The Praxeological Concept of Equilibrium


August 27, 2001

 


 


 

 

Abstract

 

            The logical equilibrium is an image of robots behaving in a uniform way again and again yet in a timeless state. It is a descendant of John B. Clark’s static equilibrium and its antithesis is the Walrasian general equilibrium, which is taken to be a simulation of a real market economy. Properly understood, it is part of what Ludwig von Mises called the method of imaginary constructions, a procedure that entails constructing counterfactuals to comprehend action. It helps one isolate appraisement and uncertainty bearing as fundamental properties of the entrepreneur role, the mandatory of the consumer role. One aim of this paper is to demonstrate this characteristic of the evenly rotating economy. A second aim is to show that Mises's own application of the evenly rotating economy as an endpoint, or "final state of rest," was unimaginative and misleading. It criticizes Mises for using the evenly rotating economy in conjunction with the promoting entrepreneur to refer to an equilibrium toward which the market process is tending. It also discusses Mises's idea that the evenly rotating economy is useful in the study of change and his use of equilibrium in market process analysis to contrast logical economists with mathematical economists.


 


 

 

            In the late 19th century, the classical notion of the natural price gave rise to two distinct concepts of equilibrium. The first was the mathematical concept developed by Leon Walras (1874). Its aim was to simulate market behavior by assuming that equilibrium is like a mechanical system. Variations of it are widely used today in econometrics. In this field of endeavor, the equilibrium is regarded either as a model of real economic behavior or as a data space toward which statistical data are tending. Footnote The second is the concept used by logical economists, as Ludwig von Mises called them. Footnote This is variously an actionless economy, an image of robots behaving in a uniform way again and again yet in a timeless state, or an economy in which all incentive to act has ceased. The aim of this paper is to discuss the second concept, which we label praxeological.

            The first to recognize that the praxeological concept was part of a method of subjectivist analysis may have been John B. Clark.(1899a: Chapter 2; 1899b) Clark viewed the static equilibrium as an image of automatons carrying on the same production, saving, consumption, and capital accumulation behavior again and again yet in the absence of time. The image is useful, Clark maintained, because it is a kind of boundary that enables economists to embark on a science of dynamics.(1899b) Footnote

            Mises presented a new justification for the static equilibrium. The basis was the recognition that economics studies distinctly human action and, therefore, that it is properly regarded as a branch of praxeology. The only method we have for comprehending action -- the praxeological method -- is what he called the method of imaginary constructions. He proceeded to argue that the static equilibrium is required when one attempts to elucidate action under the specific conditions of the pure market economy (private property, specialization, and use of money). Defining economics as the study of distinctly human action, Mises tried to avoid the mechanistic analogies implied by the terms "static" and "dynamic."(Mises 1966: 366) Accordingly he renamed the static equilibrium the evenly rotating economy (ERE). Footnote

            Unfortunately, Mises did not complete the project of logically supporting his use of the ERE. In his treatise, Mises (1966) used other imaginary constructions as counterfactuals to derive the properties of action in general – the individual's conceptions of means and ends, time, and uncertainty. It would have been logical for him to use the ERE for the same purpose to describe the properties of economic interaction. However, although he provided some hints on how it might be used in this way, he mainly used it as an image toward which economic interaction is tending. In doing this, he equated the ERE with what he called the "final state of rest" Footnote and set the stage for market process analysis, as it has developed within the Austrian economics literature.

            This paper will develop stronger foundations for the first use and argue that, in light of the praxeological foundations for economics that Mises provided, the second use of the ERE was unimaginative and misleading. Specifically, it neglects the broader, praxeological concept of entrepreneurship which, while it can only be understood by means of the ERE as a counterfactual, does not imply a tendency toward an ERE in any useful sense. From the standpoint of modern professional equilibrium theory, this exercise can be seen as describing a conception of equilibrium that has apparently been neglected in the literature. Footnote

            The argument begins in part one by describing the use of the ERE as part of the method of imaginary constructions. Part two examines the second use in greater detail, showing that it was the source of several confusing ideas and deviations from the praxeological method that Mises seemed to advocate. Part three is a brief conclusion.

 

 

THE ERE AS PART OF THE METHOD OF IMAGINARY CONSTRUCTIONS

 

            To understand the first use of the ERE, one must begin by recognizing that it is an application of what Mises called the method of praxeology -- the method of imaginary constructions.(ibid.: 248)

The specific method of economics is the method of imaginary constructions...Everyone who wants to express an opinion about the problems commonly called economic takes recourse to this method...An imaginary construction is a conceptual image of a sequence of events logically evolved from the elements of action employed in its formation. It is a product of deduction, ultimately derived from the fundamental category of action, the act of preferring and setting aside.

 

The main formula for designing of imaginary constructions is to abstract from the operation of some conditions present in actual action. Then we are in a position to grasp the hypothetical consequences of the absence of these conditions and to conceive the effects of their existence. Thus we conceive the category of action by constructing the image of a state in which there is no action, either because the individual is fully contented and does not feel any uneasiness or because he does not know any procedure from which an improvement in his well-being (state of satisfaction) could be expected. Thus we conceive the notion of originary interest from an imaginary construction in which no distinction is made between satisfactions in periods of time equal in length but unequal with regard to their distance from the instant of action.(ibid.: 237)

 

The function of an imaginary construction is to "to serve man in a scrutiny which cannot rely on his senses."(ibid.)

 

Elucidating Action in General

            Consider how Mises used the method of imaginary constructions to elucidate what he called the properties of the category of action. He tried to imagine a being who exists but who does not act. There seem to be only three possibilities. In the first, we imagine a person who is fully content. She has no unsatisfied wants. She may be content because she feels no uneasiness or because she can conceive of no way of causing her future condition to be different from what she expects it to be.(ibid.: 237) In the second, she is not content and she can conceive of different alternative ways of satisfying her wants. However, her choices have the characteristic of absolute certainty. In this case, she is not an actor but a simple calculator. She chooses the best among the alternative known plans available.(ibid.: 3) The third possibility is the automaton, or robot. The robot behaves according to algorithms assigned by its maker. This possibility is similar to the second one and an argument might be made that there are only two possibilities. Footnote However, by distinguishing the third from the second, we can emphasize a meaning of non-action that is particularly relevant to building an image of the market economy -- that non-action refers to behavior that is not chosen by actors but merely specified by the economist. The importance of this will become evident later in the paper.

