. 8
( 10)


prices of resources and products, the quantities of resources used in each

production process, and the quantities of products produced. In this
chapter the task is approached by first analyzing the market process as it
directly affects a single product, and then analyzing the corresponding
market process affecting a single productive factor.
In the analysis of the single-product market, stable prices for all factors
and all other products are assumed to be known. Equilibrium conditions
can be spelled out for the market. These define the scale of plant for
each producer, the level of utilization of each plant, the output consumed
by each consumer, and the product price. Perfect knowledge can be shown
to lead to the fulfillment of such a pattern of dovetailing decisions.
By mentally arresting specified types of changes, it is possible to spell
out various "incomplete" patterns of equilibrium. In particular it is of
interest to work out the pattern of dovetailing decisions that can be achieved
with given plants (short-run equilibrium) and given products (equilibrium
in the very short run). The relevance of these situations of incomplete
equilibrium is found in the time sequence of the market processes leading
up to complete equilibrium. The analysis of these processes makes up the
core of the subject under investigation. The thread running through
these processes is the consistent revision by producers and consumers of
their plans, until all sources of plan incompatibilities among them are re-
In the analysis of the single-factor market, stable prices for all other
factors and for all products are assumed to be known. Equilibrium con-
ditions can be spelled out for the market. These conditions define: the
size of plant used by each producer in the production of each product using
the particular factor; the current volume of output for each producer of
each product in which the factor appears as one of the variable inputs; the
price of the factor and the quantity of it sold by each of its owners. Once
again perfect knowledge is implied in the fulfillment of these conditions.
Imperfect knowledge implies disappointed plans that will lead to plan
revisions on the part of resource owners and producers. These plan re-
visions, too, may be expected to follow a typical time sequence, with some
adjustments being made only after maladjustment has prevailed persistently
for a long time.
The principal limitation on the usefulness of the analysis of market
processes treated in this chapter arises from the assumed "insulation" of
these processes from the full interaction with the rest of the adjustments
that will be generated throughout the entire market system by any initial
maladjustments in the areas under direct examination.

Suggested Readings
Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949,
pp. 324-336.
Wicksteed, P. H., Common Sense of Political Economy, (Reprint-1933 ed.), Rout-
ledge and Kegan Paul Ltd., London, 1949, Bk. 1, Ch. 9.
Wicksell, K., Lectures on Political Economy, Routledge and Kegan Paul Ltd., Lon-
don, 1951, Vol. 1, pp. 196-206.
Machlup, F., The Economics of Sellers' Competition, Johns Hopkins University
Press, Baltimore, 1952, Chs. 9, 10.

The General Market Process

I N THE present chapter we seek to un-
derstand how the competitive market process works in a system where no
prices are considered as "given" or constant. In such a system the prices
of all factors, and of all products, are variables that take on values de-
termined by the market process itself. For such a system to be in equilib-
rium, all market decisions must mesh completely; the economist cannot
be satisfied to seek consistency only among a selected group of decisions
against the background of a "given" set of other decisions that remain
external to the analysis. When an autonomous change occurs somewhere
in the system affecting the fundamental data on whose basis certain de-
cisions are made, the economist must trace the impact of this change upon
all subsequent decisions. Until now we have been proceeding step by
step, confining ourselves primarily to partial analyses. In this chapter we
will discuss, after a preliminary foray into one more hypothetically re-
stricted market, the problem of the general market process in a market
where both factors and products can be bought and sold at prices freely
determined by market forces.
For most of this chapter we will be working with a system organized
on the following lines. There are a large number of resource owners.
Each resource owner finds himself endowed daily by nature, without cost,
with some bundle of resources whose content does not change from day
to day. The composition of this bundle differs from one resource owner
to another, but each resource appears in the daily endowment of many
resource owners. (None of them have monopoly power over any resource.)
Each of these resource owners is free either to retain his resources for his
own consumption purposes or to sell any quantity of them for what he can
get for it. There are also in the system a large number of prospective
entrepreneurs who may find it worthwhile to buy resources in the market,

convert them into finished products, and sell these products for what they
can bring in the market.1 Finally there are the consumers. (These in-
dividuals, in addition to being consumers, are also resource owners, en-
trepreneurs, or both.) Consumers buy products in the market with in-
comes that they earn as resource owners or entrepreneurs.
The fundamental data that must ultimately determine the course of
the market process are (a) the daily endowments of resources, and (b) the
tastes of consumers. These are assumed to be given and unchanging
throughout the analysis unless inquiry is specifically directed toward the
consequences of a change in these data. On the one hand, consumer
tastes play a role in determining the quantity of resources that will be
sold to the market at any given price since, as we saw in the preceding
chapter, a unit of a resource will be sold only if its price is high enough
to outweigh its marginal utility in consumption to the resource owner. On
the other hand, of course, consumer tastes (along with consumer incomes)
play a major role in determining the quantity of each of the products that
consumers will buy at given prices. The composition and quantity of
the resource endowments will determine (along with the tastes of resource
owners as consumers) the quantity of the various resources that will be
sold to the market at given prices. At the same time the composition and
quantity of resource endowments play a major role in the determination
of consumer incomes.
The central problem is to understand the way market forces determine
the decisions that will be made (a) by each resource owner concerning the
sale of each unit of each of the resources in his daily endowment; (b) by
each of the prospective entrepreneurs concerning the purchase of the var-
ious resources, their organization into various productive complexes, and
the choice of products to be produced; and (c) by each of the consumers con-
cerning the purchase of the various available products. These decisions
will determine the prices of each of the factors and of each of the products,
the quantity of each factor employed, the method of production used for
each product, the quantity of each product produced, and the quantity of
each of the available products purchased by each consumer. Consistency
between all these decisions means that the resulting market phenomena will
be maintained indefinitely within alteration. Inconsistency between any
sets of decisions will be revealed through disappointments and will be fol-
lowed by revisions in future decision making. Inconsistencies will thus
generate ripples of change affecting wide areas of decision making. Our
problem is to understand how the market forces generated by the revelation
of these inconsistencies determine subsequent market phenomena. First
we take up a preliminary model.

For the sake of simplicity we continue to refrain from taking explicit notice of in-
termediate products, the produced means of production.

In this preliminary analysis we simplify the statement of the problem
outlined in the previous section by making a major modification in the
institutional framework of the system. For the purposes of the present
section, we deal with a system different from that dealt with in the rest of
this chapter, in that production can be carried on by a market participant
only with resources that were in his initial endowment, not with resources
bought from others. Resources can be bought only for direct consumption.
During the rest of this chapter (after the present preliminary model) we will
be dealing with the system, outlined above, where resource owners do sell
resources to entrepreneurs who then produce products for sale to consumers.
In this section, however, each resource owner, if his resources are not to be
left idle, or to be used directly in consumption, must himself combine the
resources that he possesses, in order to produce products that he must then
consume himself or sell to other consumers. This case differs from the
hypothetical systems considered in Chapter 10 in that in the present problem
the prices of all products are determined by the market process that we wish
to investigate, with no market decisions imagined to be imposed externally.
Our case differs from the multi-commodity case considered in Chapter 7 in
that in the present problem, production decisions can and must be made,
and these production decisions also must be explained in terms of market
forces. Our present case will provide the simplest and most direct intro-
duction to the analysis of the central problem of this chapter, the explana-
tion of the general market system outlined in the previous section.
We turn, then, to consider a system where resource owners (if their
resources are not to be used for consumption or to be left idle) must them-
selves employ their resources to produce goods for their own consumption or
for sale to other consumers. Our problem is to understand how market
forces in such a system would determine the quantity of each resource con-
sumed directly by each consumer, the quantity of each product produced,
the method of its production, and the prices in the market of each resource
and each product.
The clue to analysis of such a system consists in its points of similarity
with the multi-commodity pure exchange system considered in Chapter 7.
There we considered a group of consumers each of whom was endowed each
day with a supply of consumer goods. Exchange ensued as each of the
market particpants sought to convert his intial commodity bundle into the
most desirable one obtainable by barter in the market. For each partici-
pant this involved giving up units of some commodities in order to acquire
units of other commodities. In our present case, also, each participant has
an initial endowment that he seeks to convert into the most desirable com-
modity bundle obtainable. In our present case a participant can convert

