Introduction

The title of this Conference is “The Formation of Economic Magnitudes.” Yet, if the papers prepared for it are true to the course of modern economic theory, most of them will, in a very real sense, not concern that subject at all. Modern economic theory is overwhelmingly a theory of equilibrium. It analyzes positions from which there is no incentive to depart, positions at which the plans and expectations of economic agents are mutually compatible. It is almost silent on the question of how such positions get reached, on how economic magnitudes get formed if they do not happen already to be in equilibrium.

Equilibrium analysis is an elegant and powerful tool, providing considerable illumination of the way in which real economies operate. But the total concentration on equilibrium now characteristic of formal economic models runs the serious risk of misunderstanding the basic insights of economics itself. Thus, the proposition that competitive industries earn no profits in long-run equilibrium is an important (if elementary) theorem. To take this to mean that competitive industries never earn profits is not only wrong, it is to lose sight of the fundamental role that profits and losses play in the allocation of resources when demand or technology changes. The proposition that competitive equilibria and Pareto-optima are closely related is a basic insight. The policy prescription that (under the conditions of the two Welfare Theorems) government interference with a competitive system is bound to be inefficient requires more than this, however; it requires the assurance that competitive economies are close to equilibrium most of the time.