            Mises identified the distinctive properties of human action in terms of imaginary constructions of beings that do not possess these properties. Beginning with the imaginary construction of a being who is fully content (the first possibility), he used the logic of contradiction, by means of the counterfactual, to determine that action necessarily entails unsatisfied wants, means by which wants can be satisfied, and an expectation that action will cause some wants to be satisfied. Footnote By the same means he determined that the presence of ends and means implies (subjective) time. Footnote Also by the same means he employed the imaginary construction of a being who possesses complete certainty (the second possibility) to determine that human action must entail uncertainty about the outcome. Footnote Finally, he used the counterfactual to determine that the human actor differs from the robot in that she possesses a will (the third possibility). This enables her to be her own programmer, as it were. Footnote

            One must presume that when Mises said that "we conceive the category of action by constructing the image of a state in which there is no action..."(ibid.: 237, as quoted above), he was referring to these counterfactual exercises. In short we use the method of imaginary constructions to construct counterfactuals in order to elucidate the properties of the category of action. Footnote

            Thus, we use an imaginary construction -- that of someone for whom choosing is irrelevant or of the robot -- as a counterfactual to help us understand the meaning of action in general. We think: "When I say that I act, I mean that I have unsatisfied ends (I feel uneasiness) because if I did not, I would have no reason to act." "And I mean that I am uncertain because if I were not, my behavior would not be action but routine selection." Or we think: "When I say that I act, I mean that I am not a robot because robots are, by definition, possess no independent will."

 

Elucidating Action in the Market Economy

            One might have hoped that, after having used the method of imaginary constructions to elucidate the properties of the category of action, Mises would follow up by elucidating action in the market economy in much the same way. Such a follow up seems consistent with his aim of presenting economics as a branch of praxeology. Mises could have shown by analogy how the same counterfactual method could be used to elucidate fundamental properties of the interaction among actors in the pure market economy. Although Human Action contains a number of passages that provide one with clues as to how this could be done, Mises's own exposition did not proceed in this way. We shall discuss Mises's use of the ERE in part 2. The aim here is to more fully elaborate a use to which Mises did not put the ERE.

 

The Praxeological Entrepreneur

            The ERE can be conceived as an image of non-acting robots that lack uncertainty. It can be regarded as a part of the method of imaginary constructions in a way that is analogous to how counterfactual, full-certainty robot behavior is part of the method of imaginary constructions in identifying the general properties of action. Such an image helps us elucidate the concept that we call the praxeological entrepreneur, Footnote who embodies all of the distinctly human action as it is manifest under the conditions of the market economy. Mises wrote about what we might call a distant cousin of the praxeological entrepreneur although he did not elucidate its properties. It is convenient to call this cousin the functional entrepreneur. In the market economy, he said, everyone is an entrepreneur and every economic (entrepreneurial) action entails intersubjective uncertainty and speculation.(ibid.: 253-4)

Economics, in speaking of entrepreneurs, has in view not men, but a definite function. This function is not the particular feature of a special group or class of men; it is inherent in every action and burdens every actor. In embodying this function in an imaginary figure, we resort to a methodological makeshift. The term entrepreneur as used by catallactic [economic] theory means: acting man exclusively seen from the aspect of uncertainty inherent in every action...(ibid.: 252-3)

 

Entrepreneur means acting man in regard to the changes occurring in the data of the market.(ibid.: 254)

 

Note that the functional entrepreneur is not a datum; rather he represents "acting man in regard to changes in the data." The functional entrepreneur is a "mandatory, as it were, of the [consumer role]."(ibid.: 303)

            We see in these quotations a clear recognition that when the economist describes how wants come to be satisfied in the market economy, he focuses entirely on action that is aimed toward the satisfaction of consumer wants. Every actor is entrepreneurial in the sense that she aims to help others satisfy their wants in order to earn money for herself. Presumably also, everyone acting in the entrepreneurial role builds an image of a future state in which she has earned the money she aims to earn. She realizes, however, that the real future is likely to differ from the image in some respects.

            In these respects, Mises's functional entrepreneur is similar to the praxeological entrepreneur. The difference arises because of Mises's association of the functional entrepreneur with capitalists, factor owners, and farmers. Mises appears to write of these roles as being in similar situations (ibid.: 264, 269, 270, 271, 272, 278). However, the praxeological entrepreneur, as a role, stands aloof from these. Each producer, capitalist factor owner, and consumer in the market economy is a praxeological entrepreneur; however, to use the phrase "entrepreneurs, capitalists, and farmers," for example, is to divert attention from this fact and, by so doing, to contribute to the subversion of the praxeological method, as described here.

 

Elucidating Entrepreneurship

            If one followed the same method of imaginary constructions that Mises used to elucidate the properties of action, he would elucidate entrepreneurship by trying to isolate the properties of ends and means, time and uncertainty as they are exhibited by the entrepreneur in her function as a mandatory of the consumer role. To do this, he would contrast the ERE as an image of robot mandatories in which there can be no uncertainty with what he can know from intuition and experience about distinctly human mandatories.

            Mises did not use his method of imaginary constructions in this way. He did not follow up on his first reason for using the ERE by showing how the method could be used to elucidate entrepreneurship. I attempted to fill this gap in my 1990 book.(Chapter six) I showed that entrepreneurship can be said to have three distinct properties. The first is appraisement, which refers to identifying and pricing the factors of production. Appraisement is not limited to a set of factors that the economist might assume exists at a particular time. To make informed appraisals, an individual anticipates that during whatever action he decides to tentatively take, he and others may discover previously unknown factors of production, methods of production, and consumers' goods. The second is undertaking, which refers to the act of will that directs the factors of production to specific employments. The third is uncertainty-bearing which implies that we should interpret entrepreneurial action as a bet that one's appraisals are correct by being willing to suffer a decrease in wealth if one's predictions turn out to be erroneous. Uncertainty-bearing logically leads to an additional concept -- guaranty, a set of assets that the bettor holds in reserve to assure that losses will not exceed a specific level. I called these the "categories of entrepreneurial action." A better term might have been the properties of the functional, or praxeological, concept of the entrepreneur.

