Local versus Broader Equilibrium

     

I once asked Israel Kirzner whether entrepreneurs specifically intend to bring about some form of equilibrium or move prices toward their equilibrium values. His answer was no, and that is correct.

It is no doubt true, as Pete and Fred say, that entrepreneurs intend or strive to uncover price discrepancies which they can exploit in order to make profits.  Even when they are successful in so doing, they do not necessarily move the system in an equilibrating direction. Here we must avoid defining the equilibrium as simply the elimination of the particular inconsistency. Mere local inconsistency is not what Kirzner was talking about and most assuredly not what Ludwig Lachmann was talking about. The local equilibrium may be of interest for some purposes. Instead, the larger issue is whether this particular entrepreneurial act contributes to a more general sustainable equilibrium or whether it exacerbates the errors in the system.

If a large number of traders are fooled by animal spirits and believe housing stocks are going very high, a clever entrepreneur may buy from the pessimists and sell to the optimists, and he will make money. And as optimism grows he may be able to continue selling at higher and higher prices. He will have eliminated price inconsistencies. But the market, ex hypothesi, is not sustainable. So the local equilibrium did not contribute to producing an overall equilibrium.

Whether this is all due to some form of government intervention is an open question. Perhaps it is. But I do not think such issues will be always and everywhere due to government.

Therefore, I think it is important to explore what economic agents learn from their experience in a way that is broader that the simple focus on price inconsistencies. Entrepreneurs can make profits by eliminating local inconsistencies, but that does mean that this will equilibrate the market in a broader sense. In specific environments buying low and selling high may feed expectations of further rises in price among traders who have incorrect expectations.

A theory that pays attention to learning processes must deal with aberrations as well as successes. Alertness is about discovering price inconsistencies. This is the first level of learning. Entrepreneurs can make mistakes here. Most of us seem to agree with that. But there is a second level that involves the interpretation of how others are acting and thinking. An entrepreneur will profit by selling an asset to individuals who believe its price will rise even though the entrepreneur himself believes that it will not rise and that the individuals are mistaken. When in fact they are mistaken (especially when there are many such people) the entrepreneur has not moved the system toward equilibrium in the broader sense.