his initial endowment by sacrificing quantities of resources for a price (a)
by sale of resources directly to consumers for use as commodities, and (b)
by using the resources to produce products and then selling the products to
consumers. These exchange possibilities may arise from two causes: first,
as in Chapter 7, differences in the initial endowments of the different par-
ticipants, as well as differences in their tastes for the various resources as
commodities, may create opportunities for mutually profitable exchange of
resources between participants for direct use as commodities. Second, dif-
ferences in the initial resource endowments of different participants may re-
sult in differences in their ability to produce specific products. This,
reinforced by differences in the tastes of the participants for the various
products, may again create opportunities for mutually profitable exchange
of "resources," in the derivative form of products, between participants.
The second of these two sources of mutually profitable exchange
between market participants, it should be observed, is most illuminatingly
interpreted simply as a special case of the first of the two sources. Thus,
the whole case studied in this section is seen, too, simply as a special case of
the multi-commodity market problem in Chapter 7. This interpretation
follows directly as soon as it is realized that a product is nothing, in fact,
but the whole bundle of resources used to create it. A market participant
can thus improve his position by giving up some of his initial bundle of
assets (in the form either of (a) the original resources or (b) the product
obtained from them) in order to replace the sacrificed assets by other assets
(to be bought from other participants either in the form that these assets
appeared in initially in their asset bundles, or in the form of derived prod-
ucts) which he prizes more highly.
The complication, which sets our present problem apart from that of
Chapter 7, arises, of course, from the presence of production possibilities.
It is associated, in particular, with the versatility in production of most re-
sources. In a system without production a particular commodity is simply
that commodity; but in a system where production is possible, a particular
resource may be considered as either that resource (usable, perhaps, in
direct consumption), or as part of any one of the possibly numerous products
toward whose production the versatile resource may be applied. Our study
in Chapters 8 and 9 of the principles of production theory has taught us
that this versatility of productive resources imposes upon the producer the
necessity to choose among additional series of alternatives.
In the multi-commodity pure exchange market of Chapter 7, a partici-
pant made his buying and selling decisions on the following principles.
The market prices of any two commodities (say, A and B) determine the
terms on which he may acquire specific quantities of commodity A, say,
through purchase, for the sacrifice of quantities of commodity B through
sale. His own subjective scale of values ranks the specific additional quan-

tities of A either higher or lower than the quantities of B required to be
sacrificed. If the quantities of A rank the higher, he will seek to sell B and
buy A until, through the law of diminishing utility, the marginal utility of
A drops, and that of B rises sufficiently to make further exchange on market
terms no longer desirable. All that the market participant needs to con-
sider, then, are the prices of the commodities and their respective utilities
to him at the margin.
In the case we are now considering, the decisions of a resource owner
depend upon a number of additional factors. In contemplating the pur-
chase of a specific quantity of product A in the market (or the purchase
of a specific quantity of resource C for direct personal consumption), through
the sacrifice by sale of quantities of resource B (one of the assets in his own
initial endowment), it is not sufficient for a participant to know merely the
prices and marginal utilities to himself, of A (or C), and B. The prices, it
is still true, of course, determine the quantity of B he must sacrifice in order
to acquire specific quantities of A (or C). It is still true, in addition, that
the desirability for him of acquiring specific quantities of A (or C) will de-
pend upon the marginal utility to him of A (or C).
But in weighing the wisdom of sacrificing the required quantity of B,
it is now not enough to consider merely its marginal utility to him in direct
consumption. He must consider also the additional sacrifices possibly in-
volved in the sale of this quantity of B. These potential sacrifices include
the difference that this quantity of B is able to make (either when used as
a single unit, or when used in smaller quantities) in the production of
all the various products it is a potential factor for. In considering the
sale of the required quantities of resource B, the resource owner must con-
sider in turn all the alternative sets of possible ways these quantities of B
could be turned (in cooperation with other resources, of course) into prod-
ucts. All of these sets of possible ways B might be used in production must
then be compared with each other. The most significant set, among all
these alternative sets of possible productive contributions that the quantity
of B is able to make, will be then the sacrifice involved in withdrawing this
quantity of B from production. (The significance of any set of productive
contributions will of course be measured by whichever the resource owner
thinks more preferable: (a) the additional revenues obtainable from the
relevant marginal increments of product through sale of the finished prod-
ucts in the market, or (b) the differences in the utility for direct consumption
that can be derived from the relevant marginal increments of product,
through the direct personal enjoyment of the finished products.)
In weighing, therefore, the sacrifice of the quantities of B required by
market conditions for the sake of acquiring specific quantities of A, a market
participant will rank on his scale of values not only the marginal utilities
of the relevant quantities of A and of B, but also this opportunity cost

involved in the withdrawal of B from potential production. Only if the
specific quantity of A ranks higher on his scale of values than the full sacri-
fice involved in the sale of B”that is, both higher than the sacrificed con-
sumption of B and also higher than the alternatively sacrificed potential
productive possibilities embodied in B”will a resource owner sell B and
buy A on the terms available in the market. (Of course, once a resource
owner has produced a product, the considerations involved in a decision to
sell units of the product in order to buy quantities of other products, or of
resources to be used directly in consumption, are no different from those
that a participant in a multi-commodity pure exchange market needs to con-
We will now consider what conditions have to be fulfilled if our system
is to be in equilibrium. The following sets of decisions by market partici-
pants will have to be mutually consistent throughout the system: the deci-
sions (a) to sell resources, (b) to produce products, (c) to sell products, (d) to
buy resources, and (e) to buy products. In an equilibrium system prices
will prevail for each of the resources and products, so that each participant
is motivated to make consumption, production, buying, and selling plans,
none of which need be disappointed. The quantity of each resource that
resource owners wish to sell at this equilbrium resource price will exactly
equal the quantity that other participants wish to buy at this price for
direct consumption. The quantity of each product that resource owners
wish to sell at the equilibrium price will exactly equal the quantity that
other participants wish to buy at that price.
Each resource owner will have adjusted his consumption, production,
buying, and selling activities completely to these market prices, so that he
sees no way of rearranging his activities in any more desirable way. He is
producing those products that yield the highest revenue for the expended
resources; he is producing each product with a set of input proportions and
on a scale that yields the highest aggregate sales revenue obtainable. He
can find no way of removing any unit of any of the assets in his initial daily
bundle from one disposition to any other, without rendering himself worse
off. (1) The marginal utility that he obtains from the last unit of each of
his initial resources that he himself consumes directly is just higher than the
marginal utility of whatever else he could either: (a) buy with the additional
revenue obtainable by the sale of this last unit that he consumes, respec-
tively, of each resource; or (b) buy with the additional revenue obtainable in
the market by virtue of the marginal increment of product that these last
units, respectively, of each resource could contribute in any branch of
production; or (c) enjoy directly as the marginal increment of product that
these last units, respectively, of each resource could contribute to any prod-
ucts he might consume himself. (So that were he to consume directly either
more or less units of any of the resources in his initial endowment, he would

be worse off.) (2) The marginal increment of product derived from a
specific quantity of any one of his resources devoted to the production of a
particular product possesses, for each of the products to whose production he
might allocate this resource, approximately the same market value. (So that
were he to switch resources from the production of one product to the pro-
duction of any other, he would be worse off.) In equilibrium the prices
of resources and products each day enable each participant in the market
to successfully carry out plans fulfilling these optimal conditions, without
As we have been led to expect, it will be observed that the sets of resource
and product prices required for equilibrium in such a system must bear
strong formal resemblance to the equilibrium set of commodity prices for
a multi-commodity pure exchange market. In the pure exchange model a
market participant could improve his position by converting some of his
assets by exchange into other assets. In the present model a market partici-
pant can transform his assets, in addition, by converting them into products
and then, if he wishes, converting these products into commodities through
exchange. The technologically determined terms upon which a particular
participant can convert his resources into products, coupled with the market
terms upon which these products can be exchanged for other products,
yields sets of "exchange rates" on whose basis the resources of this partici-
pant, in effect, are converted into the products produced by a second par-
ticipant. Going one step further, by taking note of the terms upon which
this second participant was able to convert his original resources into
his products, one notices a set of terms upon which the originally endowed
assets of one market participant can be exchanged (either in their original
forms or in the form of derived product) for the originally endowed assets
of a second participant (again, in either form). By the end of each trading
day, in equilibrium, asset ownership will have been rearranged, through
production and exchange, so that no further possibilities remain for mutu-
ally profitable exchange (in the wider sense that includes production)
between any two participants. Observed in this way the equilibrium condi-
tions of prices and production in our present system are seen as reducible in
principle to the same conditions that were sufficient for equilibrium in
the multi-commodity pure exchange market analyzed in Chapter 7. Just
as we saw, in that case, that perfect knowledge on the part of all participants
in the market must lead immediately to equilibrium conditions, so also in
the present case equilibrium conditions can be seen to follow from perfect
knowledge”except that in the present context knowledge must of course
include knowledge in detail of all possible methods of combining resources
in order to obtain products.
Absence of perfect knowledge must of course lead to a group of decisions
that will be far from being mutually consistent. As usual in such a situa-

