Subjectivism and Economic Analysis: Essays in memory of Ludwig ...

SUBJECTIVISM IN ECONOMICS AND THE ECONOMYprice system, and thus help to co-ordinate specialised activities, wasextremely convenient; but we should not forget that the signals onwhich Smith relied to stimulate movement in the direction of coordinationthrough a competitive process which should not beconfused with perfect competition, were market prices that were outof line with natural prices. Smith thus had what we would now callboth a theory of equilibrium and a theory of equilibration, acombination that has proved beyond the grasp of neoclassicaleconomists.The logical flaw in Smith’s value system is that the process thatgenerates increasing wealth does so by changing the costs ofproduction by which this increase is to be measured. But thisdifficulty is relatively minor compared with that of basing any kindof natural value in an evolving system upon marginal utility, foreconomic progress extends consumption to lower-rated uses. Theeventual solution was found by postulating a general equilibrium inwhich price measured not only the marginal utility of everycommodity but also its marginal cost, which was itself a precisemeasure of the marginal utility forgone by not diverting anincrement of resources to the best alternative use. It will be observedthat this precise measure requires not only general equilibrium, butperfect competition, together with such other well-knownconditions as the absence of public goods.This was not good enough for Marshall, who saw that welfaredepended on what happened inside the margin; so he adaptedRicardo’s concept of rent to devise a general measure of bothproducers’ and consumers’ surplus. In principle, such measurescould provide rankings which might be very different from thosebased on equilibrium values alone, but their validity depended onequilibrium. Although Marshall did not expect that his measureswould be adequate for anything more than estimates of themagnitude of changes in welfare as a result of changes withinparticular industries, even that proved to be an extravagant hope;but it is noteworthy that the measurements employed in cost-benefitanalysis rely on Marshall’s ideas, and on the conception ofequilibrium that underlies them. If the validity of such incrementalmeasurement is doubtful, what are we to make of measures ofnational income that depend on a set of assumptions that are alwaysviolated, and often grossly violated, by the economies to whichthose measures are applied?It is easy to understand why some economists are not satisfiedwith such a basis of valuation, but it is not so easy to agree that17