The Function of Market Agitation

|Peter Boettke|

Individuals will continually pursue trades until the mutual gains are exhausted.  Market agitation reflects the changes being made by market participants in their attempt to bring their plans into consistency with the plans of others as embodied in the data of the market.

Obviously Mises, Hayek, and Rothbard all make this point explicitly in their work, and a great number of economists makes this point about market agitation implicitly in the stories they construct to help students understand the economic logic of competitive markets.  But to my mind, one of the best communicators of this logic is Israel Kirzner.

In Market Theory and the Price System, Kirzner states: "If a market is not in equilibrium, we have seen, this must be the result of ignorance by market participants of relevant market information.  The market process, as always, performs its functions by impressing upon those making decisions those essential items of knowledge that are sufficient to guide them to make decisions as if they possessed the complete knowledge of the underlying facts." (240, emphasis in original)

Later in his career, Kirzner would make the important distinction between the underlying variables of the market (tastes, technology and resource availability), and the induced variables of the market (prices and profit/loss accounting), and he explained how the market process can be described as the continuous activity that results from individuals on both sides of the market trying to satisfying their plans for betterment.  When the production plans of some dovetail with the consumptions plans of others, the induced and underlying variables are consistent with one another.  If no mutual consistency exists, then economic activity continues because it will be in the interest of the parties to continue to seek a better situation than they are currently realizing.

Relative prices guide us in decision making, profits lure us in our decisions, and losses discipline us in our decisions.  This is how the price system impresses upon us the essential items of knowledge required for plan coordination.

The science of economics is born out of the puzzle that the coordination problem presents to our imaginations.  The solution to the puzzle is the entrepreneurial market process.  And the resulting order of the market system is the miracle that should inspire our intellectual awe and amazement and attract subsequent generations of students and scholars to want to better understand how market forces work in theory and practice.  Focusing our intellectual attentions on the conditions associated with the state of rest (when plan consistency is achieved) more often than not impedes understanding by trivializing the miracle we witness daily.  While the characteristics of a competitive market equilibrium are essential to our economic understanding, we must nevertheless focus attention on how that equilibrium is brought about through the continual adjustment of relative prices that accomodate changes and guide individual decision makers in their necessary adaptations to shifting market conditions.  This is how markets work to ensure that individuals realize the mutual gains from trade and the mutual gains from innovation, and realize the full benefits of social cooperation under the division of labor.

Comments

[Mario Rizzo]

I have always wondered about Kirzner's use of the word "agitation" in this book. It seems to fit in with the idea that, from an individual's point of view, the changes in market prices can be disturbing, annoying and "agitating." The steady state is the quiet life. Many people hate the market precisely because it is constantly adjusting.

[Jerry O'Driscoll]

Telling is Kirzner's phrasing: "If a market is not in equilibrium..." It is as though that being in equilibrium is the natural state.

[Peter Lewin]

The ever-elusive and forever-present key question is that of behavior in disequilibrium. Expectations are inconsistent and plans are discoordinated, in the sense that not all of them can be fulfilled. The market process is no more equilibrating than than a football game. Both are intelligible yet unpredictable. What is predictable are the rules of the game; they are and must be if the game is to be played at all. The players agitate, they plan, they act; some succeed, some fail and the public is served, some better than others. Hence "agitation."

[Peter Boettke]

Peter,

Good point,but doesn't Kirzner's emphasis on the difference between induced and underlying variables result in a distinction from the football game (which would just be induced variables)? This is where I am at now-a-days intellectually. Big shift from "Beyond Equilibrium Economics" days, and a shift toward a more Kirznerian position (or even early Lachmann position).

There are these underlying realities --- tastes, technology and resource availability --- and they put constraints on our wishful conjectures.

Is this position not viable?

Pete

[Allan Walstad]

I think there's a continuum in entrepreneurship, from purely equilibrating at one end to patently disequilibrating at the other. At one end, we have simple arbitrage or incremental refinements of the organization of production. At the other end we have the introduction of the personal computer. Kirznerian vs Schumpeterian. The former might be characterized as market participants seeking to bring their plans into consistency with the plans of others, but the latter clearly involves challenging, changing, and even overturning the plans of others. There is a pretty good parallel with incremental vs revolutionary scientific discoveries. Tastes, technology, and resource availability can be radically affected by entrepreneurship; they are not merely given.

[Mike Holland]

If entrepreneurship is a continuous process is it correct that market equilibrium will never be reached and therefore market agitation will always be present? The process towards equilibrium is therefore interesting as a principle to study but irrelevant to practical policy?

[Peter Boettke]

Mike,

I would argue that UNLESS we have some understanding of the disequilibrium foundations for the equilibrium economics where we get our welfare economics from, then we have no ECONOMIC SCIENCE basis for our conclusions about market efficiency, etc.

We can for public policy base our positions on fields other than economics, e.g., ethics. But I am seeking Economic arguments for Economic Policy. At one level, we still have that because all we have to do is provide means/ends analysis. But even here, I would argue that if you push hard enough you will see that much of our means/ends analysis is based on an understanding of the market economy and economics forces at work that depend on equilibrating forces and the dovetailing of the induced and underlying data of the market.

[Greg Ransom]

Peter -- this is an elegant way to express Hayek's point that the utopian image of perfect coordination, ie equilibrium, helps motivate the problem to be explained in economics.

The utopian conception available to the imagination is road blocked by the singularly most important empirical fact of the social sciences -- individual knowledge is limited.

Statistics and econometrics don't tell us that empirical information.

And the fact is so drop dead true and significant and a part of life that math-based 'empirical economists' forget the central reality of this most fundamental empirical fact of their empirical science.

