The Fruits of Civilization (32) Market Clearing

Market Clearing

If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down. ~ Mesopotamian Islamic scholar Ibn Taymiyyah

As Ibn Taymiyyah mused in the 13th century, prices are set to maximize sales and profits. The price of a good solely reflects instant market conditions where its is on sale.

Market clearing is the process of supply meeting demand, which is theoretically done at the equilibrium price. For 150 years, from 1785 to 1935, the vast majority of economists took market clearing through the price mechanism to be inevitable and inviolate. This assumption was codified in Say’s law.

A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. ~ Say’s law (1803)

French businessman and economist Jean-Baptiste Say thought that “a glut can take place only when there are too many means of production applied to one kind of product and not enough to another.”

Say’s law was held as gospel truth to economists until the Great Depression shook their faith that the free market necessarily ate what it made. During the doldrums of the 1930s economists struggled to explain how ruinously high rates of unemployment could persist for so many years.

Keynes was one of them. He and other economists suggested tinkering with the market, blithely assuming that the otherwise perfect price adjustment mechanism was somehow gummed up by government and could be fixed by government. Ironies never cease in economics.

As US President, FDR tried everything politically feasible that the economists suggested. The only thing that worked was going to war – the ultimate act of destruction.

The assumption of market clearing still reigns for macroeconomists studying long-term issues, such as growth. Market-clearing models are employed to characterize the equilibrium toward which an economy supposedly gravitates.

Macroeconomic market clearing is codified as Walras’ law, which is an updated version of Say’s law. Put forth by French mathematical economist Léon Walras in 1874, the law posits that the values of sectoral excess demand sum to zero.

Walras’ law has wide-ranging implications. In assuming an economy as zero sum, it axiomatically (and inscrutably) finds that an excess demand in one economic sector is balanced by an excess supply in another.

One facet implied by Walras’ law is that unemployment cannot be involuntary in a market economy with flexible prices and wages: an excess supply of labor will be mopped up by a fall in money wages – an utter fiction. The tidy equivalence found in Walras’ law has been embraced by macroeconomists, despite having no foundation in actuality.

Walras’ law is accepted as valid – indeed as irrefutable – by modern-day economists. ~ Steve Keen

Keynes thought these equilibrium laws were bunk: he argued that if consumption and investment were supposedly balanced via these principles, then falling demand for consumption goods should give rise to increased demand for investment goods. Instead, investment demand is driven by expectation of consumer demand. Thus a downturn dampens expectations, leading to a general slump, as illustrated by the Great Depression which Keynes struggled with (unsuccessfully, owing to his allegiance to capitalism, and thereby failing to see its fatal flaws).

Earlier on, Marx had rejected Say’s initial proposition that “every producer asks for money in exchange for his products only for the purpose of employing that money again.” Marx noted that Say asserted that no one in a market economy wished to accumulate wealth.

Over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets. ~ Hyman Minsky

In the latter 20th century, American economist Hyman Minsky pointed out that Say’s and Walras’ laws were fallacious for failing to take into account credit and debt. Thus, sectoral demands never sum to an aggregate zero, nor is equilibrium ever in sight.

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Price does not act as an efficient market-clearing mechanism. Contradicting the spirit of his law if not the letter, Say observed that the market acts to overproduce, and then dumps the remainders at a loss while moving on. In other words, price spurs overproduction, which can cause cyclical price gyrations. This dynamic has been repeatedly observed in a wide array of products.

In a forward-looking sense, price guides investment to exploitation potential. This is the timeworn mechanism for how potential suppliers respond to price: as a signal for profit opportunity; whence oversupply. Efficient resource allocation is never in the offing via the price mechanism.