Prices and knowledge: A market-process perspective

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A theory of the market process 9THE DEFINING CHARACTERISTIC OF EQUILIBRIUMIn spite of the centrality of equilibrium to economic theory, mosteconomists have been using what Hahn (1984a:8) describes as a‘sloppy equilibrium concept’. 1 Although equilibrium has frequentlybeen associated with situations of market-clearing, 2 the essentialproperty of equilibrium, as Hayek (1937) pointed out, is the perfectco-ordination of individual plans. The confusion may have arisenbecause this wider definition will often include situations of marketclearing.However, it is the perfect co-ordination of plans that allowsthe theorist to imagine that in such a state no further change will occur,thus allowing him to speak of equilibrium.Frank Hahn (1984a:44), who describes himself as a neoclassicaleconomist, has, in a Hayekian vein, described equilibria as ‘thosestates in which the intended actions of rational economic agents aremutually consistent and can therefore be implemented’. 3 Thestochastic equilibrium notion he has in mind would be consistentwith ‘short enough and rare enough episodes of uncleared markets,’although it ‘implies almost the missing traditional complement thatmarkets are cleared’ (Hahn 1984a:60). Stiglitz (1987: 28) has alsorecently pointed out some limitations in the traditional notion ofequilibrium. According to him,Traditional theory has taken the equality of supply and demand tobe part of the definition of equilibrium. This, I think, is wrong. 4And, he adds,the equality of demand and supply should not be taken as adefinition of equilibrium, but rather as a consequence followingfrom more primitive behavioral postulates.For Stiglitz, equilibrium is better defined as ‘a state where noeconomic agents have an incentive to change their behavior’. Such astate can occur only when there remain no unexploited profitopportunities. As long as any opportunity continues to exist there isthe possibility that the agents will discover it and disturb the existingsituation (which therefore is not properly described as in equilibrium).In other words, equilibrium occurs only once agents have discoveredall the available opportunities and once they know they have done so.(As will be indicated below, this situation is compatible with the
10 Prices and knowledgeexistence of optimal ignorance.) The perfect co-ordination ofindividual plans mentioned by Hayek is made theoretically possibleby assuming that individuals have acquired the necessary knowledgeto achieve it.The essential point, then, is that the defining characteristic ofequilibrium is not the equality of quantities supplied and demandedbut, instead, the knowledge (and exploitation) by the trading agentsof all profitable opportunities, that is, ‘perfect’ knowledge. As Hayek(1937:42) put it, the assumption of ‘correct foresight’ is not aprecondition for the achievement of equilibrium but, instead, itsdefining characteristic.WHY IS DISEQUILIBRIUM IMPORTANT?This informational characteristic of equilibrium serves to explain whyequilibrium does not provide an adequate framework for studyinghow an economic system solves the knowledge problem involved indiscovering profit opportunities: in equilibrium the problem is alreadysolved. To the extent that many observed market phenomena arise asa consequence of this knowledge problem, an economics interestedexclusively in equilibrium would never be able to explain themsatisfactorily. 5 Specifically, for the purposes of this study, such aneconomics is unable to say much about any informational role thatprices may perform in disequilibrium. An economic theory ofdisequilibrium is necessary for this task.Many economists appear to be reticent about studying disequilibriumsituations, both because they believe that most economic phenomena ofinterest will, sooner or later, be accommodated within an equilibriumframework, and because they fear that a concern with disequilibrium issynonymous with the abandonment of rigorous economic theorizing.However, some have started to take a different attitude and to point outthat much is missed by neglecting the study of disequilibrium. Becausetheir remarks to this effect do not seem to have received much attention,they will be quoted here at some length. One example is provided byFrank Hahn’s (1984:4) comments regarding the ‘danger’ of considering‘nothing but equilibrium’ and the ‘foolishness’ of claiming ‘that alltheory should be equilibrium theory’:What is plain is that by narrowing our viewpoint in this manner weshall remove a great deal of interest and importance from scrutiny.
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Page 6: ContentsAcknowledgmentsvii1 Introdu
Page 10 and 11: Chapter 1IntroductionIn recent deca
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112 Prices and knowledgeMarkets and
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118 Prices and knowledgechapter 3 t
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124 Notesmoney, the behavior of arb
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126 Notes14 It is not clear why the
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128 Notes39 See also Hahn (1984a:11
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130 Notestheories of cognition held
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132 Notes3 Economists, Nelson and W
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ReferencesAkerlof, G.A. (1970) ‘T
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136 ReferencesGilad, B. (1981) ‘A
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138 ReferencesKihlstrom, R.E. and M
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140 ReferencesOsana, H. (1978) ‘O
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142 Referencesfrontiers of analytic
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144 IndexCercone, N. 79change: and
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146 Index61, 118; on costless infor
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148 Indexmisinformation 55, 57mista
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150 IndexVeljanowski, C.G. 43voting
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