2.1.4. equilibrium in the short run and in the long run

Most of economic theories are not triggered by real problems, but by hypothetical questions. In other words, at the very beginning a real problem triggered a theory, but afterwards the issue got a live on its own. Most problems discussed in textbooks about microeconomics nobody is really interested in. They can remain unresolved. In literature we would talk about intertextuality, texts refering to texts and only comprehensible if one knows the other texts the text is refering to.

In literature this is not even considered as bad, on the contrary, it passes to be something very elegant, kind of l'art pour l'art. The more a literary text is based only on other text, the more it consists of pure copies, the more beautiful. The academic world has always a strange kind of logic, on any field.

This is not true for Alfred Marshall. The statement of Alfred Marshall are very differentiated. He put forward an argument and relativises it afterwards. He describes the cardinal measurment of utility and discusses afterward the problems of this concept, he describes economic laws and describes afterwards that they are only tendencies, see methodological approach. He describes physics as the methodological paradigm, affirming later that perhaps biology has more resemblance to economy, because it has a wider methodological approach. He discusses the concept of price elasticity, but declares afterwards that it is impossible to calculate the price elasticity because the slope of the demand curve can't be determined. If someone wants to see the difference between a modern textbook on microeconomics and the original version, Principles of Economics, he just has to read it. The difference is obvious.

What we have nowadays in textbooks about microeconomics is a simplified and bad copy of the original text. The few concepts of Vilfredo Pareto can be silently ignored.

Microeconomics is almost only about the anaylsis of equilibriums of any types and under different aspects. We have partial, that takes into account only one product, equilibriums based on cardinal measurement, Alfred Marshall, we have partial equilibriums of Vilfredo Pareto based on the substitution rate of two products, an ordinal measurement of utility, we have the general equilbrium of Léon Walras and lot of other equilibriums.

All these analysis are static. They refer to a certain moment and to certain presumed optimal relationship between price and amount. The common goal of all these equilibriums is to prove that any governmental intervention and everything that distorts the result of the market is a loss of welfare.

Beside the problems already mentiones with this kind of modeling, see cardinal measurement of utility and price elasticity there is a more important problem. Actually we don't care about equilibriums.Or to put it more clearly: Without any modeling we understand that customer duties on, for instance, elaborated cacao products, have a negative impact on the consumer surplus and there is no modeling needed to understand, that the exporting countries of cacao have no chance to develop a cacao industry, if the customer duties impede them to export more elaborate products.

What we care about is the level of this equilibrium price in other words the long term factors that determinates the level of this equilibrium price.

The fact that neoclassical theory, actually the analysis of equilibriums of any kind, dominates in nowadays economic thinking can be explained. An equilibrium state is a state where nothing changes. This simplifies the task and makes mathematical / graphical modeling easier. If want to be precise, the famous ceteris paribus clause is not even needed in neoclassical thinking. If we only analyse an equilibrium or if we only consider a very short period, there is no need for the ceteris paribus clause. The assumptions, that the other things remains equal is not necessary in this case, because in the short run they don't change. In the short run we have no change in the production structure, no technological advance, the qualification of the people is the same, the size of the markets doesn't change, the preferences remain the same, there is no change in the political system and the organisational structure, preferences don't change etc..

modeling, especially mathematical modeling, requires that the relationships between cause and effects remain the same and that the important parameters are taken into the account in the modell. modeling is therefore only possible if we exclude anything casual, unpredictible, spontaneous. In other words, everything that have in the long run a decisive impact on the economic development.

That's explains the fascination of economists for equilibriums. Economists prefere modells, especially mathematical modells, because they look more intelligent, more like physics, see methodological approach. Scientific looking trivialities are prefered to relevant statements that looks less scientific.

It is posible for instance to formulate a mathematical function of the type total costs = (variable costs * the amount) + fix costs. But this function doesn't mean anything almost we found it several times in any textbook about economics. In the long run the structure of the costs changes. If maschines substitute workmen the amount of the fix costs will increase, the variable costs decrease. A change in technology or a change in the organisation, for instance outsourcing, can reduce the fix costs and increase the variable costs. An increase in demand can reduce the fix costs per unit, but increase the variable costs, if the raw materials become more expensive.

