Lesson 4 of 8
Never arriving
Equilibrium here is not a state any market is in. It is the reference point that says which way a market is being pushed, and that is all it is for.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Equilibrium here means a state in which everybody's plans fit together. Nobody claims a real market is ever in it.
- It is kept because without it there is no way to say what direction a market is moving in, or what counts as an error being corrected.
- The load-bearing claim is not that markets reach equilibrium. It is that they tend toward it, and that claim is contested inside this tradition as well as outside it.
If a tradition insists that knowledge is scattered and that competing is a process of finding out, it has a problem with equilibrium. Why keep a concept that describes a state nobody is ever in.
What the reference point is for
- 1Plans that do not fitTwo people are counting on the same thing, or nobody is supplying something wanted
- 2Someone noticesA gap shows up as a profit or a loss
- 3Plans are revisedThe people involved change what they are counting on
- 4Fit improves, and the data changes againSo the destination moves before anyone gets there
What equilibrium is a statement about
The useful definition here is about plans rather than about prices. A set of people are in equilibrium when the plan each is acting on is consistent with what the others are actually going to do, so that nobody is relying on something that will not be there.
Stated that way, the concept is obviously never satisfied. People are always relying on some things that will not happen. And stated that way, it is also obviously useful: it names exactly what a market failure of coordination is, which is two plans that cannot both be carried out.
Why the tradition keeps it
Kirzner's answer, in his 1997 Hobart Paper for the Institute of Economic Affairs, is that without a reference point you cannot describe a process at all. His illustration is deliberately simple: the same good selling at two prices in two parts of one market, with no cost of moving between them.
In a model where everyone knows the relevant facts, that situation is impossible, because the people paying more would be acting against their own preferences. Once you drop the assumption, it is not merely possible but unavoidable: the people paying more do so because they do not know about the lower price, and those accepting less do so for the same reason in reverse.
The gap between the two prices is the thing a market process acts on, and convergence toward one price is what a tendency toward equilibrium means here. Nothing in it requires the destination to be reached.
The honest version of the claim
Kirzner's own point, and it is worth stating carefully, is that until you add somebody who notices, nothing in the situation implies any change at all. The people unaware of the better price may stay unaware indefinitely. The tendency is not a law of the model. It exists only if somebody spots the gap, which is the next lesson.
That is also the joint at which the tradition disagrees with itself. Lachmann argued that because the data keeps changing and expectations are not determined by the theory, there may be no reliable tendency to anything. That argument is lesson eight, and it is the strongest objection in this course.
Check yourself
What does equilibrium describe, on this account?
- A market in which all prices are stable
- A state in which people's plans are consistent with what others will actually do
- A market with many buyers and sellers
Show the answer
Answer: B.
Defining it over plans is what makes the concept useful here: a coordination failure is exactly two plans that cannot both be carried out.In Kirzner's two-price illustration, why do some buyers pay more?
- They value the good more highly
- They do not know the lower price is available
- Transport costs differ between the two parts of the market
Show the answer
Answer: B.
He sets the example up with no transport cost, so that ignorance is the only thing sustaining the gap. Under full information the situation would be impossible.What does Kirzner say is needed before any change follows from the price gap?
- A fall in the interest rate
- Somebody alert enough to notice the opportunity
- More sellers entering the market
Show the answer
Answer: B.
He is explicit that until alertness is introduced, those unaware may remain unaware indefinitely. The tendency is not automatic in the setup.Sources
- Kirzner, How Markets Work: Disequilibrium, Entrepreneurship and Discovery, Institute of Economic Affairs, Hobart Paper 133, 1997, section on the driving force of entrepreneurial alertness, for the two-price illustration and the claim that nothing changes until alertness is introduced.
- Hayek, 'The Meaning of Competition', in Individualism and Economic Order, 1948, section I, for the objection to treating the equilibrium state as the subject.
- Hayek, 'Economics and Knowledge', Economica, 1937, is the paper in which Hayek reworked the concept of equilibrium around the compatibility of plans. It is named here so a reader can find it and is not expounded in this lesson.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The two prices are invented round figures used to show the structure of the argument. They describe no market.
- Hayek's 1937 paper was not read in the original for this lesson, and no claim above rests on it. The two-price argument and its limit come from Kirzner's 1997 paper.