. 10
( 10)

analysis of the process itself. In the following sections we will merely
make explicit what has already been implied in the earlier chapters.2

The market process, as we have seen, is kept in motion by entrepre-
neurial activity. Entrepreneurial activity is undertaken to gain profits
and therefore, of course, avoid losses. The discussions in earlier chapters
concerning the circumstances where opportunities for profit exist, and
where entrepreneurial activity may be undertaken are sufficient to indicate
that these circumstances are precisely those where resources are misallocated.
Thus, the general proposition emerges that the market process itself tends
to correct existing misallocations of resources”in fact the essence of the
process is inseparable from the tendency toward such corrective activity.
On the level of the inquiry made in this chapter, this proposition has
a definite meaning which must not be confused with other propositions
possible at other levels of inquiry. This proposition asserts there are
market forces operating upon the price system that tend to remove all in-
ternal inconsistencies within the system. In other words, prices are under
the pressure of forces tending to ensure that, as measured by prices, no
resource should be used except where the value of its productive contribu-
tion is highest. This merely restates the proposition, developed in previ-
ous chapters, that the market process tends to achieve the dovetailing of
the numerous decisions being made. The process commences with an
initial absence of such consistency among decisions. The process itself is
the agitation whereby decisions are rendered consistent. This agitation
is the continual reshuffling of resources from one employment to another;
the process does not cease so long as complete consistency had not been
The key point is that the misallocation of a resource implies the exist-
ence of an unexploited opportunity for profit. A profit opportunity exists
wherever a given resource or a given product can be bought in the market

2 See especially pp. 38-43 and pp. 250-259.

at one price and sold again for a higher price. We have seen that the
more general kind of profit possibility”where a producer sells his product
for a sum exceeding his costs of production”also can be viewed, as being
created by the existence of two prices for the "same" economic good. In
such cases the producer bought resources for one sum and resold them (as
a finished product) for a greater sum. A possibility for profit exists wher-
ever there is a price discrepancy, even if its existence is unknown. The
price an entrepreneur pays for any resource reflects the highest value placed
by other entrepreneurs upon the productive contributions they believe
the resource can render at the relevant margins”at least insofar as they
are aware of the current price of the resource. If other entrepreneurs
believed they could derive a higher market value from the productive con-
tribution of an additional unit of the resource, their competition would
tend to force up its price to this point. On the other hand, the price
the entrepreneur obtains for his product, together with the technological
productivity of the resource, will determine the value that he should place
upon the productive contribution of the resource. If an opportunity for
profit exists, due to a discrepancy in price between the product and the
required resources, it follows that unless someone perceives and seizes this
opportunity, a misallocation of resources will inevitably occur. A block
of resources capable of rendering, in one use, a productive contribution
with a high market value (evident in the price that could be obtained in
the market for their product in this use) will be employed in other uses
only if the market value placed on their productive contribution at the
margin is lower (as evidenced by the price that the block of resources can
be secured at). The discovery of a profit opportunity amounts thus to
the discovery of a situation where, from the normative viewpoint, resources
are being misallocated. The grasping of a profit opportunity amounts, by
the same token, to a step in the direction of correcting such misallocation.
Prices and the opportunities for profits that they may present play
a dual role in the market process whereby resource misallocation is cor-
rected. First, a price discrepancy exposes an existing misallocation of re-
sources. The perception of an opportunity for profit is thus the discovery
of such misallocation. (This, of course, is not surprising, considering the
fact that we are defining the correctness or incorrectness of allocation in
terms of existing prices.) Second, a price discrepancy promotes corrective
action. A price discrepancy means a chance to make profits. By definition
entrepreneurs seek profits; thus, the very situation that symptomizes the
need for a correction creates the forces capable of inducing such action.
Moreover, and this is of fundamental importance, the entrepreneurial
search for profits implies a search for situations where resources are mis-
allocated. The price system not only announces the existence of incorrect
employments of resources and makes it worthwhile to correct them; it makes

it worthwhile to ferret out such cases that may exist. (It is, of course, an
aspect of this function of the price system that induces entrepreneurs to
constantly seek out new products, new patterns of consumer tastes, new
resources, or new techniques of production.)

Thus, any appraisal concerning the efficiency of the market process in
detecting and ironing out existing "waste" in resource employment is re-
duced to an appraisal of the ability of entrepreneurs to detect and seize
profit opportunities. If those who are financially able and willing to
accept the risks of entrepreneurship are competent to their task, they will
attain a high degree of success in pouncing upon even the smallest profit
opportunities. They will familiarize themselves with current prices in
all parts of the market, for all kinds of resources and products. Specialists
among them will concentrate, perhaps, on maintaining complete aware-
ness of all price movements relating to certain limited kinds of productive
activity. The ceaseless activity of such entrepreneurs will tend to keep the
opportunities for profit relatively small and very short lived. This, as we
know, is merely a different way of saying that their activity will prevent
resources from being grossly misallocated, and that whatever cases of mis-
allocation do emerge will be of only temporary duration.
On the other hand, if entrepreneurs are not adept in discovering price
discrepancies, these discrepancies may conceivably persist for some time, and
may even reach considerable proportions. Entrepreneurial errors may be
fully as "wasteful," from the normative point of view of allocative economics,
as corrective entrepreneurial activity is "beneficial." When an entrepreneur
makes losses, at the same time he has also wasted resources in employments
less valuable than others open to them.
The price-profit system rewards the successful entrepreneur”the one
who corrects existing cases of resource misallocation”and penalizes the
unsuccessful ones. In the long run, the market process itself thus attracts
only those most able and competent to direct the future course of the process.
After all, the efficiency of the market process in detecting waste can only be
judged against the background of alternative possibilities. Since some
entrepreneurs may be incompetent, and since profit incentives are as attrac-
tive to the competent entrepreneur as to the others, it will be the competent
and successful entrepreneurs who will tend to stay in business. If the best
entrepreneurial talent is insufficient to remove all misallocation, even with
the inducement of the profit motive, then the remaining misallocation must
simply be undetectable.
The entrepreneur, as noted before, does not have to know all the
information concerning a misallocated resource. It is sufficient for him

to detect a price discrepancy. Changes in consumer demand, the avail-
ability of resources, and the technologies of different branches of production
will probably create numerous cases where the allocation of resources is
inadequate. The entrepreneur need not discover the exact nature of these
changes in order to perform corrective action. All that he needs to know
are the relevant price changes that have occurred. If he becomes aware
of price changes in the product markets before these are reflected, corre-
spondingly, in the resource markets, he will be able to make profits and
contribute toward the correction of an otherwise inadequate pattern of
resource employment. In fact, this is one of the chief advantages of a price
system as a means of communicating knowledge (for the purpose of a more
correct allocation of resources), namely, that it conveys only that part of
relevant information essential for corrective action.