tion, the discovery of this absence of consistency will take the form of dis-
appointments suffered by participants who have formulated plans of market
action on the basis of assumptions concerning market conditions that prove
to have been mistaken. We may discard the possibility of more than one
price emerging for a particular resource or product since we are already
familiar with the market movements that will be generated by the eventual
discovery of such price discrepancies. Disequilibrium will exist whenever
the price of any resource or product results in a greater or smaller aggregate
quantity of it asked to be bought, than the aggregate quantity of it desired
to be sold. In general, the aggregate quantity of a resource asked to be
bought will be, we know from earlier chapters greater as its relative price
in terms of other goods is lower, since more people will then wish to
acquire it for consumption, as compared with the alternative consumption
and productive opportunities available. The fact that a given price for a
resource generates a demand for it in the market that cannot be satisfied
at the price is a result of the absence of mutual recognition between (a)
those who own the resource and, being less eager sellers than others, are
not prepared to sell more of it at the low price; and (b) those who are disap-
pointed in their attempt to buy the resource at the ruling price, and who
would have been prepared to offer higher prices had they known that this
was necessary. The first of these two groups are those for whom either
the marginal utility of the last units of their respective supplies of the re-
source, or the value of the relevant marginal increments of product obtain-
able from these units, ranks higher than the marginal revenue obtainable
through sale of the resource in the market. The second of the two groups
are in precisely the opposite position. Mutually profitable exchange possi-
bilities thus exist ready to be exploited. As knowledge is spread, members
of the second group will offer higher prices for the resource.
Generally, any set of resource and product prices motivates each market
participant to transform his initial asset endowment by sacrificing the direct
consumption of his resources for the sake of acquiring other commodities
either through direct exchange, or through production, or through the
combined process of production and subsequent exchange. We have seen
that the technological laws governing the various relevant production func-
tions, together with the market prices of resources and products, determine
the terms upon which, through these various ways, he can acquire at the
margin additional quantities of any particular product by sacrificing other
assets. With the terms of technological transformation given, a set of mar-
ket prices that induces (to take one possibility) too many people to convert
the resource A (either by direct exchange, or by production followed possibly
by exchange) into the asset B (which may be in the form of a derived prod-
uct), as compared with the quantity of B desired to convert to A, will result
in disappointments. These disappointments will result in a revision down-

ward of the relative price of A, and a revision upward of the relative price
of B.
The resulting fluctuations in the price of resources and products are
completely homogeneous with those we have discussed earlier, especially
in Chapter 7. In the present case, of course, we realize that an alteration
in the price of any one resource or product will immediately upset the attrac-
tiveness of the opportunities available to its owner through exchange and
production involving other resources or products. As knowledge of price
changes spreads spasmodically one can expect disappointed plans and con-
sequent plan revisions to be generated in a highly irregular fashion. The
direction of adjustments, however, will always be toward the elimination of
those disappointments generated at the prior set of prices. Market agita-
tion will proceed in this way initiating changes in consumption and pro-
duction in a continual tendency away from existing inconsistencies among
decisions. Of course, especially with production decisions, the changes
prescribed by current disappointment of past plans may not be implemented
immediately but may require considerable time. It would be possible, as in
the preceding chapter, to spell out analytically the conditions for the
achievement of various levels of incomplete "equilibrium."
Any alterations in the basic data of the system will generate the appro-
priate market forces that will bring about corresponding adjustments in the
decisions made by the market participants. Thus, a change in technology
will alter the terms on which resources can be converted into products, and
also alter the effective terms of "exchange" between the original assets of
two producing participants. This will bring about changes in the set of
consumption, production, buying, and selling plans of the affected persons,
resulting possibly in corresponding pressures toward changes in the sets
of resource and product prices. A shift in consumer tastes, or a sudden
alteration in the composition of the various initial daily asset endowments,
will all alter the terms upon which participants would be eager to convert
one asset, directly or indirectly, into another asset. In all these cases, equi-
librium can result only after the knowledge of the impact of these changes
has been transmitted by the market process to all the participants.

Once again it will be helpful to focus attention on the differences
between the assumptions underlying the preliminary model of the market
analyzed in the preceding section, and those that define the more general
model of the market which it is our principal purpose to examine. In the
preliminary model production could take place only with resources obtained
by the producer at the start of each day as part of his resource endowment.
Where resources were bought in the market, they were bought for direct

consumption as commodities, not for use as inputs in production. The
range of production possibilities was thus limited drastically by the composi-
tion of each producer's initial asset endowment. It was entirely possible
for a unit of a particular resource to be more efficient at the margin in one
branch of production than in another and yet to remain employed in the
area where its productivity was lower.
No less interesting from an analytical point of view, perhaps, was that
there was, in effect, no direct market for resources, as resources. In calcu-
lating his costs of production, the only market values that a producer could
use directly in the appraisal of the value of his inputs, were the prices being
paid for these resources as commodities. (Nevertheless, the market value
of a unit of resource would to some degree reflect indirectly its usefulness
also as a factor of production, since no owner of a resource would sell a
unit of it for a price lower than its worth to him, as reflected in the value
of the marginal increment of product that it could bring about.)
The most important implication, however, of the special assumptions
of the preliminary model, was that each resource owner necessarily had to
be his own entrepreneur. In calculating the worthwhileness of using a
particular quantity of a resource in production instead of for consumption,
or vice versa, a resource owner had to consider not only the marginal utility
of the resource and the price of the resource, but also the prices of the
products in whose production the resource could be allocated, and the mar-
ginal efficiency in production of the resource. In the preliminary model
of the market there was no division of the decision making responsibility
possible between resource owner and producer-entrepreneur.
In the more general model of a market system we now turn to, things
are different in these respects. Production can be carried on with resources
acquired out of the initial asset endowment of any market participant. In
the production of any one product a producer is not limited, as in the pre-
liminary model, by the quantity that he possesses of the scarcest of the re-
quired complementary factors of production. Generally, there will be
little likelihood that some resources will have to be consumed, or left lying
idle, or used in branches of production where their effectiveness at the
margin is unnecessarily low, merely because any one producer lacks the
necessary complementary factors of production.
In the more general market model there will be a genuine market where
the various resources will be bought and sold. The price paid for a re-
source will most probably directly reflect its usefulness to buyers, at the
margin, in production rather than in consumption.
Most important of all, in the general market model, it will now be
feasible to focus analytical attention upon a distinct and separate entrepre-
neurial function. In the general market model resources are bought in the
market by entrepreneurs who sell "them" (that is, in the form of products)

back to the market. We have already seen in earlier chapters that this kind
of activity differs sharply from that of the resource owner who, in his
capacity of resource owner, simply sells resources to the market; or from that
of the consumer who, in his capacity of consumer, simply buys products from
the market. A very important implication of the existence of the entre-
preneur concerns the terms upon which a resource owner is able to convert
his resources into products for his own consumption. In the preliminary
model these terms followed from his knowledge of the technological laws he
is able to operate with, and from his estimates of the prices of the products
that he can produce, and those of the products he might wish to buy. In
the more general model, the terms on which a resource owner can convert
resources into products are yielded directly by two sets of market prices,
the prices of the resources that he is able to sell, and the prices of the prod-
ucts that he might wish to buy. In the event that entrepreneurs obtain
superior knowledge of technological opportunities and of consumer tastes,
the terms of "exchange" available to a resource owner will more faithfully
reflect the best available conversion opportunities.
Despite these important differences between our present market model
and that discussed in the preceding section, our analysis will place much
emphasis on the fundamental similarities between the two systems. In both
systems resource owners are endowed each day with a bundle of assets, and
each seeks to transform his initial endowment, through "exchange," into
the most desirable bundle of assets obtainable. (In the present general
market model, it is possible for many participants to be able to act as
consumers even though they do not receive any daily endowment of assets.
Successful entrepreneurial activity may provide them with the income to
buy products in the market for their own consumption.) In both systems
resources can be transformed into products for one's own consumption by
sacrificing quantities of resource and obtaining products. (In the present
model this can be done without any act of production on the part of the
resource owner himself; he can sell resources to the entrepreneurs and buy
back products from entrepreneurs.)
The similarities between the two systems lead, as we shall see, to close
formal parallelism in the analysis of market equilibrium conditions (in
both systems), as well as in the analysis of market processes set in motion
(in both systems) by the non-fulfillment of equilibrium conditions.