 

Did Mises Recommend the Use of the ERE as a Counterfactual in the Method of Imaginary Constructions?

            Some of Mises's statements about the ERE suggest that he recommended that the ERE be used in this way. For example he pointed out that the ERE is a rigid system which "is not peopled with living men making choices liable to error; it is a world of soulless unthinking automatons; it is not a human society, it is an ant hill.(ibid.: 248) "In order to grasp the function of entrepreneurship and the meaning of profit and loss, we construct a system from which they are absent."(ibid.) However, he did not elaborate on these statements. Moreover, after pointing out that the functional entrepreneur refers to "acting man," he proceeded to employ the concept of the "promoting" entrepreneur, itself a datum yet the actions of which would lead to the ERE if there were no changes in the data. By far the majority of Mises's discussions of the ERE regarded it as a "final state of rest," or endpoint. He correspondingly relegated the praxeological and even the functional entrepreneur to a minor position.

 

 

THE ERE AS AN ENDPOINT

 

            Mises mostly used the ERE as an endpoint of the "market process." For example, he referred to the ERE as "a fictitious system in which the market prices of all goods and services coincide with the final prices."(ibid.: 247) A final price is a price that we conceive by paying "attention to factors which are bound to bring about a tendency toward price changes. We try to find out to what goal[!] this tendency must lead before all its driving force is exhausted and a new state of rest emerges."(ibid.: 245) The ERE, as Mises uses the concept here, is an endpoint toward which all prices are tending. And economics is the study of the market process, or the interaction that corresponds to this tendency.

[t]he logical economist...shows how the activities of enterprising men, the promoters and speculators, eager to profit from discrepancies in the price structure, tend toward eradicating such discrepancies and thereby also toward blotting out the sources of entrepreneurial profit and loss. He shows how this process would finally result in the establishment of the evenly rotating economy. This is the task of economic theory...The problem is the analysis of the market process.(ibid.: 355-6, italics added)

 

Human Action contains a number of variations on this theme. I shall argue, however, that in each case, Mises's description of economic interaction is unimaginative and misleading from the point of view of economics as a branch of praxeology. Before turning to these descriptions, however, I would like to explain in greater detail why this procedure is inconsistent with the procedure he used to elucidate action in general.

 

Why the ERE as an Endpoint is Inadequate

Using an Endpoint to Help Elucidate Individual Action

            We can see why the procedure of regarding the ERE as an endpoint, or final state of rest, is inadequate by considering the same kind of method applied to the elucidation of action in general. Imagine that we attempt to define and understand the properties of the category of action by imagining a fictitious system in which the means had already been used to achieve the ends sought. Let us call such a fictitious system the evenly rotating individual (ERI). Such a method would help us comprehend, by means of contrast, that ends and means must have been involved in action. It would also contain the implication of time. However, it would under-emphasize or neglect some important characteristics of action, most significantly those related to uncertainty. It would neglect the various images that the actor builds of the future, how those images change as the actor applies the means to the satisfaction of his ends, and how the actor anticipates and prepares for those changes. It is true that the actor, in carrying out an action, anticipates a future state at which his goal has been achieved. We can roughly say that this is a fictitious state in which there is no longer any incentive to act. However, the actor also anticipates that changes in his knowledge and even in his wants may occur that will make his initial decision to aim toward the achievement of a particular goal less wise than it could have been. He anticipates that he will never become an ERI (the fictitious state at which he will have no further incentive to act). He must, of course, assure that his actions are sufficiently satisfying that he can continue to survive. Thus, he tries to assure that some specific goals are actually achieved. Footnote However, he does not expect and plan to become an ERI.

            An important part of action in general consists of a particular class of changes in knowledge that we might say have two properties: (1) the individual knows that they are likely to occur although he cannot know what they will be and (2) he plans to pay attention to events as his choice "unfolds" in order to revise his choice if he regards it as profitable to do so. However, when we use the ERI as an endpoint, we seem to be led to completely disregard these. If this is true, the usefulness of the ERI as an endpoint must be limited. It is evident that we need another image. As mentioned above, there is one and possibly two of these: the image of complete certainty and the image of a robot. The robot does not possess knowledge and, for that reason, cannot anticipate changes in its knowledge. For the same reason, it cannot devise means of dealing with the anticipated changes.

 

Using the ERE as an endpoint to Help Understand Economic Interaction

            We have noted that when we use the ERI as an endpoint to help us understand action in general, we are led away from important phenomena that we must include if we want to understand action in general. A similar argument applies to an ERE that is used as a fictitious endpoint of the market process. It will not help us comprehend how individuals in the pure market economy employ their diverse anticipations of future knowledge and how the individuals come to individually deal with the uncertainty they face. It will also not help us comprehend deliberate searches for new goods and methods of production (and, by implication, the competitive pressures to make such searches). In addition it will not help us comprehend how individuals cooperate in dealing with uncertainty. It will not help us understand how specialists in appraising uncertain projects emerge; how uncertainty comes to be pooled in the sense that individuals discover that actions unfavorable to the profitability of one kind of enterprise are, at the same time, favorable to the profitability of another one; and what we might call the demand for and supply of guaranty and the endorsement of promises. To help us understand these things, we must use the ERE in a different way.

 

The Promoter

            Mises defined the promoter as follows. Promoters are

those who are especially eager to profit from adjusting production to the expected changes in conditions, those who have more initiative, more venturesomeness, and a quicker eye than the crowd, the pushing and promoting pioneers of economic improvement.

 

...[T]he promoter concept refers to a datum that is a general characteristic of human nature, that is present in all market transactions and marks them profoundly. This is the fact that various individuals do not react to a change in conditions with the same quickness and in the same way. The inequality of men, which is due to differences both in their inborn qualities and in the vicissitudes of their lives, manifests itself in this way too. There are in the market pacemakers and others who only imitate the procedures of their more agile fellow citizens. The phenomenon of leadership is no less real on the market than in any other branch of human activities. The driving force of the market, the element tending toward unceasing innovation and improvement, is provided by the restlessness of the promoter and his eagerness to make profits as large as possible. (Ibid.: 254-5).