In hypothetical examples we can put just any numbers on a piece of paper, but what we really want to know is how changes in the productive structure, or in the demand, influences this function. (Even the demand can have an influence on the COST STRUCTURE, because it can, for instance, lead to a reduction of the fix costs per unit.)

We can't get any insight on market economies by analysing a static state, because market economies are not more efficient than other economic orders because they ARE better, but because the DEVELOPE better. We are therefore interested in the PROCESS not in the STATE.

It is obviously easier to describe the position of a car at a certain moment than to calculate the time it needs to get fro A to B, but the last one is the interesting question. Due to the hundred of things we don't know, the traffic, the number of passengers, the metereological conditions, the state of the roads, the qualification of the driver etc. there is perhaps no way to calculate exactly the time needed, but an estimate about relevant issues is more important than the exact description of an irrelevant issue. If someone can estimate how long a car will take to get from A to B in ten years, it would be even more interesting.

Most of the economic modells take very few parameters into account: price, interest rates, savings, capital, marginal utilitiy, marginal costs, amount of money, profit. Know how sometimes, but only in the form of a place-holder that explains what kind be explained. Variable like the consumer / producer surplus, price elasticity, substitution elasticity are deduced from the former one. It is crystal clear that a model that works at most with ten variables can't explain a system that is determined by thousands of parameters and even less if the parameters taken into account are not even the most relevant ones.

Some readers would say that an advance in technologie could be taken into account by moving the supply curve to the right, if this advance allows to produce at lower costs, but that doesn't resolve the problem. We get a new relationship of marginal costs and amount, but we don't get an answer to the fundamental question: What induces technological advance?

Some others would say that changes in the technological structure and in the organisation, improvement of the education system, better organisation of the administration etc. etc. are not the object of study of economists, but of engineers, jurists, teachers etc.. If the real problems are resolved by other people, it is better to invest the money in these studies.

Economics is a transversal science and only conceived at a transversal science it make sense. Every problem on earth has economic aspects, however an economist must be able to study as well a problem more in detail. That means that a specialisation is needed what is possible if the things are explained in a straightforward way without useless mathematical modeling that only narrows the perspective and leads to a lot of error in thinking.

To give a more concrete example: The wool of Alpaca has similar charakteristics as the kashmir wool or the angora wool, but is less expensive. However it plays no role in the cloth market. As an exercise it would be a good idea to study this problem as an international level, in cooperation with other universities. Some can study the output market, the hindrance the textil industry in the respective countries sees in processing this wool, how clothes made of alpaca wool can be distributed and which kind of retail trades is the most suitable, the comunication strategy to be used and so on. In the producer countries, in this case Peru and Bolivia, the way this wool is treated must be analysed and if the way they do it fits international standards. That would allow students to get in touch with real problems and would be a much better exercise than moving curves around. Most of all: This is the kind of qualification that is actually needed in the real world.

If for a lack of working experience academic teachers are not able to organise projects of this kind, it is better to fire them.

In the equilibrium of Alfred Marshall someone only spends money for buying something if the thing he buys yields him at least the utility worth the money he spend for it. (If we want to be precise, the expected utility, because before he had consumed it, he doesn't know how much utilitiy it will yield.) Due to the assumption of the decreasing marginal utility prices has to decrease in order to induce someone to buy more.

This is a cardinal measurement of utility. The utility is measured with money. The problem with this kind of measurement is, that money itself follows the logic of the decreasing marginal utility and given the differences in the incomes, we can't therefore aggregate the individual demand curves, see cardinal measurement of utility.

An ordinal measurement of utility would be something like that. If we can observe that two people are willing to work a different amount of hours to obtain a good, we can say that their appreciation for this good is different. For practical purposes that is irrelevant, but the example given by Alfred Marshall shows that he was well aware of the problem.

The simplest case of balance or equilibrium between desire and effort is found when a person satisfies one of his wants by his own direct work. When a boy picks blackberries for his own eating, the action of picking is probably itself pleasurable for a while; and for some time longer the pleasure of eating is more than enough to repay the trouble of picking. But after he has eaten a good deal, the desire for more diminishes; while the task of picking begins to cause weariness, which may indeed be a feeling of monotony rather than of fatigue. Equilibrium is reached when at last his eagerness to play and his disinclination for the work of picking counterbalance the desire for eating. The satisfaction which he can get from picking fruit has arrived at its maximum: for up to that time every fresh picking has added more to his pleasure than it has taken away; and after that time any further picking would take away from his pleasure more than it would add.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER II, TEMPORARY EQUILIBRIUM OF DEMAND AND SUPPLY

This equilibrium corresponds to the ideal and can be determined without making use of money as a means of measurement. It is therefore an ordinal measurement.