The mental construction of a general market in complete equilibrium
demonstrates most illuminatingly this fundamental similarity between this
market and that of the preliminary model. When one constructs a model
of a general market in equilibrium, one realizes that the equilibrium condi-

tions have wiped out that single element in the general market system that
is its most important distinguishing feature, as compared with the prelim-
inary model treated earlier in this chapter. In a general market, as we
shall see, equilibrium conditions can exist only when there is, in effect,
nothing left for entrepreneurs to do.
For a general market to be in equilibrium, it is necessary that all deci-
sions made within the entire system dovetail perfectly with one another.
The decisions of the owners of each resource, with respect to selling this
resource, must fit in perfectly with the decisions of entrepreneurs with re-
spect to buying this resource. The decisions of consumers, with respect
to the purchase of each possible product, must fit in perfectly with the long-
run and short-run decisions of entrepreneurs with respect to the production
and sale of this product. Of course, the buying, production, and selling
decisions of each entrepreneur must show perfect internal consistency (or
else he would rapidly find that he must reorganize his plans). Moreover,
the decisions of each entrepreneur-producer must be consistent with the
decisions of the rest of the market in the sense that he know of no alterna-
tive arrangement that in the long run might prove more lucrative from his
own over-all point of view. There must be no other method of production
available to the entrepreneur, involving a difference in product, input pro-
portions, or scale of production that promises greater profits in the long
For general equilibrium to prevail, the prices of all resources and
products must be precisely at those levels necessary to induce such universal
dovetailing of decisions. The price of any resource will be such that the
quantity that owners of the resource wish to sell in the aggregate at the price,
in each period of time, exactly equals the aggregate quantity that entre-
preneurs wish to buy at the price, in order to employ in the execution of
their various long-run and short-run production plans. The aggregate
quantity desired to be sold is found by totaling, for all owners of the re-
source, the quantities each of which are (in the light of all other market
prices) just large enough for the respective marginal units to rank, each
for its relevant resource owner, just lower in subjective importance than
the additional purchasing power obtained through its sale in the market.
This aggregate quantity must in equilibrium equal exactly that which entre-
preneurs wish to buy at the price”an aggregate made up of quantities that
(in the light of technological possibilities and all other market prices) are
each just large enough for the respective marginal units of resource to yield
a value of marginal increment of product that ranks, for each relevant
entrepreneur, just higher than the additional expenditure involved in its
The price of any product will be such that the quantity entrepreneurs
plan in aggregate to produce and sell in any one period exactly equals the

aggregate quantity that consumers wish to buy. The aggregate quantity of
a product planned on being produced in any one period is an aggregate
made up of quantities of products each of which (in the light of techno-
logical possibilities and all other prices) are just large enough for the long-
run marginal costs associated with the respective marginal units to rank, for
each relevant entrepreneur, just lower than the corresponding marginal
revenue. This aggregate quantity must be in equilibrium equal exactly
to that which consumers wish to buy at that price”namely, that quantity of
the product found by totaling, for all potential consumers, the quantities
that (in the light of all market prices) are just large enough for the respec-
tive marginal units to rank, each for the relevant consumer, just higher than
the sacrifice represented by the additional expenditure required for these
marginal units.
Entrepreneurial decisions, for general equilibrium to exist, must in
addition satisfy, with respect to each product individually, and with respect
to each factor individually, the remaining conditions for equilibrium dis-
cussed in Chapter 10. No producer must be producing a product for which
his total revenue falls short of his long-run opportunity costs”that is, the
total revenue in his branch of production must not fall short of the total
revenue he could have obtained by applying the same resources in some
different branch of production.2
Under these conditions the flow of resources, products, and incomes
could be maintained without change through any length of time. Each re-
source owner, in the light of the set of prices available to him for the sale of
various resources, and in the light of the prices of the various products, is
able to construct a plan that dovetails perfectly with every other relevant
plan being made in the market. Every consumer earns, in his capacity
of resource owner, an income that, considering the market prices for the
various products, enables him to plan a regular consumption program that,
again, dovetails perfectly with every other relevant plan being made in the
market. The resources made available by the resource owners for produc-
tion are being combined in plants of varying size, in varying patterns of
input proportions, in the production of various different products”the net
result being (a) a stream of output containing the various products in a
precise pattern to fit the aggregate buying plans of the consumers, (b) a
stream of income to resource owners in a precise amount and pattern of
distribution that should make possible the equilibrium set of consumer
plans, and (c) an organization of production such that no entrepreneur can
discover anything to be done with any group of factors in the system, that
might result in the ultimate creation of greater market value than is, in fact,
now being created by the group.

2 See pp. 214-216, 228-230.

An important corollary of these conditions is that no entrepreneurial
profit can exist in equilibrium. We may define the profit earned by an
entrepreneur very broadly for our purposes as the difference between the
revenue received through his employment of a group of factors, and the op-
portunity cost of the factors (that is, the highest revenue being received
through the employment of a similar group of factors elsewhere in the econ-
omy). If a market is to be pronounced in equilibrium, there can be no suc®i
profit. The existence of profit in this sense would mean that those entrepre-
neurs who are now employing the group of factors "elsewhere" will eventu-
ally attempt to take advantage of the opportunities "here" to earn a greater
revenue. Equilibrium can only exist when each similar group of factors
is earning the same revenue in all areas of the market.
This can be made clearer by recalling that any group of factors suffi-
cient for the production of a particular product is, for analytical purposes,
the product. For equilibrium to exist, there can, of course, be only a
single price in the market for each given good or group of goods. In equi-
librium, therefore, there can only be one price for a product, no matter if
this product is in its final form, or whether the product is in the form of the
group of factors necessary for its production. Consequently, the price that
an entrepreneur must pay in equilibrium for his factors of production
cannot be less than the price he receives for his output. This will be true
for all entrepreneurs employing a given factor group: each will be paying
the same price for the factor group, and each will be producing a product
yielding total revenue exactly equal to the cost of the factor group. No
entrepreneurial profit or loss can exist.
This absence of entrepreneurial profits most clearly demonstrates the
proposition that in equilibrium a general market leaves no room for entre-
preneurial activity. It is worthwhile to consider some of the implications
of the absence of entrepreneurial profits. The sum of the prices of a group
of complementary factors of production will be the same in all employments;
and this sum, we have seen, will equal the value of the product of such a
group of factors (this value being again the same for all employments).
Now this, clearly, is (at least in one respect) exactly what would occur if
omniscient resource owners wrere to produce the products themselves without
separate entrepreneurial assistance. In his calculations such an owner of a
group of resources would consider them as equivalent in value to the most
valuable product that the group is able to yield. In weighing the wisdom
of withdrawing a particular bundle of resources from production to con-
sumption (or vice versa), he would balance against its usefulness in consump-
tion, its effectiveness in earning revenue, the latter equal to the value of the
final product. In a general market, with production being carried on by
entrepreneurs, exactly the same calculations will be made if the market is in
equilibrium. The price of a factor group that is just sufficiently high to

lure them away from direct consumption by resource owners is precisely the
value of the most valuable final product that these resources can produce.
We will soon see, once again, how closely the existence of equilibrium
in a market is bound up with perfect knowledge. As usual the mental con-
struction of a market in complete equilibrium is merely a means to an end.
Our principal purpose is to understand the market process in the absence
of equilibrium conditions. In the general market model, we will find,
entrepreneurial activity is the driving force, and the analysis of this activity
is the key to the understanding of the entire process. For this reason we
place such emphasis on the absence of entrepreneurial profits in equilibrium,
and on the absence of opportunities for entrepreneurs to do anything better
than is in fact being done. All this is different in a market not in equi-
Our discussions of conditions in an equilibrium general market make
it easy to see what is meant by disequilibrium in such a market. We will
continue to work with a market where the basic data are unchanged from
period to period. The regular resource endowments continue without
alteration; consumer tastes for the various products undergo no change.
The only changes are those brought about by the market process itself. In
a general market not in a state of equilibrium, market phenomena induce
market participants to make plans that are not completely consistent with
each other. Clearly, this must be the result of the absence of omniscience
on the part of market participants.
In a general market, the absence of equilibrium means that resources
are being used in production processes not best adjusted to the existing
pattern of product prices. Alternatively, absence of equilibrium means that
product prices are not perfectly adjusted to existing production patterns.
Put in still another way, the absence of equilibrium means that the prices of
resources are not completely adjusted to the prevailing patterns of con-
sumer tastes; or alternatively, that the prices of products are not adjusted
to the prevailing pattern of resource availability.
These maladjustments will necessarily make themselves felt sooner or
later. In this way, knowledge of these maladjustments will spread and will
enforce changes in the plans of market participants. For example, the
organization of production may produce "too much" of one commodity and
"too little" of a second, in relation to consumer tastes. The producers erred
in their estimation of the relative significance to consumers of the two com-
modities. The result will be that with given prices expected by the pro-
ducers to prevail for the two commodities, a greater quantity than expected
will be asked of the second commodity, while a smaller quantity than ex-
pected will be asked of the first commodity. The disappointments of both

producers and consumers will alter the relative prices of the two commodi-
ties and revise the production plans of the entrepreneurs.
One very important observation is that a state of disequilibrium in a
general market expresses itself through the creation of profit possibilities.
It is especially illuminating to notice the way this market phenomenon
focuses attention directly on the real nature of general market disequilib-
rium. Whenever a market does not fulfill the conditions necessary for
equilibrium, it would be possible to transfer a block of resources from one
actual employment in the market to some other employment yielding greater
market value (that is, greater revenue) than the actual employment. This
reflects the fact that the decision actually made, with respect to the alloca-
tion of the block of resources, was not completely adjusted to the other
decisions being made in the market at the same time. This decision
erroneously assumed that no superior opportunity existed anywhere in the
market for these resources. In fact, however, a fuller knowledge of the
value that consumers place upon this block of resource (possibly in some
other form) would have led to a different allocation. Thus, the value
placed upon this block of resources by whoever made the "mistaken" deci-
sion is less than its value elsewhere in the market. Only imperfect knowl-
edge on the part of those in the market could have permitted the emergence
of two "prices" for the same "good." Not only the individual who made
the mistaken allocation was in ignorance of the true state of affairs. Every-
body else who would have been in the position to take advantage of the
price differential, but did not do so, was equally ignorant. In this way,
whenever disequilibrium exists in the general market, an opportunity exists
to earn entrepreneurial profit by buying where market value is low and
selling where value is higher.

