AN INTRODUCTION TO ECONOMICS by Maurice Dobb 1932
THE SECOND set of complications arises when from the simplified case of exchange between two commodities, say cloth and corn, we pass on to more complex considerations of equilibrium in the real world, where purchase and sale of a large range of commodities are continually taking place. In considering the price of any particular commodity, say corn, one must consider it as being exchanged against the whole mass of other commodities or against generalised purchasing power, or money. (The two things come to the same thing, since money has no utility of its own apart from that of the things it can purchase.) Hence the buyers’ demand for corn (whether measured in terms of money or of commodities in general) must be expressed as a function not only of the utility of com, but also of the marginal utility of all other commodities. Any change in the supply, and hence in the marginal utility and price, of any of these other commodities will therefore alter this demand function. The so-called Lausanne School, represented by Walras and Pareto, have accordingly occupied themselves with this more complex problem of general equilibrium, attempting to establish the terms of equilibrium of all commodities by means of a system of simultaneous equations to cover the aggregate of commodities. English and American economists, on the other hand, have in general confined their analysis to the problem of a particular commodity treated in isolation. To make this possible, the assumption is necessary that the price of all other commodities (and hence the marginal utility of money to buyers) is constant; and this requires the further assumption that the commodity in question is so small a part of the buyers’ total expenditure that a change in its price exerts no appreciable influence on the price of other commodities (by affecting the demand for them) or on the marginal utility of money to buyers. Such a reaction is regarded as being so small as to be negligible (what mathematicians call of “the second order of small quantities”). A similar assumption has to be made on the side of supply. It has to be assumed that a change in the output of this particular commodity (say, silk stockings) does not appreciably affect the demand for the factors of production (land, labour, capital) and hence does not alter the price of these latter. This assumption will be valid if the production of the commodity in question occupies only a small part of the factors of production in the community at large. When, however, a commodity such as corn is being considered, which bulks large both in the average consumers’ expenditure and in the employment of one or more of the factors of production, this convenient assumption breaks down, and a solution is only possible by the more complex methods of the Lausanne School. Neglect of these essential limitations to an analysis of particular equilibrium has produced some impressive fallacies, even among the great; and for this reason those categories of “elasticity of demand,” “increasing returns,” etc., so familiar to economic textbooks are pitfalls for the unwary.