Editorial
Market Process and Market Dynamics
by Fred E. Foldvary, Senior Editor
Unimpeded movements of prices and quantities are often referred to as “market mechanisms.” The term “mechanism” has the same origin as “machine.” The parts and structure of a machine such as a clock is its mechanism. By extension, a system that produces some result is a mechanism. In biology, there is a doctrine of mechanism which says that life can ultimately be explained as a physical and chemical process.
by Fred E. Foldvary, Senior Editor
However, an economy is not like a machine. A clock has a determined outcome, based on its mechanical setup. But a market involves spontaneous actions of persons with subjective values which can change unpredictably. Markets are spontaneous orders where entrepreneurs confront an uncertain future by being alert to opportunities and changing conditions. If a clock is ticking properly, there is little uncertainty about the time it will show in the future; indeed, we depend on it to be accurate. But the future rate of interest is not determined and cannot be known.
“Mechanism” is therefore not an apt metaphor for market activity. Another term often used is “market forces.” In physics, force equals mass times acceleration (F=MA). Acceleration is a change in velocity, either to a different speed or a different direction. The economic analogy of mass is goods and services, while acceleration is a change in price or quantity. Market forces are therefore changes in the prices and quantities of goods, as market actors seek to exhaust gains from trade. Market actors raise prices in response to shortages and lower prices in response to a surplus; the increase quantity in response to profits, and decrease quantity in response to losses.
But these responses are not automatic. It is uncertain whether the shortage will persist, or whether other actors are also seeking to exploit gains from trade. The market direction is based on expectations which can turn out to be incorrect, and so market forces can sometimes be in the direction of greater disequilibrium. So theses forces are not determined or mechanistic.
The term “force” in human affairs also refers to coercion and the military (armed forces), so the term “market forces” can be confusing, as people might think of coerced accelerations rather than the voluntary actions in the pure free market. There can be market forces in response to governmental interventions. But the meaning of “market” in its purity is voluntary production, exchange, and consumption. A pure free market is voluntary for all persons affected.
Adherents of the Austrian school of economics, of the view that markets work well, often refer to the exchange of goods as “the market process.” Austrian economics is often called “market process” theory. Israel Kirzner has written a book entitled The Meaning of Market Process, in which he emphasizes entrepreneurial discovery and describes the function of markets as a means of coordination. “Process” describes the market better than “mechanism” or “forces” as it implies motion and development in time. Sanford Ikeda has a chapter entitled “Market Process” in the book The Elgar Companion to Austrian Economics in which he describes it as a spontaneous order using private property. The Austrian-school view of the market process emphasizes uncertainty, incomplete coordination, and discovery, in contrast to neoclassical models that unrealistically assume perfect knowledge and instant and complete coordination.
But “process” also implies a procedure or operation, such as with processed food. Processed American cheese typically combines several cheeses with other ingredients to create a mix which is then heated and blended. The market is not a procedure or operation, so the term “market process” might, like “market forces,” have connotations that are non-market.
A term which avoids these nonmarket connotations is “market dynamics.” “Dynamic” implies not just motion in time, but also change. Dynamic has the connotation of energy, vigor, and excitement. In physics, dynamics is about kinetics: motion, momentum, acceleration and deceleration, shifting and changing elements and patterns.
In thermodynamics, for example, heat is irreversibly transformed into mechanical energy, entropy being the amount of energy unavailable for work. Entropy is also the amount of dissipation in a system as entropy increases and the amount of usable energy decreases, like the sun as it burns away and its heat dissipates into space. An example of the thermodynamic effect in human affairs is the tendency of a room to become ever more messy unless energy is applied to clean it and put articles into proper order. So too in an economy, capital goods and human capital dissipate unless there is an investment in maintenance and enhancement.
Dynamic models in economics are those in which variables change over time, in contrast to a static model that exists in a moment in time. The classical economic model of rent and wages uses a dynamic model, in which the amount of labor increases in a territory with different quality grades of land, inducing changes in wages and rent as land of ever less productivity is used.
The impact of market dynamics can be appreciated by contrasting it with the model of the evenly rotating economy in which there is constant momentum. In the ERE, there is production, consumption, exchange, interest, and a market process, but no change. In the real world, there is continuous change as the population grows, resources get depleted, subjective values change, new opportunities are discovered, and new products created. We can guess at but cannot really know the future, and so in this economic environment, the market is dynamic.
In physics, work is force which acts on an object to move it. Physical force implies mass which accelerates. In economics, work involves labor that accelerates resources and goods. When there is a shortage, entrepreneurs accelerate production and raise prices with the expectation of greater profit, but this anticipation is at best an educated guess, as the action of others is unknown and as costs and preferences can change unpredictably.
The market is a dynamic dance, not a clock machine or a cheese to be processed or a stick that forcefully hits an unwilling victim. Spontaneous-order economics is dynamic rather than static or evenly rotating. The movement of prices and quantities is better depicted as market dynamics rather than a market process or market mechanism or market forces.
Copyright 2006 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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Also see: Our Unconscious Economic Theories
A Triumph for Modern Green Economics
Why Do Republicans Hate Free Markets? |
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