Reconsidering Economic Theory

Informing the central message of Adam Smith is the recognition that no one understands everything but private individuals in the pursuit of self-interest can contribute to the advantage of others even though they may not intend to do so and may not concern themselves with the economy as a whole. A system of private property and market competition is needed to make this possible: Private property empowers the individual and creates scope for discretion in coping with local situations, that are what each individual knows best; market competition provides incentives for individuals to expand their potential and exercise effective choices. In setting forth this vision of the competitive process, Smith and his followers explicitly recognized that producers and consumers adapt their behavior to price signals that reflect imbalances in supply and demand.

A century after Smith, Léon Walras formalized the idea of a balance or equilibrium in supply and demand and specified two complementary mechanisms of out-of-equilibrium adjustment: consumers' tâtonnement (literally, “groping in the dark”), involving price adjustments in response to discrepancies in supply and demand, and producers' tâtonnement, involving quantity adjustments in response to profit opportunities. He emphasized that such a system of dynamic relationships would not converge to a general equilibrium but would oscillate around one, sometimes approaching a steady state (like a “glassy sea”) and sometimes exhibiting more or less turbulent fluctuations (like an “ocean storm”).