A correct description of what really happens in reality is given by Joseph Schumpeter. We don't optimize our income by spending it in a way that the last unit of money is the same in all uses. (In theory than we had reached the optimum, because there is no way to improve our situation in spending it in a different way.) If we are in super-market we don't calculate if 1 kilo of pasta is better than 1/2 kilo of pasta and a pack of puff. Actually we have learned from the past in a somehow "intuitive" way what basket suits best to our preferences.

A more realistic description is given by Joseph Schumpeter.

(Actually there is another interesting point in this paragraph. Joseph Schumpeter doesn't refer to a decreasing marginal utilitiy, but to the competition between altenative goods, see Say's Law. The language, in the german original, is a little bit weird.)

Die Bestimmung der Menge eines jeden Gutes und daher seines Wertes steht also für jedes Gut unter Drucke aller übrigen Güterwerte und erklärt sich vollständig nur durch Rücksichtsnahme auf sie. Wir können deshalb sagen, dass die einzelnen Güterwerte für jedes Wirtschaftsobjekt ein Wertsystem bilden, dessen einzelne Elemente in gegenseitiger Abhängigkeit voneinander stehen. In diesem Wertsystem drückt sich also die ganze Wirtschaft des Individuums aus, alle seine Lebensverhältnisse, sein Gesichtskreis, seine Produktionsmethode, seine Bedürfnisse, alle seine wirtschaftlichen Kombinationen. Dieses Wertsystem ist dem einzelnen Wirtschaftssubjekt niemals in allen seinen Teilen gleich lebhaft bewusst, sein größerer Teil liegt vielmehr in jedem Augenblick unter der Schwelle des Bewusstseins. Auch wenn es Entscheidungen über sein wirtschaftliches Handeln trifft, hält es sich nicht an die Gesamtheit aller in diesem Wertsystem zum Ausdrucke kommenden Tatsachen, sondern an gewisse bereit liegende Handhaben. Es handelt eben im wirtschaftlichen Alltag im Allgemeinen gewohnheits- und erfahrungsgemäß und knüpft bei jeder Verwendung eines bestimmten Gutes an dessen Wert an, der ihm erfahrungsgemäß gegeben ist.

Josehp Schumpeter, Theorie der wirtschaftlichen Entwicklung

The determination of the amount of each good and therefore of his value is under the pressure of all the other values of goods and can therefore be explained by taking the other goods into account. We can therefore say that the individual values of the goods form a system of values for each economic object and that any single value of a good depends on the values of the other goods. By this system of values the whole the whole economy of the individuum is determined, his perspectives, his method of production, his needs and all his economic combinations. The single economic object is never fully aware of this system of values, most part of it is under the threshold of consciousness. Even if the individuum makes economic decisions he doesn't take into account all the facts determined by this system of values, but sticks to the best known. In normal economic live he sticks to routines and habits he knows best by experience.

This is actually true and beside that there is no need for the assumption that the homo oeconomicus behaves in a rational way, is fully informed and optimizes its resources as a consumer or producer. A market economy works as well if there is only a tendency to reach the optimum. In other words, the first chapter of any textbook about microeconomy, the chapter where they explain the
ceteris paribus clause, is superfluous.

The market he describes next is a market where product are only CHANGED, but not PRODUCED. This is a very big difference. In a market where product are only CHANGED the adaptation of the supply to the demand (or the demand to the supply) can only be achieved through an adaptation of the PRICES. Thats obvious, because the amount is fixed. From this kind of market exists an extreme version, an institutional market. That's the market Alfred Marshall starts his discussion with.

An analysis based on a market where products are only changed, but not produced, is an analysis of the short run. In the short run we have actually only one relationship: The relationship between amount and prices. In the short run nothing changes. Due to the fact that only already produced goods are changed, we can completely abstract from the production structure. Therefore we get rid immediately from the most difficult part. The period to be taken into account in a typical exchange market, for instance a fish market, is very short, normally only one day or even only a few hours. In this time the preferences won't change either. We can therefore forget this problem as well.