Until now our discussion has implicitly assumed perfect mobility of
all resources. In other words we have argued as if every resource owner will
respond immediately to the offer of a higher price, and that all that is
needed for a profit-seeking entrepreneur to succeed in luring away resources
from a "wrong" employment to the correct one is to offer slightly higher
prices than are being offered by the other (less well-informed) entrepreneurs.
In a purely formal sense this assumption is irreproachable, but needs some
interpretation and caution when the analysis is applied to real world situ-
It may happen that a resource owner cannot transfer the sale of his
resource endowment from one branch of production to another without
incurring costs. Such costs may be either psychological or pecuniary in
nature (or both). A laborer may feel an attachment to his job, friends,
and surroundings that is sufficiently strong to prevent his changing jobs
for a small increase in pay. Some resource owners may prefer that the
services of their resources go into one branch of production rather than into
another. Again, the different location of two entrepreneurs competing for
the services of a given block of resources may involve out-of-pocket expendi-
tures on the part of the resource owner desiring to take advantage of a more
attractive price offer. All these may be grouped together as costs of trans-
ferring resources. These costs have the effect of reducing the mobility of
resources, and of delaying the adjustments that would otherwise be secured
by the market process.
Insofar as these costs express the personal tastes of resource owners, or
reflect, say, the direct employment of other resources physically neces-
sary to effect resource transfers, it is misleading to say that these costs inter-
fere with the correct allocation of resources. These costs may be no less

real, and no less "deserving" of being considered in the pattern of resource
allocation, than any other kinds of cost. A system which directs labor to
a more productive employment for one less productive, but that altogether
ignores the costs of transporting the laborers from the one location to
another would clearly be inefficient. Similarly, any other costs of moving,
insofar as they can influence prices, must be considered in the appraisal of
the allocational efficiency of a price system.
Any inquiry into a real world concerning the efficiency of its allocation
pattern must bear these considerations in mind. Especially if the norma-
tive standards of the inquiring economist lead him to measure efficiency
against a yardstick that does not consider certain of these costs of transferring
resources, he must be prepared to find the market process delayed in the
execution of its allocative functions. It may happen, in addition, that
from the long-run point of view, such costs of transfer may be less formi-
dable than in the short run. (In the long view, it might not be more diffi-
cult to make friends in a new location than in an old location; in the long
view, it might not cost more to furnish a home in a new location than to
refurnish a home in the old location; and so on.) 3 In this case the market
process will secure results (in respect to advancing toward a more correct
allocation of resources) slowly but surely, if the conditions that call for a cor-
rection in resource allocation are sufficiently permanent in character.

A genuine obstacle to the ability of the market process to secure the
correct allocation of resources is the monopolization of resources. We have
seen in the preceding chapter that where a resource has been endowed only
to one market participant, he may be able to exact monopoly prices from the
market for the sale of the resource itself, or he may be able, by monopolizing
the production of products that require the monopolized resource as a
factor of production, to exact monopoly prices for the products. In such
cases the monopolist's control over the resource enables him to defy the mar-
ket process. He serves his own interests best by refusing to allow his re-
source to be combined with other resources where, together, they can make
their most valuable productive contribution to the market (as measured by
the prices of the other resources and the price of the product from which the
monopolist is able to bar them).
Whereas in the absence of monopoly power, entrepreneurial activity
tends to manipulate the allocation of resources so as to lead toward the
3 From a wider point of view, the long run increases mobility in the sense that young
members of a labor force, for example, can begin their careers in places strange to their
parents, far more easily than their parents themselves could have changed location.

elimination of profit, the monopolist-producer may be able to secure a
permanent gain in the form of an excess of sales revenue over costs of pro-
duction, which is immune from erosion through the efforts of other entre-

Besides monopoly power (which may be endowed by nature), there
may be numerous artificial obstacles to the process working toward correct
resource allocation. Although such obstacles are ruled out of a pure market
system by definition, 4 arbitrary controls may easily be grafted on to a
market system. (Most present-day "capitalist" economies, in fact, consist
of market systems where a greater or smaller volume of obstacles have been
imposed for various reasons.) From the point of view of the market system
itself, all such arbitrary controls are "obstacles" that "interfere" with the
normal operation of the market process. Such controls hamper the alloca-
tive functions of the market system. (From the point of view of policy,
therefore, the advantages expected to follow from the imposition of any
controls upon the market system must be compared with the consequent
loss in allocative efficiency.)5
Market participants may band together (for example, through appro-
priate extensions of governmental power) to circumscribe the range within
which each participant can exercise free choice in the market. A very gen-
eral form that such circumscriptions may assume is that of imposed restric-
tions upon price movements. Minimum (or maximum) prices may be
declared for particular products (or for products sold to particular con-
sumers), or for particular resources (or for the resources when sold to
producers of specified products). If the free market prices do not conflict
with the imposed price floors (ceilings), then, of course, the restrictions are
innocuous and, indeed, superfluous. But where the price that would have
emerged on the free market is prohibited, the restrictions tend to interdict
the market from allocating resources in the optimum manner with respect
to the given availability of resources, the given tastes of consumers, and the
given distribution of knowledge concerning these data. Exchanges that
might have taken place at lower (higher) prices are prohibited. Quantities
of output that might have been produced and sold at lower (higher) prices
remain unproduced; the resources that might have been employed in more