 

According to this definition, the promoter concept seems to have two attributes. First, it represents the difference in the speed of reaction to a change in conditions, some individuals being pacemakers and leaders and others being imitators and followers. Second, it represents "restlessness" and "eagerness to make profits as large as possible." In addition, such characteristics lead to innovation and improvement.(ibid.: 255) Thus, it would appear that Mises means to include in the promoter concept the discovery of new methods of production and new products. There is no mention of the promoter's uncertainty. Footnote

            In his first use of the promoter concept, Mises does not mention innovation and improvement. In his section on "Entrepreneurial Profit and Loss," he says that what produces "the specific entrepreneurial profits and losses...is the extent to which the entrepreneur has succeeded or failed in anticipating the future -- necessarily uncertain -- state of affairs."(ibid.: 292-3) "If all entrepreneurs were to anticipate correctly the future state of the market, there would be neither profits nor losses...An entrepreneur can make a profit only if he anticipates future conditions more correctly than other entrepreneurs."(ibid.: 293) Here, Mises introduces uncertainty with the idea that all entrepreneurs do not anticipate correctly. There is nothing here that hints that of innovation and improvement. On the other hand, innovation and improvement is not denied either. It is possible that by "anticipating the future," he means to include anticipating the new goods and methods of production that the promoter expects to be discovered. Footnote

            Mises's next discussion of promoters also neglects innovation and improvement. Moreover it de-emphasizes uncertainty. He begins by pointing out that

[t]he driving force of the market process is provided neither by the consumers nor by the owners of the means of production--land, capital goods, and labor--but by the promoting and speculating entrepreneurs. Quicker of apprehension and farther-sighted than other men, they look around for sources of profit. They buy where and when they deem prices too low, and they sell where and when they deem prices too high. They approach the owners of the factors of production, and their competition sends the prices of these factors up to the limit corresponding to their anticipation of the future prices of products. They approach the consumers, and their competition forces prices of consumers' goods down to the point at which the whole supply can be sold. Profit-seeking speculation is the driving force of the market as it is the driving force of production.(ibid.: 328)

 

He goes on to say that "market agitation never stops." But he does not discuss innovation, new products, or methods of production. Instead, he focuses on what he calls the tendency toward final prices and equilibrium prices.(ibid.: 329)

            Finally, in his discussion of the prices of the goods of higher order, he says that

[t]he tasks incumbent upon the theory of prices of factors of production are to be solved by the same methods which are employed for treatment of the prices of consumers' goods...The operation of the market is actuated and kept in motion by the exertion of the promoting entrepreneurs, eager to profit from differences in the market prices of the factors of production and the expected prices of the products.(ibid.: 334)

 

As before, the discussion of promoting entrepreneurs is about a tendency toward final prices and not about innovations and discoveries of new products and methods of production. Nor is there anything specific about how individuals deal with uncertainty in this analysis.

            The conclusion that seems warranted from this discussion is that Mises's concept of the promoter as the driving force of the market process which would cause the emergence of an ERE in the absence of a change in the data is unimaginative and misleading. It does not help us understand innovation, discoveries, uncertainty-bearing, and the various ways that individuals deal with uncertainty.

 

Does the Theory of Prices Require the ERE as an Endpoint?

            In conjunction with his discussion of the prices of higher order, Mises claims that the theory of prices, as part of the operation of the market, requires an endpoint. He says:

We conceive the operation of the market...in a twofold way. We think on the one hand of a state of affairs which leads to acts of exchange: the situation is such that the uneasiness of various individuals can be removed to some extent because various people value the same goods in a different way. On the other hand, we think of a situation in which no further acts of exchange can happen because no actor expects any further improvement of his satisfaction by further acts of exchange...The operation of the market is actuated and kept in motion by the exertion of the promoting entrepreneurs, eager to profit from differences in the market prices of the factors of production and the expected prices of the products. The operation of this market would stop if a situation were ever to emerge in which the sum of the prices of the complementary factors of production--but for interest--equaled the prices of the products and nobody believed that further price changes were to be expected. Thus we have described the process adequately and completely by pointing out, positively, what actuates it and, negatively, what would suspend its motion. The main importance is to be attached to the positive description. The negative description resulting in the imaginary constructions of the final price and the evenly rotating economy is merely auxiliary. For the task is not the treatment of imaginary concepts, which never appear in life and action, but the treatment of the market prices at which the goods of higher orders are really bought and sold.(ibid.: 334) Footnote

 

In this statement, Mises argues that an adequate conception of "the operation of the market" requires one to specify (1) what actuates it and (2) what would suspend its motion. Certainly, we need to specify what actuates it. The same is true of action in general. Unless we specified an actor's desire to remove felt uneasiness, we could get nowhere. In the market economy, the activating element is the desire for goods, which can only be obtained through monetary exchange, combined with the belief on the part of praxeological entrepreneurship that it can earn profit by producing goods that are desired. But for what purpose do we need to specify the conditions that would suspend its motion? It is true that we need an image in which there is no motivation to interact economically. It is only by contrast with such an image that we can define action and economic interaction in the first place. It is also true that the entrepreneurial act that is intended to earn profit must anticipate an endpoint at which some profit will have been earned. But it seems that there is no compelling reason why we need to specify what would suspend entrepreneurial action. Such an image would be appropriate only if our purpose was to show that, in reality, such a suspension never occurs. In other words, one needs the ERE but not for the purpose that Mises claims it is needed in this passage. The argument here is that it is needed in order to show that individuals in a market economy would never act in such a way as to bring about the ERE.