Let's illustrate that with an example. At a fish market on a certain day there is a certain amount of fish that must be sold until the end of the day, because the next day the fish is rotten and has to be throw away. The amount of fish is therefore fixed and has to be sold. On this single day, actually a few hours in the case of an institutional fish market, the preferences of the demander won't change, but they will buy more fish at a cheaper price. Restaurants for instance will do that if they know that more people will eat fish if they get it a better price. Therefore the only way to balance the supply and demand is by the price. Perhaps some fishers will learn something and offer less or more fish the next day, but this is not part of the analysis.

We understand immediately that this situation is very different from a market where products are actually produced. In markets where products are actually produced we don't have a simple price <=> amount relationship. In the long run everything will change. And the direct relationship between price and amount is the less important one, although textbooks on microeconomics focus exclusively on this relationship.

We will see later on, that in short run the demand determines the price, but in the long run the costs.

Let us then turn to the ordinary dealings of modern life; and take an illustration from a corn-market in a country town, and let us assume for the sake of simplicity that all the corn in the market is of the same quality. The amount which each farmer or other seller offers for sale at any price is governed by his own need for money in hand, and by his calculation of the present and future conditions of the market with which he is connected. There are some prices which no seller would accept, some which no one would refuse. There are other intermediate prices which would be accepted for larger or smaller amounts by many or all of the sellers.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER II, TEMPORARY EQUILIBRIUM OF DEMAND AND SUPPLY

What Alfred Marshall describes is an intitutional market and a market were products are EXCHANGED for money, but not produced. The paragraph shows as well something very typical for Alfred Marshall. Instead of simply assuming a marginal decrease of utility, like modern textboods do, he tries to get a full picture of reality. In this case he assumes that the price for corn depends also on the future conditions. In other words, the farmer tries to figure out what will be price in the future.

If we take a closer look on an issue, we always see that in practise things are more complicated. In his expample, the farmers are not obliged to sell, they can keep their corn for years, at least if they are not of urgent need for money. In our example, the fish market, the sellers has to sell their fish, because otherwise it will spoil. (The possibility to freeze it exists, obviously, but that is expensive.)

If we take into account that product are produced and not only exchanged we are confronted with the dynamic of market economies, at least time is a factor that can be neglected. The difusion of know how, the technological advance, the coming up of new producers in other parts of the world etc.. can happen very quickly or very slowly, but in the last fifty years it happens very quickly. The dramatic increase in the demand for smpartphones didn't lead to higher prices. The opposite is true. Very quickly competitors showed up and the price for smartphones fell. It is the DEMAND that leads to a fall of prices. Exactly the opposite of what we see in modern textbooks.

If the supplier and the demander have a precise idea about the price they want to sell or buy a product it is very plausible that some amounts will not be sold. Let's say we have the demanders A, B, C who are willing to pay respectively 240, 250 and 260 dollars for one tonne of corn and the suppliers 1,2,3 who want to pay 240, 250 and 260 dollars for one tonne of corn. If the three sellers or suppliers were in front of their respective tonne of corn with a price tag in their hands all three demander would try to buy first the the tonne of A, however only 3 will get it, because he is willing to pay more than the others.

There would remain two tonnes for 250 and 260 dollars and two demanders willing to pay 240 and 250 dollars respectively. The tonne for 250 dollars will be sold, but the tonne for 260 dollars not, because the remaining demander is willing to pay only 240 dollars. In this case, a situation were the seller and the buyer are completely inflexible, not the whole amount will be sold.

The situation changes if the sellers what to sell the whole amount and the buyers want to buy the whole amount. In this case buyer 1 would realise immediately that that he will get nothing if he doesn't pay more and seller C would see immediately that he will not anything if he doesn't lower the price. A at the other side would realise immediately that he can raise the price to 250 dollars, but that doesn't mean that buyer 3 will pay 260 dollars, because he understood that he can get his tonne for less. At the end A,B,C will buy their tonnes for 250 dollars respectively. In practise the situation is a little bit different, because there is no price tag and the result depends on bargaining.