4 See pp. 13-14.
5 Of course, a society might attempt to alter the consequences of a free market sys-
tem, not by hampering the free market, but by redistributing at the start of each day
the initial natural endowments of the market participants. This would change the
data, but might permit the market process to continue without obstacle. Not all nat-
ural endowments, of course, can be transferred.

important uses must seek employment in the production of other, less
important products. Resources that might have been employed at lower
prices (or at higher prices) remain idle, with either a consequent direct loss
of potential output (output for which consumers are prepared to pay), or
a consequent loss of efficiency because of the use of inferior substitutes or
substitutes needed urgently for other purposes.
In addition, hindrance of the market process may consist of artificial
obstacles to resource mobility (for example, immigration laws). Or there
may be institutional grants of monopoly power (for example, patent laws).
Or there may be an infinity of different patterns of taxes and subsidies that
might bring about an allocation of resources different from what would
result from the unhampered market process. Clearly, each such possibility
must be analyzed on its own merits. The general tools of analysis developed
in earlier chapters must be applied to the special restrictions imposed in
each case. In each case the restrictions will then affect in some way the re-
sulting complex of productive organization, incomes, and resource employ-
These interferences with the market mechanism may prevent it from
revealing existing misallocations of resources (as when the market is pre-
vented from allowing the "true" prices of resources or of products to
emerge), or they may prevent the exploitation and correction of such mis-
allocations as are discovered (as when the mobility of resources is restricted,
or when competition is artificially curbed, or when special taxes or other
sanctions are imposed on profits, or when inefficient producers are sub-
A market economy, even the purest of pure, can never be a Utopia.
So long as scarcity is the fundamental fact of economic life, the participants
in the market must resign themselves to limited consumption. Participants
are endowed with only limited, periodic initial resource endowments. They
may be able to convert these endowments in the market, through exchange
and/or production, into more highly desired income streams. However
successful they may be in their attempts to do this, they can still imagine
income streams that they would prize even more highly but that are beyond
their reach. All that a market can do is to provide the framework within
which participants may squeeze the utmost out of their initial endowments
through a system of social competitive cooperation and division of labor.
Even if such a process were carried through to its ultimate possibilities,
nobody would necessarily be guaranteed against unhappiness or even
hunger. All that participants would be guaranteed against would be waste.
But, as we have seen, the market process cannot be carried to its utmost
possibilities. All that the market can offer to its participants, therefore, is
a process that is ceaselessly at work tending to prevent waste from being

perpetuated and from being carried too far. This is certainly no guarantee
against dissatisfaction, but it is at the same time of tremendous value when
the extent and complexity of the required processes are considered. Inter-
ference with the webs of forces that are woven through the market process
limits the attempts of participants to coordinate their activities through
an engine of remarkable efficiency”the market. The analysis of the mar-
ket process can clarify the costs involved through such interference, making
it possible for market participants to decide, through the political process,
upon the extent to which they are willing to lay aside their engine of effi-
ciency for the sake of special purposes of possibly overriding importance.

This chapter appraises the degree of coordination among the decisions
made individually by market participants that can be achieved by a price
system. The appraisal undertaken here deals with the degree of success
achieved by the market in detecting and correcting existing "errors."
A unit of resource is said to be misallocated if the market value of the
actual productive contribution falls short of the market value of some alter-
native productive contribution that it could be making elsewhere in the
economy. A unit of resource can be misallocated only as a result of the
imperfect knowledge of some market participants. An appraisal of the
efficiency of the market process therefore involves the appraisal of the way
it detects gaps in available knowledge, and the way it proceeds to fill these
gaps. The key point with respect to the market process is that the mis-
allocation of a unit of a resource (together with the antecedent imperfec-
tion of knowledge) implies the existence of an unexploited opportunity for
profit. Price discrepancies expose misallocation in the form of profit oppor-
tunities. Further prices promote corrective activity by attracting entre-
preneurs to seize these opportunities. The entrepreneurial search for
profit implies a search for the consequences of previously imperfect knowl-
edge and an attempt to correct them.
Rapidity in this process of correcting existing misallocations requires
resource mobility. An obstacle to the process may be monopoly control of
certain resources. Numerous artificial obstacles may conceivably be intro-
duced into an economy that may hamper this market process. Control of
prices is the most direct kind of obstacle of this group. The analysis of
the market process throws light on the costs involved in attempts to interfere
in such ways with the market process.

Suggested Readings
Hayek, F. A., "The Use of Knowledge in Society," American Economic Review,
September, 1945, reprinted in Individualism and Economic Order, Routledge
and Kegan Paul Ltd., London, 1949.
Baumol, W. J., Economic Theory and Operations Analysis, Prentice-Hall Inc.,
Englewood Cliffs, New Jersey, Ch. 13.

The Application oj Market Theory
to Multi-Period Planning

has outlined the process by
which decisions of individual market participants interact and are brought
into mutual coordination. Through the price system, the owners of re-
sources are attracted to sell their respective resources to entrepreneurs whose
production plans are designed to dovetail with the consumption plans being
made by consumers. The presentation of the analysis, thus far, implied
that the masses of decisions involved in the process of plan-interaction were
made solely with reference to a single short period of time. Resource own-
ers were viewed as deciding each day on the quantity of the day's resource
endowments to offer for sale and the prices to ask. Consumers were viewed
as deciding each day on the best pattern of income allocation to seek to
achieve. Entrepreneurs were seen as deciding each day on what to produce,
and what particular combination of resources to employ for the production
of a given product. The market process was seen as bringing about re-
visions, each day, in the plans being made for that day as compared with
those made for the preceding day.
Once the nature of the market process is understood, it becomes possible
to extend the analysis explicitly to cover the interaction of plans made (at
any one time) for any number of future time periods. A consumer may
make plans for the allocation of his income, not merely the income for the
current week, but also the incomes of any number of future weeks. In the
summer he may make plans to buy sports clothes now, and at the same time
he may plan to set aside enough of his annual income to buy winter clothes
several months later. Resource owners may plan to sell some of their
currently endowed resources now and next year to sell a different quantity
out of the resources they expect to be endowed with next year. In each of