These considerations reveal the central role that the entrepreneur is
able to play in the market process, as well as the relation between the im-
perfection of knowledge and the existence of a state of disequilibrium.
We have discovered that whereas in equilibrium every "good" sells for
a single price throughout the market (no matter what the form in which
the good may be), in the disequilibrium market more than one price pre-
vails for the same "good" (either when the good is sold in different forms
for different prices, or when the same goods sells for different prices). In-
consistency among the decisions of market participants reveals itself in the
form of more than one price for the same "good." This is an important
discovery, since it links general market analysis of the most complex order
with the analysis of the simplest of conceivable markets. We know that

in a single-commodity market, for example, equilibrium requires a single
price throughout the market. We now know that equilibrium in the
general market requires precisely the same condition, somewhat more
broadly interpreted. We know, in fact, that all disequilibrium in the
general market may be interpreted as the absence of this single equilibrium
We recall further, from analysis of the single-commodity market, that
the simplest type of entrepreneurial activity is arbitrage”simultaneously
buying a commodity where its price is low, and selling it where its price
is higher. And we recall that it is precisely this kind of entrepreneurial
activity that tends to wipe out these price differentials”converting a market
initially in disequilibrium into an equilibrium market. Now we have
discovered that all entrepreneurial activity, in the most complex of the
general markets, reduces analytically to precisely the same kind of arbitrage
activity, buying at a lower price to resell at a higher price.
Just as more than one price for a single commodity is possible only
because of imperfect knowledge, so also in the general market the existence
of more than one price for a "good" is possible only through ignorance.
And just as the single-commodity market is brought toward equilibrium
by the spread of knowledge and its exploitation by those entrepreneurs who
find out first, so also in the general market, the market process operates
through the discovery by the more alert entrepreneurs of the existence of
these price differentials, and their subsequent exploitation of these op-
All profit opportunities in the general market thus appear as the ex-
pression”in the existence of a lower price and a higher price for the same
"good"”of a fundamental inconsistency among market decisions. It is
the ceaseless search by entrepreneurs for such profit opportunities that
prevents the continuation of existing market activities”in other words, it
is the search for profits that renders such a market state one of disequilib-
rium. Those entrepreneurs will be earning profits who discover these
price differentials before the others. It is their activity that tends to wipe
out these differentials, thus removing the inconsistencies among the de-
cisions being made in the market.

In this section we will discuss the various kinds of market forces that
may be set into motion by entrepreneurial activity as a result of particular
disequilibrium conditions.
1. Simplest of all will be the market agitation initiated by the discovery
of more than one price for the same physical resource, or the same physical

product. We have analyzed this already in Chapter 7. Entrepreneurs
who find out this price discrepancy will simply buy the product or resource
at the low price from those who do not know that any higher price can
be obtained for it, and will sell at the higher price to those who do not
know that it can be obtained at any lower price. In so doing entrepreneurs
are wiping out a lack of coordination between decision makers. Among
those who were aware only of the lower price, there were presumably
some who might have sold more of the product or resource than they are
prepared to sell at the lower price. Similarly, among those who knew
only of the higher price, there were presumably some who might have
bought a larger quantity had they known of the lower price. Entrepre-
neurial activity leading to a single intermediate price will remove this lack
of coordination.
Of course, in considering a general market, we understand that the
adjustment in the prices of the particular resource or product will affect
market activity with respect to other products or resources as well. The
nature of these secondary adjustments will depend on the particular rela-
tionships between the products or the resources. In general, the adjust-
ments will follow the pattern we discuss below in the next few paragraphs.
2. A second possibility for entrepreneurial activity may be created by
inconsistencies affecting most directly the decisions being made with respect
to two different products. Ignoring the possibility of more than one price
for the same physical resource, or the same physical product, there may
be an absence of coordination among the production, selling, and buying
decisions affecting two different products. This kind of inconsistency has
already been noticed in this chapter, and it is, in addition, similar in some
respects to cases considered in Chapter 7.
It may be possible, for example, that both consumers and entrepreneurs
have each independently misjudged the relative significance that consumers
attach to two particular products. As a result of this error consumers
have adjusted their buying plans, and producers their production plans,
according to the expectation of a price for the one product that is "too
high," and a price for the second product that is "too low." Since all
concerned make the same error, their price expectations prove initially
correct. (We may imagine that the prices of the various resources, too,
have become completely adjusted to the entrepreneurial plans constructed
according to these expectations.) These production decisions are clearly
inconsistent with each other in the light of prevailing consumer tastes.
These production decisions would be mutually consistent only if the rela-
tive prices of the products would induce each consumer to allocate his
income among the various available products in such a way that in ag-
gregate, consumers wish to buy precisely those quantities of each of the
two products that producers have planned to produce. But if the market

price of the one product is too high, and the price of the other product
too low, the terms of "exchange" between the two products are such that
disappointments must necessarily occur. These terms of "exchange" be-
tween the two products will in general induce consumers to allocate income
so that more of the second product is consumed in place of the first product
than would have been the case with "correct" relative prices for the two
products.3 As a result producers of the first product discover that they
have produced "too much" of it (that is, they find they cannot sell at the
prevailing price all they have produced in expectation of this price); while
producers of the second product discover that they have produced too
little (that is, they are unable to satisfy all consumer orders made at the
ruling price for their product).
It should be observed that the inconsistency among production de-
cisions and consumption decisions relevant to the two products implies
still further inconsistencies in decisions relevant to the resources allocated
to these products. Although we have imagined resource prices to be
completely adjusted to the plans of producers, the lack of coordination
between the latter plans implicitly makes the decisions regarding the
buying and selling of resources also internally inconsistent with each other
in the light of consumer tastes. Thus, the adjustments that eventually
will be brought about through the discovery of the fundamental incon-
sistencies in decisions with respect to the products will also exercise an
influence upon the resource markets.
It is not difficult to perceive the opportunities for entrepreneurial ac-
tivity created by these market inconsistencies. The entrepreneur who
gathers the earliest information concerning the disappointed plans of the
producers of the first product, and the disappointed plans of prospective
consumers of the second product, is in a position to gain profits by exploit-
ing his superior knowledge. He will refrain from producing the first
product and will expand his output of the second product for which he
will be able to ask and obtain a new higher price. In this way (assuming
both products to use the same inputs) he will transfer resources from
an employment where marginal revenue will be less than marginal cost
(since he knows the price of the first product will fall, so that the equality
between marginal revenue and marginal cost previously expected with the
originally planned output will not be achieved), to an employment where
marginal revenue will be greater than marginal costs (after the rise in
price for the second product).
Similarly, where the first product has been produced with resources
different from those used for the second product, the more alert entre-
preneurs will cut down their purchases of the resources used for the first
3 Where the two products are complementary goods, the direct consequences of the
market error may be more complicated than is spelled out in the text.