We have another type of market where goods are only exchanged for money, but not actually produced. The stock market. This is the market which most resemoble to the market on which a large part of the argumentation of Léon Walras is based, but this market is very far from being typical. In other words, the analysis of Léon Walras can't be generalised.

Let's say we have on our stock market three sellers which want to sell a certain amount of stocks at a certain price.

seller A 300 stocks for 50 dollars

seller B 120 stocks for 47 dollars

seller C 90 stocks for 46 dollars

And let's say that we have three buyers who want to buy a certain amount of stocks for the prices listed below.

buyer 1, 380 stocks for 51 dollars

buyer 2, 100 stocks for 48 dollars

buyer 3, 80 stocks for 38 dollars

On the stock market a mediator select the price that maximises the turnover. We get therefore this picture.

seller	buyer	turn over
300 à 50	380 à 51	(300 * 51) = 15300
120 à 47	100 à 48	(420 * 48) = 20160
90 à 46	80 à 38	(510 * 46) = 19360

The price that maximises the turnover is therefore 48 euros. The buyer willing to pay 48 euros will get 40 stocks.

The possibility to determin the price of a good is through an auction, which has obviously almost no importance in former times, but due to the internet this type of market has become relevant. However if we analyse what happens in auction we can doubt a little bit about the relevance of the consumer and producer surplus.

The idea of the consumer and producer surplus is that the consumer pays what he is actually willing to pay and not only the market price. In other words, he has to reveal his preferences. If someone is willing to pay 90 dollars for an item and the market price is 80 dollars he "saves" 10 dollars. In an auction however exists the possibility that the good is worth for another one 100 dollars and therefore he will get it.

The auction therefore, at least in theory, diminishes the consumer rent. However if we have a look what is happening in ebay we see that more and more sellers sell the things at a fix price, although it would have been more logical to sell it through an auction which would oblige the buyers to reveal their preferences. The problem is that the offer is so huge, that people are not obliged to reveal their preferences. Competition make the auction imposible. Nobody will bid a higher price than the one he had to pay if he buys the good somewhere else.

Auction only works for second hand products, where the actual price is unknown and beneath the price to pay for the new product or if their exists only one unit of the item (paintings and thinks like that).

Actually the only way to reduce the consumer rent is to offer different versions of the same product. There is a certain probability that people willing to pay more than the market price, will pay more for a little extra than it costs to produce it. Someone who is willing for instance to pay more than the market price for a car, will pay something for a sunroof that exceeds the costs of adding it.

After having analysed the short run, markets where products are only exchanged, but not produced, Alfred Marshall starts to analyse dynamic markets, in other words, he analysis what will happen in the long run.

We have next to inquire what causes govern supply prices, that is prices which dealers are willing to accept for different amounts. In the last chapter we looked at the affairs of only a single day; and supposed the stocks offered for sale to be already in existence. But of course these stocks are dependent on the amount of wheat sown in the preceding year; and that, in its turn, was largely influenced by the farmers' guesses as to the price which they would get for it in this year. This is the point at which we have to work in the present chapter.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER III, EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY

Alfred Marshall distinguishes therefore between market where the stocks have been already produced, "...the stock offered for sale to be already in existence..." and markets where products are actually produced. It is obvious, if we put a side markets like the stock market, the market for products which can't be increased that all products sold have been produced before. But it make a big difference anyway if we consider a market in the short run, in the short run they are not produced, but only exchanged, and the long run.

In the short run the only way to balance supply and demand is through prices. In the long run there are hundreds if not thousands parameters that play a role.

Those who believe that this is trivial, might be right. However Léon Walras didn't understood the problem as we will see later on, see markets where products are exchanged and markets where products are produced.

In the short run nothing changes and therefore the only remaining variables are the price and the amount. That's obvious. No ceteris paribus clause needed.

If we have analyse a certain type of engine at a certain moment we get a relationship between the amount of energy and the performance. A certain car at a certain moment needs 8 liters on a motorway at 70 miles per hour and 12 liters at 90 miles per hour. But deduce that this will always be the case, is absurd.

But even if we only consider markets where products are only exchanged things are more complicated. We can learn from Alfred Marshall that still in the 19th century they were future markets. If the dealers believe that the price for corn will raise, they will buy more of it now and sell it afterwards. If the opposite is true, the sellers will sell more. This created a new market, the dealing with futures. In this case someone buys the right to buy something in the future at a fix price. If the prices of this good raises above this fixed price, he had luck, otherwise he had bad luck.

