On Equilibrium

I have found a common misrepresentation from many, including mainstream economists, is that critics of their models do not understand them or the role of the assumptions. Those mainstream economists rely on an incoherent essay from Milton Friedman to dismiss criticism of the realism of assumptions.

My favorite criticism, though, is that their conclusions do not follow from their assumptions. I like to show this by constructing numerical examples that contradict their teaching.

On the other hand, some do criticize the realism of assumptions. I have seen some complain that the economy is never in equilibrium. It is unrealistic to assume equilibrium. I often find this unconvincing.

One can go back at least as far as Adam Smith, the distinction he draws between market prices and 'natural' prices, and his metaphor of a gravitational process. At any given time, some commodities may remain unsold on the market, and the quantity demanded for some may exceed the quantity supplied at a moment in time. The rate of profits may vary among firms and industries more than one might expect because of differences in risk, the desirability of certain industries, and so on. A leveling process that may never be completed exists at a given moment in time. Capitalists, reacting to price signals, will be disinvesting in some industries and expanding in other industries.

One who studies 'natural' prices, that is, the system of prices of production, is investigating tendencies, not making a claim that equilibrium exists. Even after the marginalists started constructing an incorrect theory, they kept this approach. Alfred Marshall wrote about, market prices, the short run, and the long run. Here is Walras:

Finally, in order to come still more closely to reality, we must drop the hypothesis of an annual market period and adopt in its place the hypothesis of a continuous market. Thus, we pass from the static to the dynamic state. For this purpose, we shall now suppose that the annual production and consumption, which we had hitherto represented as a constant magnitude for every moment of the year under consideration, change from instant to instant along with the basic data of the problem... Every hour, nay, every minute, portions of these different classes of circulating capital are disappearing and reappearing. Personal capital, capital goods proper and money also disappear and reappear, in a similar manner, but much more slowly. Only landed capital escapes this process of renewal. Such is the continuous market, which is perpetuating tending towards equilibrium without ever actually attaining it, because the market has no other way of approaching equilibrium except by groping, and, before the goal is reached, it has to renew its efforts and start over again, all the basic data of the problem, e.g. the initial quantities possessed, the utilities of goods and services, the technical coefficients, the excess of income over consumption, the working capital requirements, etc., having changed in the meantime. Viewed in this way, the market is like a lake agitated by the wind, where the water is incessantly seeking its level without ever reaching it. But whereas there are days when the surface of a lake is almost smooth, there never is a day when the effective demand for products and services equals their effective supply and when the selling price of products equals the cost of the productive services used in making them. The diversion of productive services from enterprises that are losing money to profitable enterprises takes place in various ways, the most important being through credit operations, but at best these ways are slow. It can happen and frequently does happen in the real world, that under some circumstantces a selling price will remain for long periods of time above the cost of production and continue to rise in spite of increases in output, while under other circumstances, a fall in price, following upon this rise, will suddenly bring the selling price below cost of production and force entrepreneurs to reverse their production policies. For, just as a lake is, at times, stirred to its very depths by a storm, so also the market is sometimes thrown into violent confusion by crises, which are sudden and general disturbances of equilibrium. The more we know of the ideal conditions of equilibrium, the better we shall be able to control or prevent these crises." -- Walras (1954: Lesson 35, Section 322).

So Walras did not think any economy would ever be in equilibrium. On the other hand, many may incorrectly think Austrians, like Ludwig von Mises, dispensed with the assumption of equilibrium. But here he is asserting that the assumption of equilibrium is necessary for economic theory:

One must not commit the error of believing that the static method can be used only to explain the stationary state of an economy, which, by the way does not and never can exist in real life, and that the moving and changing economy can be dealt with only in terms of a dynamic theory. The static method is a method which is aimed at studying changes; it is designed to investigate the consequences of a change in one datum in an otherwise unchanged system. This is a procedure which we cannot dispense with." -- Ludwig von Mises, 1933. Intervention. (quoted by Kurz and Salvadori)

I do think, however, one can criticize the Arrow-Debreu model as not being consistent with this approach and always assuming that equilibrium exists. Any time to reach equilibrium in the Arrow-Debreu is too long. Any such equilbirum that might have a tendency to be approached cannot be expected to be consistent with the data. Many supposed dynamic models in economics are still subject to this old objection.

Many questions remain about how to analyze whatever tendencies to equilbrium that may exist. I have barely even touched on the distinction between logical and historical time, a distinction commmon to Joan Robinson and Ludwig Lachmann.