[Troy Camplin]

In thermodynamics, one gets equilibrium when one has a gas at constant temperature and pressure. Underlying equilibrium is random motion. Random motion gives one a bell curve distribution of movement. Further, there are no interactions beyond bounding off of each other. No complex dynamics emerge in such a system.

In economies, one finds power law distributions, which are features of self-organizing network processes. Such processes are, pretty much by definition, not at equilibrium.

One can talk about a system "equilibrating," of course -- but systems that equilibrate have negative feedback only. Positive feedback only of course gives rise to cycles. Complex processes, like economies, have bipolar feedback -- negative and positive feedback taking place at the same time. This results in complex dynamics and the emergence of strange attractors. The economy is a kind of far-from-equilibrium process. This is what has to be understood if we are going to understand how the economy works.

One may argue that one cannot understand complex dynamics without simple dynamics, nor far-from-equilibrium states without understanding equilibrium. This seems odd considering the fact that simple dynamics and equilibrium are special cases almost never found in nature, whereas complex dynamics and far-from-equilibrium states dominate.

[Mario Rizzo]

The problem with underlying realities is that they can be malleable. For example, consider tastes and the "framing" issue. To the extent (and it may be significant) that a producer-seller can alter observed choices by framing a potential choice in different ways, it is as if tastes can be created -- not simply discovered. However, I would guess that the choice change possiblilities would be within some -- to be determined -- limits.

This suggests that equilibria will not be exactly determined by underlying variables. But it also suggests that the distinction between induced and underlying variables is overblown. A hard-and-fast distinction might be good Econ 101 but it is not more than that.

Jerry and I (and the later Hayek) had it right. Equilibria should be modelled more loosely or, if they are modelled deterministically and as exact points then, at least, we ought not to take the model literally.

[Peter Boettke]

Mario,

How do you make sense of Hayek's observation that unless prices tend to cost as a matter of economic reality there could be no economic _theory_?

Doesn't that imply the sort of Kirznerian thought experiment?

I agree that the market process cannot be modelled deterministically, but that doesn't imply I think that you cannot model the market process as forever tending in the direction defined by the complete dovetailing of plans with objective realities of a given situation.

[Peter Lewin]

Pete,

I am not sure how helpful the induced-underlying distinction is, though I suppose it is very similar to the idea that all action takes place, must take place, within a (largely) invariant (institutional) structure. As I have often said, it is because of high predictability in one sphere (the rules of the game) that we can live with and benefit from the lack of predictability in another sphere (the plays and outcomes).

This is exactly true for both the football game and the game of life. Also, in both things happen that alter both spheres (sometimes we are induced to alter the rules). I am not sure why you say the football game involves only induced variables. The rules of the game are the underlying variables, the actual idiosyncratic plays are the induced variables, no?

I like the Beyond Equilibrium Boettke better :-) - professionally speaking.

On Hayek's observation about prices tending to costs, I believe this is an unfortunate way to affirm his abiding faith that the market process is equilibrating. Like, "we all know that through competition prices tend to approach their costs of production." Hayek was not an equilibration skeptic. He struggled for a theoretical scheme that would make equilibration plausible and, in the end, pretty much abandoned talk of equilibrium in favor of the concept of "order" - which turns out to have been a good move in light of later developments in complexity theory and emergence, to which he himself contributed a lot.

[Mario Rizzo]

Pete,

It was the "old" (younger) Hayek that made that broad point about prices tending to cost. I think the first thing we need to figure out is what the word "tends" means here. If it means that prices will conform to costs *if* everything that could make this untrue is omitted from consideration, we don't have a statement about the world here. At most, we have a statement about a particular model.

[Dom Armentano]

Mario,
I would think that "prices tending to cost" means that there are always forces at work aiming to discover and exploit that P/C differential. So "tending" means (since we are always borrowing examples from sports or physics)that there is always a prevailing "gravity" at work (if you will) in all market situations where economic profits are thought to exist. Now, the nature of that "gravity" we (Austrians) understand to be greed and self interest and the mobility of resources, etc. In some instances, of course, this gravity will actually tend to narrow the differentials while in other instances, of course, it may not. None of this casual empiricism, however, has anything to do with the overall correctness of the theory of market process and the overall "tending" forces since what we discover after the fact could always be due to exogeneous changes. And, finally, I think that both Kirzner and Schumpeter buy into this approach although they might (do) disagree, perhaps, on the overall importance of it in explaining capitalism's economic success.

[John]

While I get what is meant here I'm not sure I like how it's presented. The idea the the "market information" actually exists is a bit problematic. I think Buchanan had a short piece on this idea a while back.

The idea that the equilibrating information one can act on simply exists is problematic. We must also consider the possibility that this "equilibrating information" was in fact created within the market interactions and was not something that was "there to be discovered".

In short, the view that the economy is off equilibrium and then moved to it's equilibrium through finding this hidden information sell the complexity and beauty of market processes short. I suspect these types of cases happen, and even with some frequency.

Why I find that description a bit lacking for me these days is I don't see where we get much of an explanation of growth within the market process. If we then take the view this "information" isn't there for someone to find and use to equilibrate but rather that the market interactions are producing the information which then propels the away from it's equilibrium we have a story of growth.

Hopefully I've written clearly enough to get my idea across -- I'm certainly not trying to dismiss Kirzner or all the work he's done in this area.

[Peter Lewin]

Indeed John, you express quite nicely an issue much explored in the SDAE version of modern Austrian economics. Works by Lachmann, Rizzo, Rizzo and O'Driscoll, Dan Klein, and others, and most recently in the wonderful new book by Richard Wagner "Mind, Society, and Human Action: Time and Knowledge in a Theory of Social Economy" address this specifically.