Markets are useful tools for managing economies, but how they work needs to be better understood; there is a grand myth and misrepresentation surrounding them.
Resistance to growth in the SRT economy is very easy to identify. A zero growth equilibrium in macroeconomics will be established where aggregate supply equals aggregate demand. Should companies try to grow by increasing supply the aggregate economy will resist this growth by lowering price (deflation) by which profitability is killed off forcing firms to cut production thus returning the economy to the zero growth equilibrium or normal profits. Should growth be attempted by an increase in demand, the aggregate economy will naturally counter this by increasing price (inflation) until it becomes too costly to consume forcing consumers to stop buying; demand is forced back to the natural zero growth equilibrium. In CE this is referred to as ‘overheating’. Rising demand is countered by the economy’s natural resistance to growth using this approach as the economy attempts to grow rapidly against the market’s resistance, that is, its equilibrium or zero growth position. This phenomenon is common in fast growing economies that may inevitably have to slow themselves down despite the fact that they have not reached their desired per capita income and growth targets. To achieve growth increases in demand and supply need to take place simultaneously, however, the operating structure of the CE model [in the circular flow of income (CFI)] requires demand and supply factors to compete for the same scarce resources thus effectively heading off this avenue through which growth may take place.
Businesses backed into a corner may then attempt to increase profitability by reducing supply side costs – a common method for escaping the crunch of market forces. However, cutting supply to increase price or reduce costs and thus induce profitability will generally cause a decline in demand at the industrial level thus restoring zero growth. This is due to the fact that if a business cuts costs to lower TC (or the cost of supply) this raises internal profitability, but the external economy kills growth in this way by causing supply side factors to be dumped such as jobs, machinery, plants, factories and so on. Hence, unemployment levels begin to rise in the economy.
The market system is so efficient at preventing growth that no sooner is one hole plugged it opens another.
More Market Myths
Some may argue that when demand exceeds supply price goes up encouraging new businesses to enter the market hence stimulating growth. However, when it does, supply increases and price declines to original levels forcing them back out. Inevitably the economy’s equilibrium may close them down or force them to relocate due to lack of profitability. The so called equilibrium [of the free market left to itself] is never stable or able to sustain long run confidence in the market.
Similarly, there is a belief that excess supply is naturally discouraged by falling prices, which forces businesses out of industry. Supply is reduced by the equilibrium to a level equal to lower levels of demand, but how is this beneficial? Shrinking supply is an indication of declining growth. It means industries are closing, plants are shutting down, employees are being laid off and the economy is declining or contracting. The [free market] equilibrium is thus working against businesses and stunting growth yet the interpretation in CE is that it is achieving something desirable as it is maintaining a ‘balance’ [sic financial stability and therefore should not be interfered with .e.g. by providing a stimulus]. This reasoning is ill conceived.
Market forces in the economy naturally challenge growth at each level. It is strange that this limitation is not appreciated [or openly taught] in the laws of demand and supply.
Despite this CE continues to believe and teach that market forces and the equilibrium condition they maintain (that encourage zero growth) are a positive economic condition economies must strive to uphold.
This is a very serious myth or is simply a well propagated and respected mistake.
The aggregate economy creates a System that is a powerful enemy of businesses…
Are markets useful and what purpose do they serve? This can be answered with another question. Are brakes on a car useful, or do they just slow it down?
Market forces are and will remain very useful in managing economies for stalling or restraining and preventing them from growing when this growth may exceed recommended targets or is required to remain at the market equilibrium where growth is constant at zero.
The real problem today is that it is likely most policy makers are taught to believe free or liberal markets and the forces at work within them are the gas pedal, and the ‘good feeling’ of ‘perceived stability’ of an equilibrium equates to ‘growth’. Managing an economy is not this simplistic. This is a distortion of facts and a myth that needs busting if sources and causes of real growth are to be identified.
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Split Velocity Solutions Ltd 