The price dealers are willing to pay depends on their expectations on the future, the price is only the effect of something else.

Even in the corn-exchange of a country town on a market-day the equilibrium price is affected by calculations of the future relations of production and consumption; while in the leading corn-markets of America and Europe dealings for future delivery already predominate and are rapidly weaving into one web all the leading threads of trade in corn throughout the whole world. Some of these dealings in "futures" are but incidents in speculative manoeuvres; but in the main they are governed by calculations of the world's consumption on the one hand, and of the existing stocks and coming harvests in the Northern and Southern hemispheres on the other. Dealers take account of the areas sown with each kind of grain, of the forwardness and weight of the crops, of the supply of things which can be used as substitutes for grain, and of the things for which grain can be used as a substitute. Thus, when buying or selling barley, they take account of the supplies of such things as sugar, which can be used as substitutes for it in brewing, and again of all the various feeding stuffs, a scarcity of which might raise the value of barley for consumption on the farm.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER III, EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY

He does not only doubt that a market where products are only exchanged but not produced is very typical, he even doubts that the analysis of these kind of markets is easy. It is easy to formulate a mathematical formula of the type price= prohibitive price - degression factor * amount. The prohibitive price is the price nobody buys the good, the degression factor describes the decrease of the price necessary to induce people to buy one unit more of something and the amount the units sold. In other words we have a very typical approach for economics. All the really interesting things are in the degression factor. It is quite easy to put one a piece of paper, 1/3, 1/4, 1/5 whatever, but is impossible even to describe him qualitivly.

If we take into account the fact that products are produced, we address the dynamic part of an economy and the long run.

But in this and the following chapters we are specially concerned with movements of price ranging over still longer periods than those for which the most far-sighted dealers in futures generally make their reckoning: we have to consider the volume of production adjusting itself to the conditions of the market, and the normal price being thus determined at the position of stable equilibrium of normal demand and normal supply.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER III, EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY

A big part of this manuel we have dedicated to the question whether the price is determined by the costs, in the case of David Ricardo et alter by the labour materialised in a good or by the demand, the preferences of the people, see natural price / market price, the impact of demand on prices, the price depends on the the demand.

Although Alfred Marschall had already resolved the problem, in the short run the prices are determined by the demand, in the long run by the costs, Carl Menger started the discussion again with very absurd results.

At least in economics the question is not really whether a theory is wrong or right. The question is whether a theory is relevant. A false theory about a relevant topic is more interesting than a correct theory about something completely irrelevant. A relevant theory puts the right things on the agenda and because it discusses a relevant issue will be corrected or improved in the long run. In the case of an irrelevant theory it is not even important if it is wrong or right. A wrong theory about an irrelevant issue is as important as a correct theory about an irrelevant issue.

The two extrem positions, the duo infernale David Ricardo / Karl Marx at one side and Carl Menger on the other side are as confused as irrelevant, although the errors are different. David Ricardo and Karl Marx assume that only the costs determine the price what is possible at first glance. If there is always a exceed of the demand, as they assume, the costs determine the consumptions possibilities. However in this case it is the demand that determines WHAT is produced. If nobody has the money to buy perfume, because all money is spend to satisfy basic needs, no perfum will be produced.

(We disregard the more sophisticated arguments. The prices determines as well HOW something will be produced. The prices decide how the resources will be allocated.)

Carl Menger on the other side assumes that the martinal utility determines the price. (Or, if we cant to be exact, the competition between different alternatives, see Say's Law.) The problem of Carl Menger is that he doesn't distiguingish between subjective preferences and purchasing power. It is well possible that someone wants to have something, but if it is to expensive he can't buy it and he can buy it, if it becomes less expensive.

It would have been possible to abbreviate this discussion, several hundred pages in The Capital of Karl Marx and hundred of pages in Principles of Economics de Carl Menger by reading Adam Smith carefully, see natural price / market price, because in this concept implicetely we find the idea that the value of something is determined by the costs AND by the demand. The natural price is the price that covers all costs and the market price depends on the preferences of the people. What is missing in Wealth of Nations is the distinction between the long run and the short run. (See below the quote taken from the Principles of Economics by Alfred Marshall.)