 

The ERE, Comparative Statics, and the Study of Change

            Once Mises decided to not further explore the concept of the functional entrepreneur, he was led to employ the ERE concept in a number of dubious ways. These include a focus on change rather than action. Consider the following statement:

[I]n order to analyze the problems of change in the data and of unevenly and irregularly varying movement, we must confront them with a fictitious state in which both are hypothetically eliminated...This so called static method is precisely the proper mental tool for the examination of change. There is no means of studying the complex phenomena of action other than first to abstract from change altogether, then to introduce an isolated factor provoking change, and ultimately to analyze its effects under the assumption that other things remain equal...The static method, the employment of the imaginary construction of the evenly rotating economy, is the only adequate method of analyzing the changes concerned without regard to whether they are great or small, sudden or slow.(ibid.: 247-8)


In order to study change, Mises says, one must abstract from change, introduce a factor provoking a change, and study the hypothetical effects of the factor, other things equal. Professional economists have called this the method of comparative statics. But the method of comparative statics is also used in the study of non-economic phenomena. Natural scientists use it. In natural science, its use is associated with the study of a tendency toward equilibrium. We learn how a factor contributes to change by isolating it from the other factors, provoking a change, and then studying the resulting movement toward equilibrium. An example from Clark is of a pebble thrown into a still pond.

            But the economist does not study change per se. He studies economic action. Accordingly, Mises's statement seems beside the point. To judge whether the method is useful, let alone necessary, we must ask how it helps us understand action. To focus on change instead of action is to divert one's attention away from the praxeological roots of economics. Footnote

 

Comparing Market Economies With Different Characteristics

            Comparative statics, as used here, should be distinguished from the method that subjectivist economists use to compare economies containing different characteristics, such as different degrees of market intervention. Consider the problem of determining the effect of a market intervention on an otherwise pure market economy. The economist's goal is to compare the imaginary pure, unhampered market economy with a market economy (also imaginary) that contains the intervention. To say this differently, the subjectivist economist compares entrepreneurship under the conditions of the pure market economy with entrepreneurship under the conditions of the hampered market economy. For example, we study how the imposition of a price ceiling in a particular market makes the entrepreneurial actions different from what they otherwise would be).

            Contrast this with the method of comparative statics, which is used in mainstream professional economics. According to this method, one begins with an ERE, imagines that a market intervention occurs, and then considers what a new ERE would be like after all of the individuals had adjusted to the intervention. Such a procedure is hazardous since it disregards or diminishes the significance of praxeological entrepreneurship.

 

Logical and Mathematical Equilibrium

            One use that Mises makes of the idea of a tendency toward the ERE is to argue against mathematical economics, which also uses the notion of equilibrium as an endpoint. He says that the

mathematical economists disregard dealing with the actions which...are supposed to bring about the evenly rotating economy...They stress exclusively the imaginary state of equilibrium which the whole complex of such [speculative] actions would attain in the absence of any further change in the data. They describe this imaginary equilibrium by sets of simultaneous differential equations. They fail to recognize that the state of affairs they are dealing with is a state in which there is no longer any action but only a succession of events provoked by a mystical prime mover...They deal with equilibrium as if it were a real entity and not a limiting notion, a mere mental tool. What they are doing is vain playing with mathematical symbols, a pastime not suited to convey any knowledge.(ibid.: 250, italics added, as quoted above)

 

In contrast, the "logical economist"

shows how the activities of enterprising men, the promoters and speculators, eager to profit from discrepancies in the price structure, tend toward eradicating such discrepancies and thereby also toward blotting out the sources of entrepreneurial profit and loss. He shows how this process would finally result in the establishment of the evenly rotating economy. This is the task of economic theory...The problem is the analysis of the market process.(ibid.: 355-6, italics added, as quoted above)

 

As opposed to this, the

mathematical economist does not contribute anything to the elucidation of the market process [i.e., the process in which the promoters and speculators are the driving force]. He merely describes an auxiliary makeshift [the ERE] employed by the logical economists as a limiting notion, the definition of a state of affairs in which there is no longer any action and the market process has come to a standstill. That is all he can say. What the logical economist sets forth in words when defining the imaginary constructions of the final state of rest and the evenly rotating economy and what the mathematical economist himself must describe in words before he embarks upon his mathematical work, is translated into algebraic symbols. A superficial analogy is spun out too long, that is all."(ibid.: 355)

 

Thus the difference between the mathematical and the logical economist is that the former pays no attention to the market process, which Mises defines as the actions of promoters and speculators that would cause the ERE to be reached if there were no further changes.

            Mises's argument is not as convincing as it could be. The telling argument against mathematical economics is that whereas mathematical models are designed as simulations, the ERE in economics is only useful because we know from intuition and experience that human beings would never be in it. Mathematical economics may help us in building images of complex EREs -- i.e., of robot economies with various specializations. However, the goal of mathematical economics to simulate the market economy is fundamentally unrealizable. Unless the mathematical economist explains how his model will help one comprehend action -- in other words, unless his ultimate aim is to do praxeological economics -- he has no reason to think that his work will have any usefulness in understanding economic interaction.

 

Entrepreneurship or Robot Entrepreneurs?

            The shortcoming of Mises's criticism of mathematical economics is more obvious when we consider that it relies on Mises's concept of the promoter. Mises described the "action" of the promoting and speculating entrepreneurs as that of discovering price discrepancies. What are these price discrepancies? Unless we take the broader view of the appraising, praxeological entrepreneur, as defined above, they are nothing but the discrepancies that we, as economists, assume to exist when we define a disturbance to the initial equilibrium. Thus, in the analysis of the market process, Mises gives the appearance of assuming that the promoting and speculating entrepreneurs discover the objective facts that he assumes are present at the time when he introduces the change. But the “discovery” of assumed objective facts does not require distinctly human actors. We could just as easily postulate the existence of robot profit-maximizers who are programmed to "be alert" to such discrepancies. Once one specifies the price discrepancies, one only needs to add algorithms that enable the robot profit-maximizers to identify them.

            Moreover, we can specify that robot profit-maximizers differ from each other and that objective time will pass to differentiate early discoverers from potential late discoverers. We may further assume that some identify discrepancies sooner than others and that some are mere copiers. By doing this, we may deduce a time path toward the new equilibrium. The mathematicians are unlikely to be swayed.

