Lionel Robbins in his introduction to Philip Wicksteed's classic, The Common-Sense of Political Economy, first explains Wicksteed's exposition of individual maximzing behavior and the optimaility conditions associated with system equilibrium. Maximizing and optimality are vital concepts in understanding economic systems. But Robbin's adds an interesting caveat, especially given that it was written in 1932, as he distinguished between Wicksteed and Pareto. "Wicksteed's approach is by no means the same as Pareto's. His analysis of conditions of equilibrium is much less an end in itself, much more a tool with which to explain tendencies of any given situation. He was much more concerned with economic phenomena as a process in time, much less with its momentary end-products." (p. xix).
Prices do their job through time as they guide accomodating adjustments on both sides of the market through relative price changes. As the blogosphere explodes with discussions of how new money works its way into the economy, and the Washington DC community of pundits and politicians devise policy schemes to avoid the fiscal cliff, Marketplace yesterday afternoon ran a fascinating story about guar gum which captures in my mind the essence of market theory and the price system. Guar gum is an important ingredient in fracking. In 2010, the guar gum bean was sold for $1/pound on the world market, but due to the explosion of hydraulic fracking over the past few years the price for guar gum had risen by early 2012 to $12/pound. This induced action on multiple margins. Yes Virginia, this is economics forces at work (emphasis intended and necessary).
In this instances, higher prices for guar gum resulted in (a) quest to find alternatives to the guar gum bean for the role in played in fracking, (b) reduced consumption of guar gum, and (c) an inducement to farmers to increase production of guar gum. As quickly as guar gum prices spiked, they fell back almost to 2010 levels. Guar gum in once again cheaper than the substitute products that were developed to be used in fracking.
This story captures so much about the "marvel of the market" and the price system. And it stresses how that system works through time. Prices have to be free to do their job. But they don't do their job instantaneously. Economics forces are always at work, and in a dynamic sense their work is never done.
What implications would you draw for monetary economics of this understanding of how the price system works through time?