these examples a single unified plan is made to cover a number of periods
of time. A decision within each of these plans, with respect to any one of
the periods, is a part of the whole multi-period plan”the decision made for
one period fits in with the decisions made for the other periods. (This is
of course completely analogous to the situation with respect to a plan made
for only a single period, say a particular month. Plans for the quantity
of food to be bought this month are coordinated with, and fit into, plans
made to buy clothing during the same month.)
In reality, of course, all planning is multi-period planning in the sense
that the component parts of any plan are related to one another in some
sort of time sequence. One does not plan, in any one month, to buy or
consume both food and clothing perfectly simultaneously. Even plans
made for only the next half-hour specify the sequence of activities. How-
ever, it has been convenient to ignore this aspect of plans thus far in this
book. The discussion assumed that within each period activities were
being planned for, the sequence of activities was of no importance”pre-
cisely as if the length of the time period were compressed into a single
moment in time. In this appendix we consider in barest outline the conse-
quences, for the analysis of the market process, of the relaxation of this
assumption. We wish to take notice of the kinds of alternatives facing the
individual resource owner-consumer who plans for several successive periods
of time. We wish to explore the consequences of the interaction, in the
market, of the plans of numerous such individuals. In addition, we will
consider the consequences of the fact that production planning too, involves
planning for a number of successive periods in the future. In particular,
we will notice the market consequences of multi-period production planning.

The analysis of individual multi-period plans and of the interaction
in the market of numerous individual plans of this kind can be demonstrated
most simply by the case of the pure exchange economy discussed in Chapter
7. It will be recalled that in such an economy each of the participants finds
himself endowed each day with some bundle of endowed commodities which
he is free to consume himself or to exchange in the market for other com-
modities. No production is possible in such an economy: consumption is
restricted to the commodities in one's own endowment, or to the commodi-
ties obtained by exchange from the endowments of others.
In Chapter 7, each of the participants was viewed as coming to market
each day with a plan of action”for buying and for selling”based on his own
scale of values on the one hand, and on the market prices that he expects
to prevail for each of the commodities on the other hand. Such a plan of

action was viewed as incorporating no provision of any kind, however, for
future "days." No commodities were saved for future consumption nor
were any other opportunities seized for the transformation of one's current
endowment into means of future consumption. The scales of values, and
the market prices, upon which the marketing plans of any one day were
based, referred exclusively to commodities endowed on that day.
As soon as multi-period plans are considered, a whole new series of possi-
bilities becomes relevant. Until now a plan has called for the sacrifice of
a quantity of one commodity by sale today, for the sake of the acquisition
by purchase on the same day of a quantity of another commodity. A multi-
period plan, however, may call for, in addition, the sacrifice of a quantity of
one commodity out of the endowment of one particular day, for the sake
of the acquisition, on some other day, of a quantity of another (or for that
matter the same) commodity. Where numerous market participants are
in touch with one another, and are aware of the multi-period plans that
each is seeking to implement, opportunities are likely to present themselves
for mutually profitable inter temporal exchanges. The terms upon which
such exchanges will be effected will depend on the degree of coordination
that the intertemporal market has secured between the different plans.
Even in a Crusoe economy, and even on the assumptions that no possi-
bilities for production exist, opportunities for intertemporal allocation
may be opened up through storage. We may assume that the storage, for
the sake of tomorrow's consumption, of a commodity acquired out of today's
endowment calls for no sacrifice other than today's consumption of the
stored commodity. (In this way we may justify the treatment of storage
in an economy without production.) A decision to store a commodity for
the future implies the acceptance of the sacrifice of current consumption
for the sake of future consumption. In a market economy several addi-
tional opportunities are likely to exist for the sacrifice of present for future
consumption. A market participant, for example, may sacrifice a com-
modity today by sale in order to acquire for tomorrow's consumption a
commodity that will appear in tomorrow's endowment of a second partici-
pant. And of course such opportunities may exist for "intertemporal
transfer between any two "days."

Clearly, the existence of such opportunities for intertemporal exchanges
arises from the differences that exist between the scales of values of the
different market participants, in respect to the order in which the pleasures
of prospective consumption on different dates are ranked today. Smith
gives a dozen oranges today to Robinson in return for the latter's promise
to return fifteen oranges on the next day. On Smith's scale the oranges of

today rank lower than the oranges of tomorrow; on Robinson's scale the
order is reversed. The divergence between the degrees of time preference
of Smith and Robinson have thus created the conditions for intertemporal
The emergence of intertemporal exchanges of this kind is accompanied
by intertemporal terms of exchange. In the single-period market discussed
in Chapter 7, there were market prices for each of the commodities ex-
changed. These prices represented the terms upon which a participant
could transform a given quantity of one commodity into a different com-
modity by exchange. In the multi-period market, quite analogously, inter-
temporal exchanges yield rates of exchange according to which given
commodities of one date can be transformed by exchange in the market into
commodities (either the same commodities or different ones) of a different
date. If Smith gives up 100 oranges today in exchange for Robinson's
promise to return 110 oranges a year hence, this 10% "orange-rate of inter-
est" represents the relevant terms of intertemporal exchange. In a mone-
tary economy, of course, intertemporal exchanges need not be on a barter
basis. Instead of Smith obtaining a promise of oranges next year in direct
exchange for oranges today, he may accept a promise of money for next year
and then buy oranges next year when the promise is redeemed. (Or again,
he may accept money now from Robinson for his sacrificed oranges, and
then, in a separate transaction, lend this money for a year to Jones, and buy
oranges next year when the loan is repaid.) Under these conditions, terms
of intertemporal exchange will be represented most clearly by the money
rate of interest, taken in conjunction with the current prices of the various
commodities, and with their expected prices for the various relevant
future dates.
If a market where intertemporal exchanges are taking place is to be
in equilibrium, the multi-period plans of all the participants must "fit in"
with one another. The terms of intertemporal exchange must be such
that for each planned sacrifice of a quantity of commodity of date a, for the
acquisition of a commodity of date b, some other participant should have
been induced to plan the same exchange in reverse. If, as a result of
imperfect knowledge of each other's desires, rates of intertemporal exchange
are any different from the equilibrium pattern, some participants coming
to market, at the end of a trading day, will have been disappointed in
their attempts to accomplish intertemporal exchanges; and they will, in
making plans for entering into such exchanges on the following day, revise
their estimates of the market intertemporal rates of exchange. For equi-
librium to exist in the intertemporal market, it is clear, a very precise rela-
tionship will be required between (a) the current price of each commodity,
(b) the prices that each of the various participants expect to prevail for the