In the short run, if products are not produced or in a situation where the production structure doesn't change and therefore an increase in supply lead to higher costs per unit the price is determined by the demand.

An extreme case is obviously a situation where only a given amount of goods is changed. If the quantity can't adapt itself to the demand, the demand and the supply is balanced only by the price. There can't be a reaction on the amount, because the amount is fixed. This is the situation that Léon Walras and Vilfredo Pareto assumes as typical, although this situation is a very special case.

It is obvious that in a situation where the supply can only satisfy the increasing demand if the economic machine is driven beyond its optimum, for instance because the expenditures for energy increases in an out of proportion way, the demand decides about the amount produced. Only if people are willing to pay more, the amount can be increased. In the long run however, and that's what we are interested in, the technology, the organisation, the know how, the distribution and the logistic etc. will improve and competition will keep prices low.

Carl Menger would be very astonished to see that nowadays, at least in industrialised countries, almost everyone has a car, although the utility that yield a car has decreased, because public transport is much more efficient.

We have to distinguish therefore clearly between the short run an the long run.

Thus we may conclude that, as a general rule, the shorter the period which we are considering, the greater must be the share of our attention which is given to the influence of demand on value; and the longer the period, the more important will be the influence of cost of production on value. For the influence of changes in cost of production takes as a rule a longer time to work itself out than does the influence of changes in demand. The actual value at any time, the market value as it is often called, is often more influenced by passing events and by causes whose action is fitful and short lived, than by those which work persistently. But in long periods these fitful and irregular causes in large measure efface one another's influence; so that in the long run persistent causes dominate value completely. Even the most persistent causes are however liable to change. For the whole structure of production is modified, and the relative costs of production of different things are permanently altered, from one generation to another.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER III, EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY

The last sentence "...For the whole structure of production is modified, and the relative costs of production ..." refers the the fact that in the long run resources will be realocated. (For a more detailed discussion about the allocation of resources see optimal allocation of resources).

In the short run are certain technology is given and therefore the marginal output of each productive factor, for instance labour and capital (machines etc.) and therefore the input of capital and labour is determined. If it is less expensive to weld the bodywork of a car manually, it will be done manually, but if it is cheaper to let it done by a machine, it wil be done by a machine. In other words: Labour will be substituted by capital and capital by labour until the marginal monetary output of both is the same.

It were useful if the people who teaches the concepts of Alfred Marshall, actually almost all what is studied in microeconomics are concepts of Alfred Marshall, would read him, at least one time in her life.

Pay attention to the last sentence: "A man is likely to be a better economist if he trusts to his common sense, and practical instincts, than if he professes to study the theory of value and is resolved to find it easy."

But nothing of this is true in the world in which we live. Here every economic force is constantly changing its action, under the influence of other forces which are acting around it. Here changes in the volume of production, in its methods, and in its cost are ever mutually modifying one another; they are always affecting and being affected by the character and the extent of demand. Further all these mutual influences take time to work themselves out, and, as a rule, no two influences move at equal pace. In this world therefore every plain and simple doctrine as to the relations between cost of production, demand and value is necessarily false: and the greater the appearance of lucidity which is given to it by skilful exposition, the more mischievous it is. A man is likely to be a better economist if he trusts to his common sense, and practical instincts, than if he professes to study the theory of value and is resolved to find it easy.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER V, EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY,CONTINUED, WITH REFERENCE TO LONG AND SHORT PERIODS

We can't really attribute the failures of the graphical / mathematical modells we find in textbooks to the founder of these models, Alfred Marshall. Alfred Marshall leaves no room for doubt what he thinks about this kind of mechanical thinking. "...and the greater the appearance of lucidity which is given to it by skilful exposition, the more mischievous it is..."

Summarising we can say that the concepts of Alfred Marshall are sometimes helpful. In the previous chapter, see cardinal measurement of utility we analysed some markets and we got results that wouldn't be so easily accesible to "commen sense". We have seen by analysing the taxi market that we get a strange kind of result if we have a monopoly price in a polypol.