factor and will expand their purchases of the resources used for the second.
A tendency is thus caused toward a fall in the prices of the former resources
and a rise in the prices of the latter resources. Profits are gained by these
nimbler entrepreneurs because they perceive that they can obtain a high
price for the second product. They see that resources hitherto thought
able to create the greatest market value at the margin when allocated to
produce other products (for example, the first product, perhaps) will in
fact create the greatest market value when applied at the margin of pro-
duction of the second product. Continuation of previous plans for the
production of the first product must involve losses, they perceive earlier
than others, at least on the marginal units produced. Their search for
profits and fear of losses induces them to alter their decisions in the pattern
Entrepreneurial activity will continue in this fashion for as long as
the relevant decisions have not been shaken down into full mutual con-
sistency. Prices of the products, quantities produced of the products, and
prices of the resources affected must all be such as to eliminate plan dis-
appointments. In a general market at any one time we may expect numer-
ous groups of products (and these groups containing probably more than
two products in each group) that will have the kind of inconsistency dis-
cussed here. In all such cases the market will be in agitation set off by
entrepreneurial discovery of the profit possibilities thus presented.
3. A third possibility for entrepreneurial activity may be created by
inconsistencies in market plans revealed most glaringly in the decisions
affecting two different productive resources. We have seen, of course, that
imperfection of knowledge in the market for products implies inconsis-
tencies among decisions in the resource markets as well, and we have also
seen that the resulting market forces will bring about corresponding changes
in the decisions made in the resource markets. But there may be incon-
sistencies that have their root directly in resource market decisions.
Let us suppose that all resource owners and all entrepreneurs err in
their assessment of the relative ease with which two different productive
factors can be made available to the market; or that they err in their as-
sessment of the relative usefulness of the two factors in the various branches
of production open to the market as a whole. As a result of these errors,
all concerned (correctly) expect prices for the resources that are "too high"
for the first resource and "too low" for the second resource.
Presented with these market terms upon which the one resource can
4 The discussion in these paragraphs illustrates what were described in Ch. 2 as
"horizontal relationships" existing among different sub-markets. The reader may work
out for himself possible further developments that might follow7 (working horizontally)
on the course of events described here. The reader may wTork out, for example, the
consequences for the market prices of products that are used complementarity Avith one
or other of the two products referred to in the text.

be substituted for the second, producers in aggregate ask to buy too much
of the second resources and too little of the first, in comparison with the
quantities of the two resources that their owners (in the light of the market
terms upon which they can replace the one resource by the other in direct
consumption) are offering for sale. We may assume that product prices are
completely adjusted to the expected and initially realized resource prices,
so that no entrepreneur sees any opportunity of improving his position from
what he expects to gain by means of his production plans made in the light
of the ruling resource and product prices.
Nevertheless, the resource prices are inconsistent with equilibrium
conditions. Producers are induced by the relative prices of the two re-
sources to produce definite quantities of various products requiring these
resources, with methods of production calling in each case for an input
mix with definite proportions of the various available resources. Resource
owners are induced by the relative prices to sell definite quantities of the
two resources. The aggregate quantity offered for sale of the second re-
source falls short of what producers are planning to use, while that offered
for sale of the first resource is greater than what producers plan to use.
The relatively high price of the first resource, as compared with the second,
has led producers to plan production with methods substituting more of
the second resource for the first, and to plan to produce more of those
products requiring relatively heavy inputs of the second resource, and
less of those products requiring relatively heavy inputs of the first resource.
The relatively high price of the first resource may be inducing resource
owners to substitute quantities of the second resource in direct consump-
tion in place of quantities of the first.5
Some of the resource owners who have made plans to sell the first
resource, and some of the producers who have made production plans
calling for employment of the second resource, will find themselves disap-
pointed. This is, of course, the direct result of the inconsistency between
the decisions in the resource markets and will set into motion the appro-
priate corrective market forces. But the inconsistencies directly perceived
in the resource market also imply indirect inconsistencies in the decisions
made at the level of the product market. Consumers, we assumed, have
been making consumption plans fully adjusted to the production plans
that entrepreneurs have been making on the basis of their expected ability
to buy all of each of the two resources that they might wish to buy at the
expected prices. Since some of the plans of the producers are disappointed,
some of the plans of consumers, too, are going to be disappointed (since

¯ This will not necessarily be the case. For some resources especially, economists
have learned to expect a "backward-sloping" supply curve. The high price obtained
for the first resource may make it worthwhile for its owners to sell less of it, since the
smaller quantity sold can command a "sufficient" range of purchasing power.

these latter plans presuppose successful fulfillment of the former). The
inconsistent plans of the producers are reflected here in the derived, in-
consistent plans of the consumers.
This situation provides opportunity for entrepreneurial profits. As
soon as some alert entrepreneur senses what is happening in the market
for the two resources, he will immediately offer to buy quantities of the
first resource at prices loiuer than the market prices prevailing initially.
He will be able to secure these low prices, since resource owners will have
been forced by their disappointments to revise downward their estimates
of the price of the first resource. The alert entrepreneur will then apply
his supply of the first factor to the production of those products that, re-
quiring heavy inputs of the first factor, had been sold in the product market
at correspondingly high prices. No consumers, until now, have been dis-
appointed in their plans to buy products requiring heavy inputs of the
first factor (since we have assumed the existing product prices to be com-
pletely adjusted to the output plans of the producers, and no producer
who planned to buy the first factor has been disappointed). The price of
the products requiring heavy inputs of the first factor, therefore, has no
reason to fall. Thus, the alert entrepreneur who discovers the new lower
price the first factor can now be obtained at is able to gain profits. Similarly,
the discovery by the alert entrepreneur of the new lower price of the first
factor (relative to that of the second, especially in view of the higher price
that will certainly be charged very shortly for this second factor) may
open up for him opportunities for profit through the substitution at the
margin of units of the first factor in place of units of the second, in the
production of those products using both factors.
These profit possibilities have been made possible by the existing faulty
allocation of resources. The "erroneous" market prices for the two re-
sources had guided producers into substituting the second resource for the
first in production, and into producing products requiring heavy use of
the second resource in place of products requiring heavy use of the first”
although, in view of the real factors underlying the market, a different pat-
tern of production would have been more efficient. In view of consumer
tastes, technological possibilities, and the willingness of resource owners
to sell factors, the initially planned production pattern "wasted" the first
resource and used the second resource too heavily.
As more and more entrepreneurs move in to exploit the profit pos-
sibilities thus created, they set into motion tendencies in price movements
that both reflect the improving pattern of resource allocation and render
more limited the possibilities for further profits. On the one hand, as
entrepreneurs buy more of the first resource, and buy less of the second,
they are directly easing the pressures that had been forcing the price of
the first resource to fall, and that of the second to rise. At the same time,

with the shift from the production of products requiring heavy inputs of
the second resource toward products requiring heavy inputs of the first,
a tendency is brought about for the price of the former products to rise, and
for that of the latter products to fall.
We recognize, especially with respect to entrepreneurial activity set
into motion by inconsistencies in the resource markets, that corrective ad-
justment may take considerable time to be completed. Even alert entre-
preneurs may find themselves unable to exploit their earlier knowledge
of market conditions, due to past decisions. They may be saddled with
plants that cannot easily be converted from the production of one product
to another, or from one method of production to another, or from one scale
of output to another. What appear to be profits in the long-run view
may not be profits in the short-run view (due to the differences in the
respective opportunity costs). But eventually market forces will bring
about the adjustments outlined above. Of course, in the general market
we are dealing with, adjustments of this kind must be expected to bring
about alterations in the conditions of related markets as well. These al-
terations, too, although they are likely to be of a smaller order of magnitude,
will bring about adjustments that may be analyzed by one or other of the
examples being considered here.
4. A fourth possibility for entrepreneurial activity may exist even
where all resource and product prices are completely adjusted to the
production and consumption plans that have actually been made. This
possibility arises from the fact that these plans may not reflect the op-
portunities that "really" exist. Producers may be ignorant of particular
inventions that might lower their costs; consumers may be ignorant of
the way a new product may suit their given tastes.6 In such cases resources
are being used to produce goods that are less valuable than the goods that
could be produced with the same resources, if the existing knowledge was
fully exploited.7
Definite opportunities for entrepreneurial activity arise from cir-
cumstances of this kind. Disequilibrium conditions emerge as soon as
someone perceives the profit possibilities inherent in the situation. He
will then exploit these possibilities by applying the new invention to pro-
6 Clearly, a question of semantics is involved here. If one chooses to define tastes as
referring only to those commodities that the consumer knows, then by definition a prod-
uct that is still unknown, cannot be described as an unseized consumer "opportunity."
Nevertheless, the wider interpretation of "tastes" is in keeping with common usage.
7 Of course, the purist may point out that there are always unknown technological
possibilities that future generations will discover. From this point of view a market
system might be described as always in a state of disequilibrium, with respect to the
infinity of knowledge that is beyond human reach. A more workable approach, how-
ever, is to define relevant technological knowledge as that which is possessed by someone
in the system. Disequilibrium then exists, with respect to this knowledge, so long as it
has not yet been placed at the service of the market.

duction (or by introducing the new product to the consumer market).
The innovator (this term is used to distinguish him from the inventor)
will then be able to produce products more cheaply than others, without
having to sell these products at a lower price, or he may be able to produce
a new product selling for a price greater than its full per-unit costs of pro-
The market agitation set in motion in this way will gradually tend to
subside as profit opportunities are exploited away. As knowledge of the
new production possibilities spreads, the prices of resources, and of prod-
ucts, will adjust until equilibrium is restored, with no further opportunity
for profitable entrepreneurial activity.
With respect to all these different kinds of inconsistencies among de-
cisions, and the entrepreneurial activity they give rise to, we must not
forget that entrepreneurs may not only gain profits but may also incur
losses. In fact, whenever a market is not in equilibrium, some entrepre-
neurs are clearly foregoing (unintentionally, of course) more desirable oppor-
tunities for less desirable ones. Thus, in the broad sense, entrepreneurial
loss is always present in a disequilibrium market. Entrepreneurial losses
are incurred when producers make "wrong" decisions; that is, whenever
they use resources for purposes other than those that the market ranks as
most important. Entrepreneurial mistakes are due, of course, to mistaken
assessments of market conditions. Even in a market where, like the model
we are dealing with, the basic data”resource availability and consumer
tastes”do not change, there is ample room for entrepreneurial mistakes.
Entrepreneurial mistakes are responsible for any subsequent disappoint-
ments in the plans of all market participants. However, the market con-
tains a built-in device that operates to minimize the likelihood of
entrepreneurial mistakes. This device is precisely the fact that such mis-
takes are inescapably accompanied by losses”that are, by definition, some-
thing entrepreneurs seek to avoid.