various commodities on each of the future dates, and (c) the various money
rates of interest prevailing on loans of various maturities.
Of course, just as in the single period case considered in Chapter 7, an
intertemporal market may be expected, in general, to be in disequilibrium.
Changes in time preference from one day to the next will alter the plans
being made and will (on top of all the other changes in the data that tend
to keep a market in disequilibrium) complicate the market forces of adjust-
ment that are set into motion by the disequilibrium existing in the market
on any one trading day. The intertemporal market, moreover, is subject
to complications that are of especial relevance to multi-period decisions.
Such decisions, we have seen, depend in an extremely sensitive way upon
the expectations that participants hold concerning the prices of the various
commodities on different future dates. (Intertemporal exchanges may
clearly arise merely as a consequence of divergent price expectations on the
part of various market participants.) The uncertainty and the risk neces-
sarily attached to expectations are likely to color the plans being made on
any one day, and, in particular, the revisions in plans that will be made as
the result of previously disappointed plans. Within the framework of
this book, all that can be done is merely to point to these complications
without any thorough further examination of them.

The possibilities of intertemporal exchanges outlined thus far indicate
the role that speculation can play in a pure exchange economy. Suppose
there is reason to believe that during some particular future time period
the endowments of market participants will contain relatively few oranges
(as compared with the endowments of other periods of time). Then many
participants would gladly sacrifice the consumption of some oranges during
other periods for the sake of oranges during the scarce period. Complete
adjustment by the market to achieve this particular allocation of oranges
over time would call for the storage of oranges from other periods up to
the scarce period. A market that has achieved equilibrium with respect
to these expectations and tastes would have adjusted the current price of
oranges, the money rate of interest, and the expected future prices of
oranges into a very particular pattern. This particular pattern would be
such that exactly the "right" quantity of oranges is purchased in the market
by speculators during each period to be held in storage for the future scarce
period. With this particular pattern prevailing, no two market partici-
pants can discover any alteration in their multi-period plans that might
leave them both in a preferred position.
Where an intertemporal market has not achieved equilibrium with
respect to current expectations and tastes (for consumption in the various

periods), "arbitrage" opportunities exist which the more alert potential
speculators may exploit. Where for example a particular market partici-
pant has discovered, before the other participants have become alerted to
this possibility, the likelihood of a future scarcity of oranges, he will be
able to earn speculative profits by exploiting his superior knowledge of
future conditions. He will be able to buy oranges today at cheap prices
(or, alternatively to buy cheaply the promise of oranges to be delivered in
the future) and to sell them for high prices in the future scarce period. By
exploiting his superior knowledge in this way he is at the same time re-
allocating oranges over time, from consumption during periods where the
marginal significance of an orange is low, to consumption during a period
where the marginal significance of an orange (as ranked by consumers today)
is higher.
As market participants compete with each other for these speculative
profits, the market is brought closer toward equilibrium and further oppor-
tunities for such profits become more and more difficult to obtain. In this
way entrepreneurial activity succeeds in bringing coordination into the
mass of individual intertemporal plans, incorporating their decisions to
consume, save, lend, and borrow. All these market repercussions would
take place, as we have seen, even in an economy where production is impos-
sible. Where opportunities for production do exist (as they did in the cases
studied in Chapters 10 and 11), these kinds of intertemporal exchange (and
the resulting opportunities for speculative activity) are no less relevant. In
a production economy, however, the necessity and the opportunities also
exist to make additional intertemporal decisions; we now turn to these.

In an economy where production is possible, market participants find
themselves endowed with productive resources. It is possible for the entre-
preneur to buy resources, allow them to combine and yield output, and
then to sell the output in the product market. A fundamental feature of
any decision to produce in the real world is that any decision to produce
represents at the same time a decision to effect an intertemporal transfer of
assets. Since every production process takes time, it follows that every
decision to produce is a decision to sacrifice inputs now for the sake of
output later. This aspect of production was not stressed in the treatment
of production in Chapters 8, 9, and later chapters. In these chapters, where
attention was focused on other aspects of production, a production decision
was treated as if any difference in date between the application of resources
and the yield of products could be ignored as of no consequence. We must
now outline, or at least point to, the major implications for market theory
that arise from taking notice of such time differences. These implications,

