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The Market Process Microeconomics Lecture 5 Summer2012 ICES High School Workshops Paul Mueller & Ryan Safner Review of Equilibrium Models • Qd < Qs: Shortage Price – Buyers bid prices up 10 9 8 7 6 5 4 3 2 1 Market Supply • Qd > Qs : Surplus – Sellers slash prices • Qd = Qs : Equilibrium Market Demand 1 2 3 4 5 6 7 8 9 10 Quantity/Time – No pressure to change Price Review of Equilibrium Models 10 9 8 7 6 5 4 3 2 1 Market Supply Market Demand 1 2 3 4 5 6 7 8 9 10 Quantity/Time • Supply & Demand curves relate only P and Qs or Qd • Ceterus Paribus violations shift curves • Affects equilibrium price and/or quantity Equilibrium in the Real World Equilibrium Prices Disequilibrium Prices (Surplus!) Price Equilibrium in the Real World 10 9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 9 10 Quantity/Time • Equilibrium models are a snapshot of a market frozen in time. • Ceterus paribus never holds in reality. • The market is a process, not an endstate Price A Note on Equilibrium Models 10 9 8 7 6 5 4 3 2 1 ≠ ≯ 1 2 3 4 5 6 7 8 9 10 Quantity/Time Uncertainty Uncertainty • Ex ante: Before the action – Expected Benefits > Expected Costs: Do it! – All trades are ex ante beneficial • Ex post: After the action – Realized Benefits > Realized Costs: Profit! – Possibility of error Market Testing Markets as Emergent Extensions of Human Action This division of labour, from which so many advantages are derived, is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual, consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another. Book I, Chapter 2 Adam Smith (1723-1790) Wealth of Nations (1776) Markets as Knowledge Generators The market process…is set in motion by the results of the initial marketignorance of the participants. The process itself consists of the systematic plan changes generated by the flow of market information released by market participation – that is, by the testing of plans in the market. (1973) p.10 Israel Kirzner (1930-) Competition and Entrepreneurship (1973) Markets as Knowledge Generators [T]he efficiency of the pricesystem…does not depend upon the optimality (or absence of it) of the resource allocation pattern at equilibrium; rather it depends on the degree of success with which market forces can be relied upon to generate spontaneous corrections in the allocation patterns prevailing at times of disequilibrium. (1973) p.6 Israel Kirzner (1930-) Competition and Entrepreneurship (1973) Markets as Knowledge Coordinators The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.” (1945) “The Use of Knowledge in Society.” AER: I Friedrich August von Hayek (1899-1992) Two Types of Knowledge Scientific Tacit The Function of the Price System The marvel is that in a case like that of a scarcity of a raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly.” (1945) “The Use of Knowledge in Society.” AER: IV Friedrich August von Hayek (1899-1992) Sources & Further Reading • Buchanan, James. “What Should Economists Do?” Southern Economic Journal. • Hayek, F.A. 1948. Individualism and Economic Order. • _______. Competition as a Discovery Procedure. • Kirzner, Israel. 1973. Competition and Entrepreneurship. • Reed, Leonard. I, Pencil.