From the analysis used in the preceding sections, it will be noticed
that although we are dealing with a general market (where all prices and
quantities are free to move), the market process in such a market can be
envisaged as the picture obtained from superimposing upon one another
a number of separate processes characteristic of some one partial market
not in equilibrium. With respect to the conditions for general market
equilibrium, this was not the case. Equilibrium in the general market
(while of course requiring equilibrium also in each of its distinguishable
sub-markets) cannot be considered simply as a quilt made up of discrete

patches of partial equilibrium. General market equilibrium implies a
definite harmony between the various distinguishable sub-markets. But
the process by which a general market moves, when equilibrium conditions
are absent, may be considered as a combination of discrete partial processes.
In fact, understanding the matter in this way is rather important for an
adequate comprehension of the adjustment process in a disequilibrium
The essence of any adjustments, of any entrepreneurial activity initi-
ated by disequilibrium conditions, is the making of "corrective" decisions
by entrepreneurs in the light of new knowledge of the state of the market.
Two characteristics of such decisions may be noticed. First, such decisions
are made "spasmodically" in the sense that the required knowledge is not
acquired continuously. Second, such decisions each may be considered
made with respect to relatively small segments of the general market. The
first characteristic implies that although disequilibrium conditions are
likely to be manifest separately in many distinguishable sub-markets, never-
theless, the entrepreneurial decisions being made in each of these sub-mar-
kets are not made completely simultaneously. Thus, it is feasible to imagine
a general market adjusting itself step by step, each step taken in one sub-
market bringing about alterations in the data relevant to the conditions
for equilibrium in related sub-markets, and thus modifying the subsequent
step-by-step process of adjustment. The second characteristic, that de-
cisions are made with regard to small segments of the whole market, is a
corollary of the limitations of the human mind, including that of entre-
preneurs. An entrepreneur will make decisions affecting prices where he
perceives the opportunity for profit. He will operate against the back-
ground of other prices that he takes as given and that he does not seek to
Taken together these two characteristics of entrepreneurial decision
making imply that adjustments in a general market will be made one at
a time in limited areas of the market, that adjustment in one area will
impinge on other areas and will eventually be reflected in the adjustments
subsequently made. These subsequent adjustments may of course affect,
in turn, still other areas as well as the area where the very first adjustment
was itself made. The point is that these intricate webs of adjustments,
working in all directions and impinging back again upon areas where
these very adjustments had their roots, are woven piecemeal, not in any
continuous, grand pattern simultaneously harmonizing all areas of the
market. Appreciation of the complex chains of relationships simultane-
ously required for a state of general market equilibrium is useful principally
in giving an idea of the multitude of separate adjustments set in motion
by a state of disequilibrium, and of the power of an entrepreneurial de-

cision in one area of the market to set off intricate and wide ranging
ripples of change felt eventually thoughout the market.

Our analysis of the general market has been facilitated by the retention
of several simplifying assumptions. Although the model of a general mar-
ket discussed here has been free of many of the more restrictive assumptions
retained in earlier chapters, we are still some distance away from a model
that can be applied directly to anything likely to be encountered in a real
world. In this section we point briefly to the way our model may be
extended to eliminate some of its more glaring simplifications.
One of the more important of our simplifications has been the assumed
absence of monopoly power throughout the market. In particular, no
resource was monopolized, and no monopoly in the production of any one
product was assumed. In the next chapter we will explore the implica-
tions of the relaxation of this no-monopoly assumption.
A second of our simplifications has been to ignore intermediate prod-
ucts. We have been arguing as if the resources endowed by nature to
resource owners are directly combined and yield finished products for
consumption in a single operation. In a real world we are likely to find
that many products can be used not only for consumption but also as fac-
tors of production, while other products may be useful only as factors of
production. We have already noticed some of the implications of this
in Chapter 2. It is not difficult to perceive that the introduction of inter-
mediate products into the model does not upset the essential logic of its
analysis. The principal modification that it would entail is the introduc-
tion of new levels for entrepreneurial decision making. Producers pro-
ducing finished consumer products with produced inputs will use these
input prices in calculating their costs of production. The producers of
these produced inputs will be making decisions with respect to a higher level
of factor prices, and so on. Market interrelationships between various
levels of production can be analyzed with the same set of logical tools we
used in explaining the relationships between factor markets and product
markets. The consequences of inconsistencies in the decisions directly
affecting the consumer product market will initiate entrepreneurial ac-
tivity that will eventually affect all the related higher markets, with vary-
ing degrees of indirectness.
A more complex problem that has been assumed away thus far in our
analysis is that introduced by the duration of productive processes. We
have been assuming that in a productive process the product emerges simul-
taneously with the application of the inputs (or, at least, that any duration

of production introduced no complications). In any kind of real world
the product to be sold is available for sale only at some definite period
of time after the productive factors are employed. Thus, every process
of production involves investment to a lesser or greater extent. Where
long-run decisions are made, they will usually involve long-term invest-
ments. We will return in an appendix to a brief survey of how the prob-
lems necessarily introduced by investment can be incorporated into a
general theory of the market process.
The final complication that we will refer to is brought about by dy-
namic changes in the basic data of the market. Included are changes in
the endowments of resources provided to the society by nature”these
changes being in the size, composition, and ownership of the endowed
resource bundles; also changes in the tastes of consumers. (So far we have
assumed away all kinds of these changes, including those that an anthro-
pologist or social psychologist would ascribe to the operation of the market
process itself.) However, in earlier chapters we have alluded sufficiently
to the effects of changes in the data upon partial markets for it to be ap-
parent how these dynamic changes must be treated in the general market
model as well. A change in tastes or resource availability must be treated
as something that introduces an immediate set of inconsistencies among
decisions otherwise consistent (if the market had previously been in equi-
librium); or (if the market had previously not been in equilibrium), as
introducing a new set of decisions with respect to which the market process
must seek mutual consistency. The speed of adjustment of the market to
the new changes will depend on the rapidity with which entrepreneurs
gain knowledge of the changes, translated into profit possibilities. The
only way, as we have seen in the introductory chapters, to analyze the
economic processes of a changing world, is to realize that all action is under-
taken with respect to the tastes and available resources relevant to a
particular date. All market interrelationships flow from such action.
Eventual changes in the basic data will be translated by the market into
changing patterns of market action, each pattern traceable to the data
of a particular date. Where different sets of relevant market data bring
about adjustments with various speeds of reaction, we may expect that at
any one time the market process may be a complex set of overlapping
programs of action, each set, perhaps, referring to the data of a different
date. All this vastly complicates, but does not essentially alter, the anal-
ysis developed in this chapter.

Chapter 11 continues the analysis of the market process until it em-
braces a system where no prices are given or constant. The chapter pro-

ceeds in two steps. A market is considered where there are a large number
of owners of different resources. Each of these resources can be used to
help produce a variety of different products. No prices or quantities of
resources or products sold are assumed to be determined externally to the
analysis. However, in the first of the two steps, we confine attention to
a system limited by the requirement that production be carried on only
with resources owned initially by the producer himself; resources can be
bought only for consumption. After this preliminary case, in the second
of the two steps, a market is analyzed where production may be carried
on with the help of purchased factors of production as well.
In the first of the two steps, analysis explains the determination in the
market of (a) the quantity of each resource consumed directly by each con-
sumer, (b) the quantity of each product produced, (c) the method of pro-
duction of each product, and (d) the prices in the market of each resource
and product. Analysis proceeds on lines analogous to those followed in
Chapter 7, where a multi-commodity pure exchange economy was consid-
ered. There a market participant converted his initial commodity bundle
into the most desirable possible alternative bundle available through ex-
change. Here he converts his initial resource bundle into the most desir-
able possible commodity bundle through production as well as exchange.
The principal complication setting the present analysis apart from that
of Chapter 7 arises out of the versatility of resources in production. De-
tailed analysis reveals how, in the absence of perfect knowledge, the market
process would enforce revisions in these more complicated plans of market
participants toward greater consistency between the decisions being made
at different points in the economy.
In the second of the two steps, production may be carried on with
resources acquired in the market. This alters the character of the market
for resources, widens very considerably the scope for production possibilities,
and makes possible the emergence of a distinct producer-entrepreneur
whose activities promote the spread of relevant market information and
the smoothness of the market process.
In this general model of a market system, the conditions for equilibrium
can be described in detail, analogous to those that determined the equilib-
rium position for the preliminary model analyzed in the earlier portion of
the chapter. It is easily shown that here again, equilibrium implies
complete knowledge throughout the market. Imperfect knowledge, on
the other hand, implies disequilibrium, which expresses itself through the
creation of profit possibilities available to those who discover them first.
Detailed analysis reveals the various different kinds of entrepreneurial
opportunities that may be offered by a general market in disequilibrium,
and the way the exploitation of these opportunities tends to correct the
initial inconsistencies existing between the various decisions being made.