taken in conjunction with the widened possibilities that exist within a
production economy for those intertemporal decisions that we have already
noticed for the pure exchange economy (with their application being
widened now to cover also decisions concerning resources as well as con-
sumer goods), provide the temporal framework within which a market
system operates.
In the multi-period production economy, in fact, each decision”whether
concerning the sale or purchase of a resource, the production of consumer
products, or the sale or purchase of consumer products”has a time dimen-
sion. Each resource owner must make an allocation over time with respect
to the sale of the services of his resource (insofar, that is, as he is able to
store his resource endowment over time). Every utilization of a resource
for a particular process of production involves an opportunity cost that
reflects, not only the potential contribution to other processes of production
that this resource might make now, but also any such contribution which it
might make at other times. (Thus, even the employment of a completely
specific resource may involve an opportunity cost insofar as its use today
precludes its use in the same employment in the future.) Every process
of production, as we have seen, reflects an intertemporal transfer, sacrificing
current inputs in favor of future output. Every decision to buy or to sell
consumer products involves, of course, the very same kinds of intertemporal
decisions we considered in the preceding sections.
Now, the time dimension attached to the decisions concerning the sale
or purchase of resources or of products introduces no essential complications
beyond the analysis referred to in the preceding sections. For equilibrium
to prevail there must be certain relationships between the current prices
and the expected future prices of the respective items, and, of course, the
relevant rates of interest. These will spell out the terms upon which present
resources or products can be directly transferred into specified future ones.
The agitation of the market will be continually adjusting these intertemporal
terms of exchange so long as they perversely encourage unrealizable plans
on the part of market participants. But the inherence in every production
decision of a temporal aspect does introduce complications not previously
These complications have to do principally with the necessity faced
by each would-be producer to choose between production processes absorb-
ing different lengths of time. This, in turn, is closely related to the problem
of which particular capital goods will be employed for the production of
given consumer goods. Let us first consider the production of a given con-
sumer good, say a chair, by a would-be producer who finds only naturally en-
dowed resources available in the market. Any of several methods of
production might be employed. Each of them requires the use of pro-
ductive resources; in each of them the producer finds himself, after the

elapse of some time interval shorter than the length of the entire process,
in command of intermediate goods. If, for example, he attempts to fashion
a seat, with his bare hands, out of a tree, an uncompleted process of produc-
tion will have yielded perhaps the pieces of wood to be somehow contrived
later on into the chair. If, on the other hand, he first contrives tools to
construct the chair with, an uncompleted process of production might yield
only a hammer or a saw. In both cases the intermediate products are steps
toward the final product. In selecting the particular method of production
to adopt, a would-be producer is at the same time selecting the particular
form the intermediate goods should take.

Observing a cross section of a particular process of production prior to
its completion, then, one encounters intermediate products. Such products
constitute capital goods. Looking backward, one realizes that the produc-
tion of such capital goods has already absorbed time. In fact, it may be
possible to know of some alternative process of production that might have
yielded already, in the time already absorbed, at least some quantity of the
final product. (Thus, during the time in which the carpenter's tools have
been constructed, it might have been possible to fashion one crude chair
without tools.) Looking ahead, one realizes that the past production of
these capital goods will save future time in the attainment of thefinalout-
put aimed at. Assuming that the producer selected wisely the capital good
that he has produced, it follows that he is temporally closer to the attainment
of his own output goal than he would have been otherwise. In fact, of
course, it was precisely this prospect”of being closer to the final goal”that
justified the intertemporal transfer of assets represented by the production
of the intermediate product. In producing the intermediate products, the
producer sacrificed the inputs of an earlier date (inputs that he might have
been able to utilize for earlier consumption) for the sake of the intermediate
product of today. He did so only because of the prospect of the superior
position he is now placed in as a prospective producer, by virtue of his
command of the intermediate product.
Now, in a market economy, it is not necessary for the producer of a
final consumer product to have himself produced the capital goods he uses
in his production process. He may buy them from other producers for
definite prices. These prices, like all others in the market, will reflect on
the one hand their usefulness to users of the capital goods (as expressed in
the demand side of the market), and on the other hand will reflect (in the
conditions of supply) the sums required by the producers of the capital goods
to have made it worth their while to devote their resources to the production
of these goods rather than others. Demand conditions for capital goods

will thus reflect the relatively greater nearness in time to the final production
goal, which command of these goods confers. Supply conditions for capital
goods will reflect in turn, among other costs of production, the sacrifice of
time that went into their production. Whatever the money rate of interest
that is currently prevailing, and which helps determine the terms of inter-
temporal exchange, it will be reflected in the price of the capital good, as
compared with the prices of the inputs used in its production. Ultimately,
of course, such capital goods will be produced only in the quantities that
will be demanded by the producers of final products; that is, only in the
quantities justified by the superior achievements of producers using these
goods and by the prices of the final products themselves.
Where, for the sake of simplicity, two different capital goods can be
produced out of the same inputs, but require respectively different periods
of time for their production, definite market forces will influence the deci-
sion as to which of the two should be produced. The more time consuming
of the two goods will involve the greater sacrifice in terms of postponement.
The producer of the capital goods could clearly benefit from his efforts
sooner by producing the other good. Or, if this producer has borrowed
the required inputs (or purchased them with borrowed money), and pro-
duces the more time consuming of the two capital goods, he will have to
compensate the lenders for the additional postponement that they accept,
by paying interest for the longer period. This additional sacrifice clearly
will be justified only by the correspondingly higher price obtainable for
this capital good in the market. And such a higher price will clearly only
be obtainable as a result of the correspondingly superior productivity of the
more time-consuming capital good.
If the relative superiority in production of this capital good (whose
production absorbed more time) is very outstanding, it may conceivably
offer an opportunity for intertemporal transfer of assets that is superior to
any obtainable elsewhere in the market. In this case the inputs originally
invested in the capital good have yielded a greater return in value of final
product than could have been obtained by investing the value of the inputs
elsewhere over the same period. The existence of such an opportunity
clearly will result in market agitation that will operate toward lowering the
price of the final product, and raising the prices of the inputs and of the
money rate of interest, until the opportunity for intertemporal transfer of
assets is no more profitable by this means than by other means.
The market process tends to determine in this way, not only the rates
of interest, the prices and quantities of resources used, and the prices and
quantities of products produced, but also the time structure of production.
The time structure of production refers to the lengths of the processes of
production that are necessary to make up final products. A cross section
of a production economy at any one time reveals a mass of capital goods,