            The unconvincing nature of Mises's argument is due to the fact that he neglected to use the ERE to identify the fundamental properties of entrepreneurship. Without this, there is no way of telling whether the forces he identifies when he speaks of the tendency toward equilibrium are distinctly human forces or mechanical ones. Footnote By asserting that the mathematical economist cannot represent the market process, he implies that the forces involved in the market process are not mechanical. But his argument is compromised by the fact that he does not identify these forces in his argument. A second problem is that the behavior he does specify (discovering price discrepancies) and the nature of the promoting and speculating entrepreneurs (quickness of apprehension and far-sightedness) are not characteristics of distinctly human action. Computers can be programmed to discover price discrepancies and some nonhuman animals are quicker of apprehension and more far-sighted than other animals. Footnote

 

Promoter Restlessness and the ERE as an Endpoint

            Mises wrote:

 

The driving force of the market, the element tending toward unceasing innovation and improvement, is provided by the restlessness of the promoter and his eagerness to make profits as large as possible. (Mises 1966: 254-5, as quoted above).

 

It is evident that the restlessness attribute is not consistent with Mises's use of the promoter concept in comparative statics. Restlessness -- i.e., profit-seeking behavior that leads to innovation and improvement -- cannot at the same time lead to the ERE. Consistency demands that we drop the concept of restlessness from our description of the market process or that, if we include it, we redefine the term to refer solely to programmable behavior. This explains why Mises did not mention restlessness when describing the tendency toward the ERE. Restlessness, whatever it means, cannot lead to the ERE.

 

Tendency Toward the ERE

            Literally, to say that there is a tendency toward the ERE is to say that there is a tendency for actors to reach a state in which they cease to have a motivation to act or in which they have become robots. This fact should be enough to deter us from using any notion of a tendency toward the ERE. However, Mises claimed that there is a "tendency, prevailing in every action, toward the establishment of an evenly rotating economy," although this "tendency can never attain its goal in a universe not perfectly rigid and immutable, that is, in a universe which is living and not dead."(ibid.: 250)

            What can he possibly mean by the tendency toward the ERE in every action? We can learn something by considering an isolated action of an isolated individual. Such an action is intended to achieve a goal. We assume a priori that every choice has an intended outcome. Furthermore, it seems reasonable to go on to assume that normal human beings are more likely than not to achieve the outcome they intend. Footnote On the basis of these assumptions, we might be inclined to say that there is a tendency for the chooser to reach the endpoint toward which his action aims. However, the isolated actor performs many actions simultaneously, each with a particular end. It seems unreasonable, even inconceivable, that all the endpoints of all of his particular actions would be reached simultaneously. We could get around this problem methodologically by saying that we can only understand action in general by studying one action at a time. In the study of a single action, the assumption of a tendency to achieve the intended outcome is consistent with our experience that, in a broad sense, an individual's choice has causal relevance to him. He expects that by making a choice, he will improve his prospects for meeting his ends. In this view, the aim of the notion of a tendency toward an endpoint of action is to help us describe action in general by using examples of particular, isolated actions.

            Another problem is not so easy to circumvent. Equilibrium requires that the endpoint aimed at, or the action taken to achieve it, is not itself likely to present the actor with a motivation for further action. However, every action leads, and is expected to lead, to new knowledge on the part of an actor during the period of time while the action is occurring. And this new knowledge is relevant to the actor's decisions about how to achieve his goals. This implies that the very action that we might conceive as leading to an endpoint changes the configuration of actions that an individual would regard as most appropriate for achieving that endpoint. The actor knows that he will acquire new knowledge. He may plan for this. However, since he cannot know in advance the content of his new knowledge, his plans must be contingent.

            There is problem enough in the notion that an isolated actor would reach an equilibrium in an isolated action. But now consider the notion as it is applied to the market economy. Suppose that it is somehow meaningful to say that an individual could achieve all his goals and reach a state of no action. In what sense would it be correct to say that such an individual's (or any individual's) action causes a tendency toward the ERE in an image of many actors? Clearly, in such an image, one person's choice to achieve his goals has the potential of facilitating another's achievement of her goals. But it also has the potential of interfering and of having absolutely no effect. Yet the tendency toward the ERE implies that there is a tendency for everyone's goals to be achieved to the extent that no one wants to continue to act. The problem involved in conceiving of the ERE as an endpoint is compounded.

 

The Market Process

            An important clue to Mises's reason for using the "tendency toward equilibrium" concept is his discussion of the market process. In his first statement about this he says that "[t]he market process is the adjustment of the individual actions of the various members of the market society to the requirements of mutual cooperation."(ibid.: 258) Since he uses this term in conjunction with the idea of a tendency toward equilibrium, it would appear that his goal is to elucidate what he calls "mutual cooperation." One of the salient features of the market economy, as we know it from experience, is the way in which individuals seem to cooperate in the satisfaction of each other's ultimate wants (i.e., the wants of consumers as a role), even though most of them do not know precisely how their actions contribute to such satisfaction. What Mises seems to have in mind when he speaks of the market process is this kind of cooperation or coordination.

            In a most important sense, every action in the market economy is intended to satisfy consumer wants. However, the competition among individuals that is intent on satisfying wants is not limited to actions that would tend toward the ERE. It consists partly of discovering wants and of producing new products to satisfy them, partly of discovering methods of satisfying wants that are unknown to others, partly of improving on the methods that others now use, partly of discovering the plans of rivals and suppliers of complementary goods and factors, and partly of developing innovative ways to deal with uncertainty. These actions, if not erroneous, are part of the cooperation and coordination that leads to a greater satisfaction of consumers' wants than otherwise. But they cannot be part of a tendency toward equilibrium. Accordingly, they cannot be part of the market process, as Mises describes it. Thus, either mutual cooperation is broader than Mises's market process, or Mises's description of the market process and mutual cooperation leaves out very important classes of economic interaction. Footnote

            In rejecting Mises's use of the ERE, we do not mean to reject the notion that entrepreneurship aims to predict future wants and to satisfy them. The argument here is that it does more than this and that Mises's concept of the market process, which is based on the complementary concepts of the promoter and the ERE, points away from a large set of other actions that businesspeople take. The concept of the praxeological entrepreneur, which is derived from the use of the praxeological concept of equilibrium, does point down such a path.

