The theory of the market

Since the latter decades of the nineteenth century, orthodox economic theory has made its main business the demonstration that a well-oiled market mechanism will produce the most efficient allocation of scarce resources among competing ends. This preoccupation has in turn dictated a characteristic mode of analysis, in which the economy is conceived in terms of “agencies,” or institutions, which, whatever their other differences, find their common denominators in terms of their market functions. Thus Rockefellers and sharecroppers are both “households,” GM and the corner grocery are both “firms.” Households, rich and poor, all demand “final goods” and supply labor and other “services” (meaning the use of capital and land); firms, big and small, demand labor and other factor services, and in turn supply final goods.

This way of subdividing the economy fits neatly into the framework of “rational choice.” Factors supply services and demand goods in the amounts and proportions that will maximize their “utilities,” given their “initial endowments,” a polite way of referring to property holdings. It can be shown that the amounts finally chosen, the so-called equilibrium supplies and demands, will be simultaneously compatible solutions to all these different individual maximizing problems.

The task of high theory, then, is twofold: first, since the models are complex, to show that there are, indeed, such simultaneous, mutually compatible solutions. This is not obvious, and, infact, not always true. Second, of equal mathematical and of greater ideological importance, are what might be called the Invisible Hand Theorems, which show that the system of market incentives will direct the economy toward these equilibrium prices, supplies, and demands.