In this way the market process enforces particular production possibilities,
more and more consistent with the underlying data, resource supply, and
consumer tastes.
The analysis proceeds on a step-by-step basis justified by the nature
of the chains of cause and effect relationships involved in the market. An
understanding of the more serious complications from which the analysis
in this chapter has abstracted will lead to the most useful employment of
it in applications to a real world.

Suggested Readings
Mises, L. v., Human Action, Yale University Press, New Haven, Connecticut, 1949,
pp. 258-323, 388-394.
Leftwich, R. H., The Price System and Resource Allocation (rev. ed.), Holt, Rine-
hart and Winston, New York, 1960, Ch. 17.

JMonopoly and Competition
in the General Market

W E HAVE been examining until now
market processes where the relevant market forces operated principally
through competitive pressures. We saw how the price that each resource
owner obtains for the resources he sells (or the price that each producer
obtains for the products he produces and sells) is determined by what he
deems necessary to offer the market in order to outstrip his competitors.
In the present chapter we consider what can be expected to happen in a
general market where the supply of particular resources (or the production
of particular products) is concentrated in the hands of single market par-
ticipants. Most of the cases we will examine are simpler analytically than
many we have considered in earlier chapters. Nevertheless, monopoly
and related problems should be treated at this stage, because they bring
about modifications in the general market model where they are embedded.
In introducing these problems we must be aware of the considerable
terminological confusion that surrounds them. The terms "monopoly"
and "competition" are used in the literature to denote a number of different
market situations. Moreover, economists frequently use these terms quite
differently from laymen. These terms have in turn led to numerous further
terms and combinations of terms in attempts to distinguish numerous
special market situations from one another. We will attempt in this chap-
ter to deal with relatively simple cases specifically relevant to the framework
of analysis developed in earlier chapters, and we will try to avoid fruitless
terminological disputes. As a result, several of the cases that we will
consider possibly will not fall neatly into the terminological pigeonholes
that have become popular in the specialist literature on the subject.

Suppose that starting from a given day, in the model of the general
market considered in the preceding chapter, a particular resource hitherto
present in the endowments of many participants, regularly appears (in
the same aggregate quantity as previously) in the initial endowment of only
one market participant. How would this affect the various prices, volumes
of output, and methods of production on the general market? 1
The favored resource owner now finds himself in a situation quite
different from his previous one. Previously, he dared not ask a price for
a quantity of the resource any higher than that asked by his most eager
competitor; that is, by that other owner of this resource who was the most
eager to sell such a quantity. Now the favored resource owner knows that
no matter how high a price he demands for his resource, he need not fear
that anyone else will offer it for less. On the other hand, however, he
knows that if he raises the price he will be able to sell only a smaller quan-
tity of the resource than can be sold at the lower price.
He knows that although no other resource owner can supply exactly
the same resource, there may be many who are willing to supply excellent
substitutes for it. He knows, therefore, that the entrepreneurs who buy
his resource will continue to do so at higher prices only with full conscious-
ness of the correspondingly increased relative attractiveness of employing
substitute resources”or even of entering into altogether different branches
of production calling for resources entirely unrelated to the monopolized
one. The monopolist-resource-owner is well aware that he faces competi-
tion, and that this competition will govern the quantities of the resource
that he can expect to sell at higher prices. The resource owner knows that
the stronger the competition provided by related resources, the more elastic
the demand for his resource will be.
This degree of elasticity of the relevant portions of the demand curve
facing the monopolist-resource-owner determines whether or not it will be
profitable for him to raise the price. It may not be profitable to raise the
price, in which case there will be no changes at all in market activities (as
a result of the original concentration of the resource into the endowment
of the single market participant).2 But if it does appear profitable to the
monopolist-resource-owner to raise the price of his resource, several further
changes and adjustments will be brought about in consequence. These
will concern the quantity of the resource bought, the organization of pro-

1 The reader should compare the discussion in this section with that (on monopoly
in the pure exchange economy) in Ch. 7 (see pp. 128-131).
- Of course, the mere fact of the altered pattern of endowments has altered the initial
"incomes" of individuals. We ignore here all consequences that can be ascribed purely
to this alteration of "incomes."

auction methods, and, indirectly, product prices and possibly also the prices
and employment of other productive factors.
Clearly, the higher price obtained for the resource will mean that only
a smaller quantity will be bought. As soon as the price increase is an-
nounced, entrepreneurs will revise their short-run and long-run production
plans in the light of the new market situation. In the short run, entrepre-
neurs will now tend to substitute more of other resources in place of the
monopolized factor; in the long run (and in some cases even in the short
run), entrepreneurs, in addition, will be likely to switch production at
the margin from the production of products calling for heavy inputs of
the monopolized factor, toward the production of other products. All
these changes in plans, involving both the input proportions used in pro-
duction, and also the scale of production, will result in a smaller aggregate
quantity of the monopolized resource being purchased by entrepreneurs
at the higher price. In effect, what the monopolist has done is simply to
hold a definite quantity of the resource off the market, and then to allow
buyers to compete with each other for the remainder. This remainder is
bought by the most eager buyers who secure their shares only by offering
a price high enough to eliminate the less eager buyers. If the monopolist-
resource-owner has correctly gauged entrepreneurial reaction to the price
increase, he will find that his total resource sales revenue is greater than
before, the increase in revenue per unit derived from the smaller quantity
of resource sold, more than offsetting the revenue lost on that quantity of
resource that he is unable to sell now at the higher price. (Of course, the
monopolist-resource-owner may discover that he has misjudged his market.
He may find that his total revenue has shrunk forcing him to lower the
price, at least to some degree. Or, on the other hand, the decrease in
quantity sold may be so slight that the monopolist might suspect that even
greater total revenue is to be obtained at a still higher price.) 3
With a smaller quantity of this resource being bought and used in
production, there will be corresponding consequences with respect to the
volume of output available to consumers. If the monopolized resource is
one for which, in the production of particular products, no substitute fac-
tors are available, these products will show most clearly the effects of the
price increase. Sooner or later entrepreneurs will switch from the produc-
tion of these products to other branches of production. Consumers will
find smaller quantities of these products for sale, probably at higher prices.
On the other hand, somewhat larger quantities can be expected to be pro-
duced of other products, possibly at somewhat lower prices. Eventually,
the market process will have brought about appropriate alterations in the
long-range plans of the producers so that a new stable pattern of prices for
3 On the calculations governing the monopolist's best choice of price, see p. 130, ftnt. 14;
see also p. 98, ftnt. 7.

the other resources will have been established, consistent with the new sets
of production and consumption decisions.
The differences between output in the market (in equilibrium) before
monopolization of the resource, and output in the market that has achieved
equilibrium after monopolization, are results of the fact that a quantity of
the monopolized resource remains unsold. The new market as a whole is
the poorer by this quantity of factor. It is in the same position it would
be in if this quantity of the factor had never been endowed by nature. The
concentration of the ownership of the resource into the hands of a single
resource owner has deprived the market as a whole of the opportunity to bid
for the output that the unsold portion of this resource might have made
possible. When the resource was distributed among the endowments of
many resource owners, it was never in the interest of any of the resource
owners to deprive the market of the output that could be derived from his
supply of the factor. The interests of both the resource owner and the
consumers were best served by the fullest possible employment of the re-
source. Now, however, it is in the monopolist's interest to leave a portion
of the supply unused, in direct contradiction to the interests of the con-
This outcome is not the necessary result of the monopolization of the
resource. When demand conditions are not favorable to the wishes of the
monopolist, he may be forced to offer his entire supply of the resource to
the market at the old low price. Any increase in price, he would fear,
would result in lower total revenue. In cases such as this no adverse conse-
quences for the market as a whole can be ascribed to the monopolization of
the resource.


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