each of them an intermediate product leading toward some final output.
The make-up of this mass of capital goods, the degree to which they repre-
sent greater or smaller investments of past time, is a reflection of the earlier
operation of the market process. The greater the degree that market partici-
pants have in the past been prepared to sacrifice earlier for later consump-
tion, the "deeper" will be the time structure of the existing capital stock oí
the economy. The continued operation of the market process will now
determine (a) how this existing stock of capital goods will be used for further
production (that is, for the production of what products each of the capital
goods will be employed), (b) whether the stock of capital goods will be added
to, merely replaced as they wear away, or permitted to depreciate without
replacement”and (simultaneously with the determination of the quantity,
if any, of new capital goods to be produced), (c) the particular capital goods
to be produced and especially the time structure of these goods (that is, the
lengths of time to be taken for these goods to be produced, and the planned
lengths of time for which these goods will be used severally in further
processes of production in the future). The analysis of the way the market
process determines these matters comprises the body of the theory of capital,
a branch of price theory where the temporal aspects of the market are of
the essence.
Suggested Readings
Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949,
Chs. 18, 19.
Stackelberg, H. v., The Theory of the Market Economy, Oxford University Press,
New York, 1952, Bk. 2-Ch. 6, Bk. 3-Ch. 3, Bk. 5-Ch. 3.
Malanos, G., Intermediate Economic Theory, ]. B. Lippincott Co., Philadelphia,
1962, Chs. 4, 12, 13, 14.
Conard, J. W., An Introduction to the Theory of Interest, University of California
Press, Berkeley, California, 1959. Ch. 8.
Henderson J. M., and Quandt, R. E., Microeconomic Theory, McGraw-Hill Book
Co., Inc., New York, 1958, Ch. 8.

Adaptability, 2O3ra Constant returns to scale, 164
Allen, R. G. D., l69n Consumers, 15-16, 238-239
Allocation of resources, 297-310 Consumer equilibrium, 65-79
Alternative cost doctrine (see Opportu- income allocation, 63-79
nity cost) Coordination, 33-44, 297-309
Arbitrage, 114, 120, 252, 316 Cost, marginal, 199
Arc elasticity, 92n per unit, 198
Autarky, 2 social, 186
Costs, and decisions, 190-191
"Backward-sloping" supply curve, 256n fixed, l92n, 2O3n
Bain, J. S., 285n implicit, l9On
Baumol, W. J., 310 long-run, 202-206
Böhm-Bawerk, E. von, 84, l l n , 135 of production, 145, 183-209
Buyers' surplus, 110, 293 prospective and retrospective, 189-192
short-run, 198-202
Capital, 150, 317-320 variable, l92n, 200, 2O3n
Cross elasticity, 99-100, 275n
Capital goods, 192-198, 317-320
Cardinal utility, 57-59, 66n
Carlson, S., 182 Decisions, 5, 46, 144-146
Cartels, 268-270 Decreasing returns to scale, 165
Centrally controlled economy, 2 Demand, 45, 63
Chamberlin, E. H., 209 cross elasticity of, 99-100
elasticity, 89-93
Choice, 5, 46-48, 143-145
Collusion, 268-270 curve, for a factor, l79n
Competition, 106-107, 129, 265-296 facing an entrepreneur, 94-96, 199,
200, 2l5rc, 2l9n
free, 29ln
individual, 79-82
monopolistic, 285n
market, 87-89, 137
potential, 287
and revenue, 96-99
pure and perfect, 289-291
Diminishing marginal utility, 49-51, 65,
Complementary goods, 52, 75, 100, 102,
150-151 188
Diminishing returns, law of, 166
Conard, J. W., 320
Disequilibrium, 23-24, 112-115, 122-128,
Conditions for exchange, 60-61
222-225, 231-233, 243, 250-252
Consistency, 35

Distribution, 38ra General Equilibrium, 26, 29
Divisibility, of factors, output, I55w, General Market Process, 233-264
195-197 Goods of lower order, 20
Division of labor, 36, 147 Goods of higher order, 20
Duopoly, 270
Hague, W. C , 182
Economic facts, 9 Hayek, F. A., 12, 32, 296, 310
Henderson, J. M., 320
problem, 33-35
Hicks, J. R., 84
theory, 7-12
Horizontal market relationships, 20-22,
and reality, 7-10
Economics, 10-12
Economies of large scale output, 287-288
Implicit costs, !9On
Efficiency, 35
Income, 6$n,` 70
Elastic demand, 91
Income-consumption line, 72
Elasticity, 89-93, 130, 266, 280, 293n
Income effect, 77n, 78
measures of, 90-93
Incomplete equilibrium, 24-26, 214-217,
perfect, 289
of substitution, 160-163
Increasing cost, 188
unitary, 91, l3On
Increasing returns to scale, 165
Ends, 46-48
Indifference curves, l78n
Entrepreneurs, 16-18, 132, 148-150, 226-
Individual and the market, 1
230, 245-246, 304-305
Indivisibilities, 195-197, 205
Envelope curve, 2O4n
Inelastic Demand, 91
Equilibrium, 22-26, 112, 212-222, 289,
Inelastic supply, 140-141, 2l9n
"Inferior" goods, 72, 75, 78
in factor market, 225-231
Innovator, 258
in general market, 246-250
Interest rate, 314
incomplete, 24-26, 214-217, 230-231
Interferences with market process, 307-
long run, 212-216
partial, 26
Intertemporal exchanges, 313-320
short-run, 26, 215-216
Intertemporal market, 313-316
very short-run, 216-217
Investment, 153
Equi-marginal principle, 66rø
Exchange, 1-2, 60-61, 105-135, 147 Isocost line, 177
Existence Theorems, ̬9n Isoquant line, 153-163
Expansion path, 180
Expectations, 82-83, H3rc, 199-200, 2O3n, Knight, F. H., 44, 84, l73n, 182
Knowledge, 42, 108-114, 214-217, 246,
224-225, 315
250, 289, 301-302
External diseconomies, 2O7n
External economies, 2O7n
Labor, 150, 226-227
Land, 150, 226
Factor, divisibility, 155;?, 195-197, 204
Large-scale output, economies of, 287-
market, 19, 225-234
of production, 150-153
Laspeyres price-index, 74rc
proportions, 158-164, 165-180, 195-197
Law of diminishing returns, 166, 172
Firm, theory of, 149
Laws of variable proportions, 142, 165-
Fixed costs, 192n, 2O3n
Freedom, 1, 13-14 175, 196
Least-cost combination, 176-181
Free goods, lO9n, l3ln, 175, 229n, 268n,
Leftwich, R. H., 264
278, 283

