History of Economic Thought by E. K. Hunt

Author:E. K. Hunt
Language: eng
Format: epub
Publisher: M.E. Sharpe

But these ifs must be rejected. First, the whole point of Walras’s general equilibrium analysis was to show that price changes in any one market affected supply and demand in innumerable other markets. Thus, as the two prices began to change, many other supply and demand curves would shift. The initial disequilibrium would spread to many markets. As these other prices began to change, nearly all supply and demand curves would begin to shift again. Thus, disequilibrium in two markets could rapidly become a disequilibrium in all markets. How then would equilibrium ever be established?

Walras escaped this dilemma by asserting that a given price change would have a primary effect only in the market of the affected commodity. Its effects on other markets would be secondary. He then asserted his faith that “these secondary effects, however, will be less appreciable than the primary effect if there are a great many commodities . . . on the market.”69

Subsequent disciples of Walras have shown that with all of Walras’s assumptions, if the secondary effects are sufficiently small, then the market will indeed automatically achieve an equilibrium. But they have never shown that these secondary effects must, in reality, be that small.

Furthermore, several of Walras’s other assumptions are also highly questionable. He assumed that because the economy was perfectly competitive, the small, relatively powerless business firms would always react to a situation of excess supply by lowering their prices. Experience has taught us, however, that large, powerful business firms that have some control over prices tend to reduce their level of output and attempt to maintain their price in the face of an excess supply that they view as temporary. This reduction in output reduces incomes, which further reduces demand for other products. If these producers react to the resultant excess supply in their market by reducing output, then a general glut, economic crisis, or depression would seem to be the only possible result.

Moreover, Walras assumed that all exchangers would react to any set of prices as if they expected those prices to be the equilibrium prices that would continue to prevail. Again, experience shows that exchangers frequently behave otherwise, exchanging on the basis of prices that they expect to obtain in the future. John Maynard Keynes showed, as we will see in a later chapter, that these expectations can frequently make the achievement of a full-employment general equilibrium impossible.

We can conclude that Walras’s belief that the market would automatically create a full-employment general equilibrium was as much a matter of pure faith as had been Say’s belief—and both beliefs were equally unjustifiable on either theoretical or empirical grounds.

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