 

Hayek on Equilibrium and Competition

            Some neoAustrian economists who describe the market process in terms of a tendency toward equilibrium claim to take their inspiration from F. A. Hayek, Footnote Among other things, Hayek wrote: "the only justification for [our concern with the admittedly fictitious state of equilibrium] is the supposed tendency towards equilibrium."(Hayek 1937: 43-4) But Hayek makes this statement not in support of the use of a market process analysis that describes a tendency toward equilibrium but to refute the use of equilibrium analysis altogether. Since this appears to be an odd interpretation of Hayek, let me elaborate. After writing this statement, Hayek goes on: "It is only with this assertion that economics ceases to be an exercise in pure logic and becomes an empirical science."(ibid.: 44) In discussing this, Hayek calls the assertion an empirical proposition and defines it as follows: "under certain conditions the knowledge and intentions of the different members of society are supposed to come more and more into agreement..."(ibid.) To evaluate the assertion – i.e., to determine whether the facts match the empirical proposition – we must know "(a) the conditions under which this tendency is supposed to exist and (b) the nature of the process by which individual knowledge is changed."(ibid.: ) Regarding the nature of the process, he writes that those who make the assertion ordinarily make subsidiary assumptions "that people do learn from experience and about how they acquire knowledge..."(ibid.: 45) So the question of whether there is a tendency toward equilibrium turns (at least partly) on whether the conditions described in these subsidiary assumptions correspond to reality. In Hayek's terms, to determine whether there is a tendency toward equilibrium, "we should have to investigate whether [these concrete assumptions or hypotheses are] necessary and sufficient to explain a movement towards equilibrium, and we should have to show to what extent they were borne out by reality."(ibid.: 47) In his investigation, he makes the observation that we would have to assume constancy of the data, yet this assumption is neither a necessary or sufficient condition. (ibid.) He goes on to suggest a "more fruitful way of approach to the central problem."(ibid.: 48) To introduce this approach, he begins by noting a division of knowledge which is analogous to the division of labor.(ibid.: 49) Having directed the attention of the reader to the subjective knowledge of different specialists in the market economy, he begins to use his approach, which is to focus on only one of the many actors. He asks about the knowledge such an actor would need to reach a point where she has no incentive to change her plans (i.e., to reach an equilibrium [for her!]). His main point is that for the economist to claim that the individual would reach an equilibrium [for her], the economist would have to assume that the actor only acquires knowledge that she is "bound to acquire." That is, he would have to assume that the actor only acquires knowledge that she must acquire according to the assumptions made by the economist. Yet, as Hayek points out, such knowledge "is certainly not all the knowledge which...would be useful to [her] and lead to a change in [her] plan."(ibid.: 51) This is an equilibrium [for her] because the economist assumes that she has "no chance of learning about facts which, if [she] knew them, would induce [her] to alter [her] plans.(ibid.) Then he goes on to point out that the concept of equilibrium as it is used in the economics literature makes these assumptions about the bits of knowledge possessed by each separate individual. This leads him to consider briefly the further assumptions that must be made about how the separate bits of knowledge come to be combined.(ibid.) The important point is his conclusion, which requires some interpretation to comprehend. He concludes that if, by equilibrium, we mean the concept of a tendency toward equilibrium in the way that is typically used in economics, "equilibrium can really tell us nothing about the significance of [the] knowledge [that people will acquire in the course of their economic activity]..."

            Thus, Hayek did not argue in favor of market process analysis as the study of the factors that would result in an equilibrium. On the contrary, he criticized the use of the term "equilibrium" altogether.

            In his paper "Competition as a Discovery Procedure," Hayek writes that through the process of competition, individuals discover "which goods are scarce goods, or which things are goods, and how scarce or valuable they are..."(1978: 181) In an earlier paper, "The Meaning of Competition," he identified several types of knowledge that would have to exist for "some kind of finished consumption goods" to be produced. (1946: 95) The first is knowledge by producers of "the lowest cost at which the commodity can be produced."(ibid.) In effect, this is knowledge of the factors of production (which factors can be used to produce what), the methods of production, and the prices that the owners of the factors of production are willing to accept. The second is knowledge by consumers of the goods, of varying qualities, that are offered for sale, their prices, and the alternative ways of satisfying the wants that the consumption goods result in satisfying. The third is knowledge of reputation and good will. The fourth, which is a variation of the third, is knowledge of the human inputs, including the subtle differences between them.

 

are recognized that the proper way to comprehend competition is by pointing to the condition of free entry.

 

 

CONCLUSION

 

            In describing the ERE as part of the method of praxeology -- i.e., as part of the method of imaginary constructions -- Mises implicitly suggested that one could develop a more complete understanding of the abstract function of the entrepreneur by using the ERE as a counterfactual. In writing that "[i]n order to grasp the function of entrepreneurship and the meaning of profit and loss, we construct a system from which they are absent"(ibid.: 248); that "[t]he term entrepreneur as used by catallactic theory means: acting man exclusively seen from the aspect of the uncertainty inherent in every action"(ibid.: 253); and that "[i]n any real and living economy every actor is always an entrepreneur and speculator"(ibid.: 252); Mises suggested a line of inquiry into the nature of entrepreneurship that to my knowledge had not previously been taken.

            This paper has argued that this "praxeological concept of equilibrium" is a necessary step in the economist's effort to shift from an understanding of an isolated action to the understanding of distinctly human interaction under the conditions specified in the definition of the market economy. The static equilibrium, or ERE, is properly regarded as an image of a completely robotized economy. Such an image is needed to mentally organize the variety of behaviors that people in the market economy choose to perform. Because the ERE contains these behaviors but also is completely devoid of distinctly human interaction, it helps one to identify the distinctly human action and interaction that must exist for the behaviors to be performed under the conditions of the market economy. By contrasting the ERE with what we know a priori and from experience about how human beings would act with regard to supplying factors, producing, consuming and saving; we are able to isolate the distinctly human action of the market economy. We label this distinctly human action "entrepreneurship." Once we define praxeological entrepreneurship, we can proceed to show its facets and consequences under market economy conditions.

