Since the time of Marshall economists have used the constructs of demand and supply curves in their explanation and analyses of how markets determine prevailing prices and the allocation of resources among different lines of economic activity. Today almost all expositions and interpretations of price theory take a neoclassical perspective. This paper develops an interpretation of demand and supply curves and their interaction on markets that is more compatible with the general viewpoint of evolutionary economic theory.
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Brian Loasby (2001) has been making this point for a long time. So has John Foster (1993, 2000) and more recently Metcalfe and Foster (2010)
I note that many evolutionary economists are required to teach course in price theory. Undoubtedly at least some of these have felt uneasy when they laid out the standard neoclassical arguments about strong consumer and producer rationality and about the nature of market equilibrium.
Almost all of the behavioral specifications in evolutionary models make use of Herbert Simon’s concept of bounded rationality (1957). But they also go beyond this to recognize variation and innovation in behavior.
Part of the objective here might be posed as developing a price theory that we evolutionary economists can present to our students without blushing
This is not to deny that in many cases the beliefs and attitudes orienting economic action may have little contact with the empirical reality, and be better described as prejudices.
The discussion on household behavior that follows is basically that presented in Nelson and Consoli (2010)
The use of term “routine” to characterize standardized goal oriented behavior has mostly been employed to characterize what organizations do. Here I am using the term to characterize a class of individual or household behaviors as well. While I have chosen not to use the term “habit” in this context, my routine concept here is very similar to Veblen (1898) concept of habit.
There is no assumption here that this sensitivity of behavior to external circumstances is “optimal” in any way. But boundedly rational economic actors do have the capability and the proclivity to respond adaptively to the conditions they are in
The connotation here is one of intentionality. This sharply differentiates the theory presented here of adaptive response to price changes from Becker’s theory (1962)
Nor is there is no reason to believe that the consumer could state or predict what these responses would be with any precision, or that they would be the same from instance to instance
Augier and Kreiner (2000) have stressed the importance of ability to imagine in the decisions made by boundedly rational actors.
In my discussion here I have not considered household responses to the emergence of radically new goods and services, or to contexts more generally where there is little experience within the society. To deal with such situations requires a theory of how cultural as well as individual preferences and expectations emerge and change in response to new opportunities and constraints. I currently am working on these matters with Davide Consoli.
For a classic discussion see Cyert and March (1963)The alert reader will note that, while I have posed my argument about household behavior in terms of adaptive purchase responses to changes in prices, I have posed my argument regarding firm behavior in terms of adaptive responses to changes in the demand it faces. While in most (but certainly not all) cases where economists use demand-supply analysis it is reasonable as a first approximation to regard households as price takers, and assume that they can buy as much as they want at prevailing prices, in many cases where demand-supply analysis is used, it is not reasonable to assume that the demand for a firms product is perfectly elastic, and in many such cases firms set prices rather than responding to them. For firms that are price takers, by an increase (or decrease) in demand here I mean an increase (or decrease) in the price at which it can sell the prevailing quantity of the products in provides. For firms that set their prices , by an increase (decrease) in demand I mean an increase (decrease) in what can be sold at the prevailing price, or equivalently an increase (decrease) in the price it can charge and still sell what it has been selling.
I have not mentioned here the behavior of business firms in contexts for which their past experience and acquired expertise is mostly irrelevant, as contexts of radical technological change. I will touch on some of these issues later in this paper
I note that Marshall’s treatment of demand and supply has important aspects in common with the argument I developed in the preceding section. In particular, while purposeful his economic actors clearly operated with bounded rationality. And particular on the supply side he emphasized the variety of different economic actors.
Few modern treatments even go as far as Walras, who at least presented the allegory of a central auctioneer at work, who did not allow trades unless there was an equilibrium
Recall that in the prior section my discussion of adaptive responsiveness of firms on the supply side of a market was couched in terms of responses to changes in demand
In the language used by Jason Potts (2000, 2001) in most markets network connections are far from complete
And of course some potential actors may hold expectations of the price at which they can buy or sell that do not match up with the other side of the market, but which despite their continuing frustration are hard to shake,
Another advantage is that the framework is well suited for analysis of why and how markets change. While this matter will not be considered extensively in this paper, the conceptualization here links up very well with the dynamic analysis presented in Metcalfe and Foster (2010)
While the characterization of the housing market I have just given is not that depicted in standard price theory, I note that many of the features I describe, and their consequences, are well treated in the modern economic literature on how labor markets work
The analysis of Jason Potts (2000, 2001) has highlighted this kind of phenomenonThe assumption that prices were stable in the pre-shift context, and are in the post-shift one, certainly is a convenience for the argument, but is not strictly necessary
I note that in the theory of market operation and order being espoused here, even in a stable market order with no tendency for prices to change there inevitably will at least some frustrated potential buyers and sellers (as certainly is the case in housing markets). The “gap” here thus needs to be understood as a difference between the prevailing situation and conditions under which prices are stable
Of course the demand side of the market mainly consists of firms rather than households.Differential pressures on natural or otherwise fixed resources also are part of the story, but here too the changing availabilities over time were greatly influenced by the kind of technological advances that were achieved.
See for example Nelson (2003, 2008b) Nelson and Consoli (2010) recently have tried to begin to remedy this gap. See also Bianchi (1998) See Nelson and Sampat (2001), Nelson (2008a), and Metcalfe and Foster (2010)This certainly was the principal motivation for Nelson and Winter (1982), Hodgson (1993), and Metcalfe and Foster (2010)
I am indebted to Davide Consoli, John Foster, Geoffrey Hodgson, Franco Malerba, Roberto Mazzoleni, Jacob Meerman, J. Stanley Metcalfe, and Bhaven Sampat for helpful comments and suggestions on an earlier version of this paper. The usual caveat obtains