Leisure, 63M, 226-227 Monopoly, 261, 265-296, 307
Long-run costs, 202-206 gain, 284
Long-run equilibrium, 212-216 incomplete, 269
Long-run forces on supply, 191 in production, 274-282
in pure exchange economy, 128-131
Machlup, F., 77`n, 84 235, 27On, 29In, price discrimination, 291-294
296 resource, 265-274
Monopsony, 272-274, 282-284
Malanos, G., 320
Multi-commodity market, 116-128
Marginal costs, 198-204
Multi-period planning, 311-320
Marginal increment of product, 156,
167-174, 228, 241-242, 247, 300
Normative aspect of economics, 33-35,
Marginal pairs, 111
Marginal product, 156M, 173
Marginal rate of substitution, 158
Oligopoly, 270
Marginal revenue, 97-98, 198-202, 213,
Opportunity cost, 145, 184-187, 248
215, 241, 248, 292
Opportunity line, 67-69
Marginal revenue curve, 130, 275-276,
Optimal proportions, 161
Ordinal utility (see Utility, ordinal)
Marginal unit, 59, 66
Marginal utility, 48-62
"Paradox of value," 53-54
Marginal utility and consumer income
Partial equilibrium, 26
allocation, 63-65
Partial market processes, 210-235
Market, 1, 13-22
Patents, 308
adjustment and agitation, 26-29, 114-
Perfect competition, 289-291
115, 131-134, 217-225, 231-233,
Positive aspect of economics, 32-34
244, 250-252
Price discrimination, 291-294
disappointments, 23, 114
Price, monopoly, 128-131, 267, 275-282
forces, 3
Prices, 38-41, 105-141, 210-235, 241-261
general, 233-264
factor, 206-208, 225-234, 241-244, 247,
inter temporal, 313-316
255, 258
multi-commodity, 116-128
product, 211-225
roles, 15-18
Priorities, 36-38
single commodity, 107-116
Private property, 13
single factor of production, 225-234
Product differentiation, 285-287
single product, 211-225
Product, marginal, 156M, 173
structure, 18-22
marginal increment of, 156, 167-175,
system, 3-4, 13-44
228-229, 241-242, 247, 300
theory, 4-12
market (see Market)
Marshall, A., 84, 104
prices, 211-225, 241-244, 218, 253-255
Maximum prices, 307
Production, 16-18, 37-38, 142-182
Maximization, 58M
economists' view of, 143
Means, 46-48
function, 155-158
Menger, C , 20, 32
surface, 155
Menger, K., l72n
Minimum prices, 307 Profit, 39-43, 201, 249, 302-305
Mises, Ludwig v., 12, 44, 62, 147M, 209, Purchasing power of income, 73-74
Pure competition, 289-291
235, 264, 284M, 294M, 296, 320
Mobility of resources, 305-306 Pure exchange economy, 105-134, 312-
Money, 14-15 316
Monopolistic competition, 285n Purpose, 5

Quandt, R. E., 320 Specialized factors, 152
Specificity of factors, 152, 193-194, 23On
Related goods, 52-53, 75 Stackelberg, H. V., 32, 104, 320
Relative character of utility, 57 Stigler, George J., 12, 104, 2O3ra
Rent, 184-187, 230 Stonier, A. W., 182
Resources, 16, 150-153 Storage, 313
Resource, allocation of, 297-309 Subjective character of utility, 55-57
market, 19, 225-234 Substitutes, 52, 75, 100, 102, 150-151
misallocation, 299-302 Substitutability of factors, 150-151, 158
mobility, 305-306 Substitution effect, 77ra, 78
monopoly, 265-274 Supply, 183-209
owners, 16, 237-242, 247, 266 Supply curve of the firm, 202
prices, 206-208, 225-234, 241-244, 247, Supply curve of the market, 137-140
255, 258 Supply and Demand, 136-141, 229n
Returns to scale, 164-165, 204-205 Supply and factor prices, 206-208
Revenue, average, 97
marginal (see Marginal revenue) Tastes (see Utility)
total, 96 Time and production, 190-192, 316-320
Ridge lines, 167-170
Robbins, Lionel, 12 Uncertainty, l5w, 17-18, 82, 113n, 144,
Robinson Crusoe, 143-146 203, 315
Robinson, Joan, 294n Utility, cardinal, 57-59, 66n
Rothbard, Murray, 62 marginal, 48-62
ordinal, 57-60, 98n
Saving, 64n theory, 45-62
Scale of production, 163, 204-206
Scale, returns to, 164-165, 204-205
Variable costs, l92n
Scale of values, 45-60
Variable proportions, law of, 142, 165-
Scitovsky, T „ 29In
175, 196
Sellers' surplus, 110
Versatility of factors, 152, 193, 194, 239,
Shackle, G. L. S., H3n
Short-run costs, 198-202
Vertical market relationships, 18-20
equilibrium, 26, 215-216
Very short-run equilibrium, 216-217
forces on supply, 191
Viner, J., 209
Significance (see Utility)
Single commodity market, 107-116
Wages, 63n
Single product market, 211-225
Welfare economics, 298-299
Smith, Adam, l47rc
Speculation, 17-18, 315-316 Wicksell K., 135, 235
Specialization, 36 Wicksteed, P., 62, 135, l4On, 235


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