Page 68 - Global Political Economy_Understanding The International Economic Order

NEO CLASS ICAL C ONCEP T OF AN ECONO MY
activities of individuals participating in a market is spontaneous and
is guided by the “invisible hand” of self-interest.
The rational and homogeneous individuals of economic science live
in an economic universe composedsolely of prices (p) andquantities
(q) that possess no ethnic, national, or other identity. Changes in
prices and quantities constitute the signals to which individuals re-
spondin their efforts to maximize their goals or, as economists prefer,
their utilities. Individual consumers and producers make decisions
basedon changes in relative prices, market opportunities, andexter-
nal constraints. Prices, at least over the long term, are determined by
such objective economic laws as the law of diminishing returns and
the law of supply and demand. The law of demand is the most impor-
tant of the laws that drive or govern the economy. This “law” holds
that people will buy more of a goodif the relative price falls andless
if the relative price rises; people will also tendto buy more of a good
as their relative income rises andless as it falls. Any development that
changes the relative price of a goodor the relative income of an actor
will create an incentive or disincentive for an individual to acquire
(or produce) more or less of the good. This simple yet powerful law
of demand is fundamental to the functioning of the market system.
One of the most important concepts employedby economists to
understand market functioning is static equilibrium (or simply equi-
librium). An equilibrium exists when there is no tendency for the bal-
ance between such interrelatedvariables as prices andquantities to
change. 15 In less technical language, an equilibrium means that no
economic actor has an incentive to change his or her behavior and
the costs andbenefits of the existing situation are judged to have
achieved the best balance that an individual could reasonably expect.
Therefore, the potential gains from changing the situation are not
worth the potential costs, so no change takes place.
The concept of equilibrium is central to explanations of both eco-
nomic stability andeconomic change. Neoclassical economics as-
sumes that markets, at least over the long term, tendtowardan equi-
librium in which supply matches demand. When a disequilibrium
exists, powerful forces will bring the system back into equilibrium.
Economists use the term “disequilibrium” to mean any change in de-
mand, opportunities, or relative prices that gives an economic actor
an incentive to change his or her behavior in order to increase his or
her gains or decrease his or her costs. For example, an increase in the

15
Fritz Machlup, quoted in Yanis Varoufakis andDavidYoung, eds., Conflict in
Economics (New York: Harvester Wheatsheaf Press, 1990), 14.
55