However if we work with these concepts we shouldn't lose sight of the total picture and we should be aware of the other parameters and relevant issues that are not included in the model and the relationship between the time spent to get aquainted with the model and the utility of the model has to be reasonable. If mathematical modeling only serves to describe a simple concept in a "scientific" looking way it's a waste of time. Three hours spent for understanding the consumer and producer surplus is alright. Spending two month for that and measuring the consumer rent in three different ways is definitivly too much. The time saved can be used for learning C++, a new language or whatever can be useful.

Textbook on economics deals almos exclusively with static states, equilibriums. That's what we are less interested in, because in the satic state nothing changes, but what we want to know is how things change and why they change. We are actually not very interested in the amount of producer surplus, we want to know how much time it takes until all the producers have achieved the same efficiency and the producer surplus vanishes. (To illustrate it with an example.)

This topic is clearly addressed by Alfred Marshall. He distinguishes clearly between the short run, where nothing changes and the long run, where everything changes. If economists would read the original work, Principles of Economics, they could learn a lot.

The critique of Joseph Schumpeter that the neoclassical theory focuses on static states is not true. It is only true concerning Vilfredo Pareto and Léon Walras, but it is not true concerning Alfred Marshall. For Alfred Marshall the static state is a pure instrument, a simplification that allows to get some insights, a first step to analyse dynamic processes. The problem with the simplification of his concepts we find in modern textbooks is that they never overcome this state. Compared to the original modern textbook about microeconomics are a retrograde step.

This relaxation of the rigid bonds of a purely stationary state brings us one step nearer to the actual conditions of life: and by relaxing them still further we get nearer still. We thus approach by gradual steps towards the difficult problem of the interaction of countless economic causes. In the stationary state all the conditions of production and consumption are reduced to rest: but less violent assumptions are made by what is, not quite accurately, called the statical method. By that method we fix our minds on some central point: we suppose it for the time to be reduced to a stationary state; and we then study in relation to it the forces that affect the things by which it is surrounded, and any tendency there may be to equilibrium of these forces. A number of these partial studies may lead the way towards a solution of problems too difficult to be grasped at one effort.

Alfred Marshall, Principles of Economics, BOOK V, CHAPTER V, EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY,CONTINUED, WITH REFERENCE TO LONG AND SHORT PERIODS

It would be very helpful if any academic teacher of microeconomics would write this down on a piece of paper and puts this piece of paper on the wall.

The authors hopes that it became clear why Alfred Marshall is the intellectual among the "neoclassical" authors. The others, Vilfredo Pareto, Léon Walras and Carl Menger are a bunch of idiots. It doesn't make any sense to put Alfred Marshall into the same pigeonhole.

Some conclusions can be drawn from a short run analysis, see cardinal measurment of utility. In the short run these conclusions are even correct. If nothing changes, for instance in a market were goods are only exchanged and not produced, it is pretty obvious that only the price can balance the supply and demand, because the amount is fixed. In the short run the productive structure will not change either and an increase in the supply is only possible, if the prices rices and more inefficient producers can enter the market. If everybody suddenly wants to construct a house the price for the qualified labour in this sector will increase, building materials and pieces of construction equipment will increase in prices etc.. But in the long run, induced by the higher prices, more people will qualify for jobs in the construction sector, people from other countries will come, houses will be constructed in a more efficient way etc.. This is the dynamic part of a market economy. If all this processes are ignored, we ignore the strength of a market economy. In other words, we ignore all the problems which a market economy resolves best and if we ignore the problems to be resolved by a market economy, we don't need it.

If we assume that a static economy, a economic where nothing changes, is typical, then the economic development can be planed. If it can be planed, we should plan it. In this case a socialist system would be more efficient.

It is to assume that most student of economics who passed half of their time in moving curves around don't understand at the end of their studies what a market economy is about.

Summary: We are interested in knowing how an economy adapt itself to new conditions, how to improve the difusion of knowledge, how to guarantee that investment in research and development are converted in marketable products, how to improve the schooling system, the impact of technological progress, what impedes some economies to make use of technologies that can resolve their problems etc..

The mere analysis of a static situation narrows the perspective and if one invests a lot of time in this kind of analysis he risks to learn nothing really useful for the professional live.

return to the top of the page ...

2.1.4. equilibrium in the short run and in the long run

markets where a fixed amount is changed and dynamic markets