            The bulk of the credit for linking the ERE to a method of comprehending economic interaction in the market economy belongs to Mises. He provided the praxeological foundations for the use of the method of imaginary constructions in the elucidation of action in general. He also showed that the ERE is essential. Unfortunately, Mises himself mainly used the ERE as an endpoint in what he called the market process -- the tendency toward the ERE. This use directs our attention away from other types of economic interaction, namely, those that are associated with the discovery of wants and new means of production and with uncertainty bearing. Mises also used the concepts of the promoter, market process, and tendency toward the ERE to argue against the concept of mathematical equilibrium. However, this paper suggested that because he did not employ the notion of the praxeological entrepreneur, his argument was not as convincing as it could have been.

            The concept of praxeological equilibrium stands in opposition to the various uses of equilibrium that exist in the professional economics literature. Correspondingly, that literature has been criticized for lacking the "dynamic" element that is traditionally associated with the entrepreneur concept. The models of equilibrium used by econometricians and policy advisors are basically models of behavior. They represent either an image of what has happened in the past or the economist's projection of the behavior that will occur in the future. Praxeology demonstrates that one who uses them to predict the future must commit the methodological sin that F. A. Hayek has aptly labeled "the pretense of knowledge."(Hayek 1975) To give policy advice on the basis of such models suggests an arrogance that is unwarranted due to the limitations of the models.

            The obvious way to avoid the temptation is to adopt the praxeological view that while everyone acts, the "set" of particular actions that others will perform under the conditions of the market economy is almost entirely beyond the mind of any particular individual to foresee. This does not mean, of course, that economists have nothing to say about policy. It does imply, however, that they are relegated largely to the role of critics. Their method enables them to judge whether the arguments of others relating to market intervention are reasonable. They ask: "do these arguments acknowledge praxeological entrepreneurship and, correspondingly, how is entrepreneurship likely to interpret the conditions that a particular market intervention will impose?" "What action and interaction is entrepreneurship likely to perform under the changed conditions?" "Don't forget entrepreneurship (i.e., praxeological entrepreneurship)," the economist advises.

            Nor is providing this reminder an easy task. To combat the simple arguments of the layperson, the economist must ordinarily teach about the complex and subtle manifestations of entrepreneurship in highly complex lines of business, employment, and consumption. He must say: "But your arguments are too simple. They disregard some important aspects about how real human beings will act under the assumed circumstances." How can the economist be convincing? Only by asking the student to try to put herself in the shoes of the individual whose behavior the argument assumes to be able to predict.

            Such a role is, of course, quite different from that suggested by the typical policy-related paper in most modern professional journals. It is, nevertheless, the only role that is left to the praxeologist who practices his craft with the humility of an impartial scientist.

 


References




Arrow, K. J. and G. Debreu (1954). "Existence of an Equilibrium for a Competitive Economy." Econometrica. July.


Clark, J. B. (1899). The Distribution of Wealth: A Theory of Wages, Interest and Profits. Macmillan, New York.


Clark, John B. (1899). "Natural Divisions in Economic Theory." Quarterly Journal of Economics. Vol. 13: January.


De Vroey, M.(1999) "Equilibrium and Disequilibrium in Economic Theory: A Confrontation of the Classical, Marshallian and Walras–Hicksian Conceptions." Economics and Philosophy. 15(2): 161–85.


Gibbard, Allan and Hal R. Varian (1978) “Economic Models.” The Journal of Philosophy. 75 (11): 664-77. Reprinted in Bruce Caldwell (ed.) (1993) The Philosophy and Methodology of Economics. Vol 3. Brookfield, Vermont: Edward Elgar Publishing Company.


Gunning, J. Patrick (1990). The New Subjectivist Revolution: An Elucidation and Extension of Ludwig von Mises' Contribution to Economic Theory. Savage, Maryland: Rowman and Littlefield.


Gunning, J. Patrick (1997). "The Theory of Entrepreneurship in Austrian Economics." in Keizer, W., Tieben B. and R. Van Zijp (eds.). Austrians in Debate. London: Routledge.


Hayek, F. A.(1937) "Economics and Knowledge." Economica: February. Reprinted in F. A. Hayek.(1948) Individualism and Economic Order. Chicago: University of Chicago Press.


Hayek, F. A.(1946) "The Meaning of Competition." Stafford Little Lecture delivered at Princeton University. In Individualism and Economic Order. Chicago: University of Chicago Press.(1948)


Hayek, F. A. (1975) "The Pretence of Knowledge." Swedish Journal of Economics (4). Reprinted in Hayek's New Studies in Philosophy, Politics, Economics, and the History of Ideas. Chicago: University of Chicago Press.


Hayek, F. A.(1978) "Competition as a Discovery Procedure." Chapter twelve in Hayek's New Studies in Philosophy, Politics, Economics, and the History of Ideas. Chicago: University of Chicago Press.


Kirzner, Israel (1973). Competition and Entrepreneurship. Chicago: University of Chicago Press.


Kirzner, Israel. (1997) "Entrepreneurial Discovery and the Competitive Market Process." Journal of Economic Literature. 35: 60-85 (March).


Oakley, Allen. (1997) The Foundations of Austrian Economics from Menger to Mises: a Critico-Historical Retrospective of Subjectivism. Cheltenham, UK: Edward Elgar


Robbins, Lionel.(1930) "On a Certain Ambiguity in the Conception of Stationary Equilibrium." The Economic Journal. 40: 194-214. Reprinted in Robbins (1974) Economic Science and Political Economy: Selected Articles. Edited by Susan Howson. London: Macmillan.


Rothbard, Murray N. (1997) The Logic of Action I: Method, Money, and the Austrian School. Cheltenham UK: Edward Elgar.


von Mises, Ludwig (1966). Human Action: A Treatise on Economics. Chicago: Henry Regnery Company.


Walker, Donald A.(1997) Advances in General Equilibrium Theory. Cheltenham, UK: Edward Elgar.


Wieser, Friedrich von. (1927) Social Economics. New York: Adelphia Co. (first published in German in 1914)




Gunning’s Address


J. Patrick Gunning
Visiting Professor
U.S. Coast Guard Academy
Management Department
15 Mohegan Avenue
New London, CT 06320

Please send feedback:

Email: gunning@nomadpress.com
Go to Pat Gunning's Pages