If Leon Walras’ auctioneer did his job, running a business would be easier. One might say the U.S. economy ‘is in a dynamic state’ right now. (That’s an old Vietnam War phrase for ‘nobody knows what is going on.’) Rapidly changing economic conditions force changes, but such adjustments seldom are instantaneous. That complicates life for people producing all sorts of products.
Walras was a French-born 19th-century economist. Going beyond Adam Smith’s metaphor of “an invisible hand” in explaining how markets work, he suggested the mental image of an auctioneer.
In modern economies, everything links to everything else in a complex web. Food prices depend on grain prices that depend on fuel prices. Demand for bass boats depends on demand for overtime carpenters’ labor that depends on demand for houses. Wal-Mart’s profits, compared to Nordstrom’s, vary with household optimism or pessimism. The cost of flying to Los Angeles or having something trucked to Paducah increases with fuel prices, and so on.
Walras’ imaginary auctioneer illustrates how markets solve these complex interrelationships. All producers and consumers submit bids to the auctioneer listing what quantities of things they are willing to buy at which prices and what they are willing to sell. The auctioneer tabulates the bids and announces who gets to buy or sell how much of each item at what price. He then bangs his gavel, and the economy moves forward to a new round.
As a mental model, Walras’ auctioneer is useful. The real world, however, seldom is so smooth. It is as if some bid slips fall to the floor while being handed to the podium or the auctioneer errs while totaling some column.
Right now, many important factors — energy costs, housing prices, interest rates and inflation — are changing quickly. Such changes affect myriad other variables — eventually.
In the short run, things get interesting. Hog prices eventually catch up to higher corn prices. Recently, however, hog prices around 50 cents per pound and corn prices topping $5.50 per bushel have Minnesota pork producers in a squeeze.
Trucking rates will adjust to higher diesel prices in the long run. Right now, after paying for fuel, many owner-operators can’t make their monthly truck payments.
Home building, buoyed by a bubble in housing prices, boomed in the first half of this decade. It eventually will slim down to a sustainable level. In the meantime, property developers, builders and skilled laborers feel the economic squeeze.
Adjustments are inevitable but not necessarily to a new, stable equilibrium. For many products, prices and output tend to overshoot on both the upside and downside.
Low prices will force some hog producers out of business. Production capacity will dip below long-run consumption. Prices eventually will rise, and because it takes time to ramp up production again, they will rise too high and motivate too much new production. Eventually, overproduction will depress prices, starting the cycle over again.
This pattern of delayed adjustment to changing prices creates familiar expansion-contraction cycles in many industries beyond livestock, trucking and construction. If only Walras’ auctioneer were a little better and faster at his job.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.