EQUILIBRIUM

AND
DEVELOPMENT
 Schumpeter and Walras
• Great admirer of Walras’ work.

• But was hindered by it.

• Eventually reinterpreted it and used it for his

own scientific work.

• Reinterpreted Walras’ general equilibrium as a

stationary equilibrium model.
 Schumpeter reinterprets Walras
• Walras’ general equilibrium, a circular flow of exchanges
among economic agents.

• The circular flow takes place when choices and behaviour

of each economic agent is compatible with the other.

• So realising equilibrium conditions means the core of the

economic system being unaltered and so reproducing
itself.

• But despite its logical coherence Walras’ model is

incapable of addressing some important economic
phenomenon like growth, technical progress or profit.
 Schumpeter’s Entrepreneur
• Different from the traditional.

• Is an innovative entrepreneur: introduces new

combinations of productive factors into the
productive process and enjoys temporary
monopoly profit.

• Income emerges from a break in the stationary

equilibrium involving the traditional economic
agent.
 Innovation to Imitation
• Diffusion of innovation dilutes competition.

• Innovator entrepreneur leads to the emergence

of imitator entrepreneurs.

• Elimination of innovation entrepreneur’s

differential earning.

• Economy approaches equilibrium.

 Innovation: Social Impact
• Reduction in prices
And / or
• Increase in the range of products available.

• Since innovative process is continuous, no

single entrepreneur can earn a permanent
income from a single entrepreneurial act, but
the class of entrepreneurs as a whole
continually makes profits.
Schumpeter: The Anti – Neo Classical
• Did not accept the traditional neo – classical
theory of atomistic and static competition.

• Markets are not made up of large number of

competitors earning short run profits based
on prices under given technology.
Schumpeter: The Anti – Neo Classical
(contd)
• Competition actually occurs in markets of few
large firms each choosing output under
immediate technology constraints but based on
a dynamic and innovative long term strategy.

• Ultimately competition occurs by breaking

rather than accepting technology constraints i.e.
a process of creative destruction (destroying the
old while creating the new).
 On Capitalism
• Schumpeter’s theory about the innovative
entrepreneur and the phenomenon of
creative destruction occur within the
capitalism system.

• Closer to classical economists and Marx

because he tried to study the phases of
development and structural transformation
of capitalism.
 On Evolution of Capitalism
• Evolved in two phases: (a) Competitive
Capitalism and (b) Trustified Capitalism.
Competitive Capitalism
a) Large number of small firms perform
entrepreneurial function.
b) Innovation through creation of new firms.
c) Competition operates through the
bankruptcies of obsolete and inefficient
firms.
On Evolution of Capitalism (contd)
Trustified Capitalism
a) Existence of large firms.

b) Technical progress planned by the firms.

c) Growth by increasing company size rather

than number of companies.
Trustified Capitalism & Entrepreneur
• Who carries out the entrepreneurial function
in Trustified capitalism?

• Separation of entrepreneur and innovator

due to innovation emerging from R & D
department of big companies.
 Trustified Capitalism & Entrepreneur
(contd)
• Innovation more a issue with employees and
managers rather than the entrepreneur.

• So the original and traditional entrepreneurial

class disappear along with their ethical as well
as political values but other social classes
emerge which justify state intervention both in
production and distribution.

• Individualistic accumulation weakens to allow a

social drive for creating economic organisation
based on central planning.
The Trade Cycle
And
Money
 Economic Growth
• Takes place through cyclical fluctuations i.e.
in a regular evolutionary form.

• Triggered by innovations that takes place in

clusters.

• The innovations induce increase in aggregate

investment expenditure and consequent
production in all industries.
 Economic Growth (contd)
• Leads to increase in prices and profits.

• But this is only a temporary gain for as diffusion

of innovation takes place, prices adjust to costs,
monopoly profits are eliminated and the
economy faces a new equilibrium.

• So an economy is not staying in equilibrium but

rather proceeding through an (cyclical)
equilibrium path continuum.
Uneven distribution of Innovation
Random Inventions
• Debate: How is there uneven crowding of innovations
amidst random inventions.

• According to Schumpeter innovations or continued

improvement over a random invention, takes place
only with weakening or even breakdown of social and
psychological resistance to change.

• So potential for unexploited innovations builds up

and bursts out when the resistance to them softens
up.
 On Periodicity of Trade Cycle
• Depends on nature of capital goods constituting
innovation.

• Not clear if it is also the diffusion time

innovation.

• Used his wide and deep historical knowledge to

classify cycles into three types based on time:
(a) Kitchin Cycles (40 months); (b) Juglar Cycles
(10 years); and (c) Kondratief Cycles (50 – 60
years).
 Trade Cycles’ Monetary Dynamics
Innovation Profits Finance (Funds)

Credit Necessary

Banks
 Functions of Banks
1. Redistributes savings from savers to users.

2. Creates new purchasing power by creating

credit money.

3. Adds to stock of liquidity.

4. Additional liquidity allows funding of

innovations – (a premonition of venture capital
and venture capitalists).
 Banks

Credit

Forced Savings

Entrepreneur’s acquire non – produced tangible assets

Less
To
Consum
Resource Transfer More
Product
ption
ive
To
Investm
Investm
ent
ent
 Critique of Neo – Classical Notion of
Interest
• Since investment, profits and innovation go
hand in hand, innovative investments determine
the selling price of credit i.e. rate of interest.

• Implies rate of interest not determined as an

equilibrium between sacrifice of saving and the
benefit of its productive use, as it is propounded
by neo classical theories.

• Hence Schumpeter was skeptical of the neo

classical theories of interest.