently dated (Xt'), or of a different kind physically (Yt or Yt').  Further, it is always possible that there may be some outputs which are complementary with Xt, so that they will be expanded with it;  and it is possible (though less likely) that there may be some inputs which are regressive against Xt, so that they will be contracted.

The author goes on to argue that we should prefer to use the theory to examine the effects of changes in real prices rather than changes in expected prices.  The effects of changes in the prices of current outputs can be worked directly by the static rules.  But the author points out that such changes would be changes ceteris parabis (or "all other things being equal").  All other price expectations would be assumed to remain the same, even for the commodity whose price is assumed to be changed for the current period.

As the author points out, "if we stick to direct application of the main static rules, we are inhibited from considering any sorts of changes in market prices excepting those which are expected to be temporary.  We are unable to make any allowance for the effect of the current situation on people's expectations."  He then sets up the discussion to come by concluding this section with the statement that "if our theory is to lead to useful results, we must take that effect into account."