John Hicks Fixprice Distinction

John Hicks, Market Structures: Flexprice/Fixprice Distinction

In Capital and Growth (1965) Hicks notes that the fundamental weakness of the temporary equilibrium method was the assump­tion that prices change rapidly enough to ensure an equilibrium between planned demands and planned supplies even in the short run. When Hicks came to abandon this equilibrium assumption he assumed instead that prices are determined exogenously. To distinguish the two methods Hicks adopted the flexprice/fixprice terminology. The former refers to the price flexibility found in competitive market structures while the latter refers to the 'sticky' prices which are more common in less competitive markets-these prices are not completely rigid but they do not necessarily change in response to a disequilibrium between demand and supply.

These two methods of price determination are obviously extremes and in his History book (1969) Hicks attempted to trace out the development of different types of market structures to indicate the conditions under which one or other tended to dominate. A crucial factor in this development has been the role of the merchant. Markets developed from barter to monetary forms of exchange largely because a merchant of some sort was prepared to act as a stockholder i.e. was prepared to buy goods in order to sell them later at a profit. In this role the merchant performed the function of price-maker and determined prices in relation to stocks - raising prices when stocks were (abnormally) low and vice versa. The margin between his buying and selling price was a reflection of the service he rendered to consumers by reducing their transaction costs. The size of this margin depended on the degree of competition. Thus the most competitive markets tended to be highly organised markets in which transaction costs were further reduced by the establishment of strict trading rules -like the stock exchange. In these markets margins could be so low that all transactors appeared to be price-takers. It was this type of highly organised market that formed the basis of Walras's model. However it was the (slightly) less competitive, unorganised markets (in which merchants were active) that Marshall used in his model.

Since the unorganised, flexprice markets were the dominant form historically, Marshall's method was closer to reality. However, these flexprice markets have been increasingly replaced this century by fixprice markets. This development has been caused largely by technological factors - basically economies of scale and product standardisation. These factors have tended to diminish the role of merchants and enhance the power of producers to fix price.

For Hicks the distinction between flexprice and fixprice markets is vitally important specifically because they have different implications for stocks and flows (1956b, 1979c). This can be more easily appreciated by analysing Keynes's model of the General Theory. According to Hicks, Keynes was aware of the change that had taken place in market structures since Marshall's time and therefore realised the importance of the fixprice method. Consequently Keynes characterised some markets as flexprice (e.g. the bond market) while others are taken to be fixprice markets (e.g. labour and goods). In addition, in the (flexprice) bond market, the price of bonds is determined almost entirely in terms of stock relations (liquidity preference) while in the (fixprice) labour and goods markets the quantities of these items are determined almost entirely in terms of flow analysis (the multiplier process). Thus in the fixprice markets a disequilibrium between demand and supply generates quantity adjustments. In this way the flexprice/fixprice distinction enables Hicks to illuminate one of the central features of the General Theory model, i.e. the multiplier process, which is shown to depend on quantity adjustments in fixprice markets.

More recently Hicks has used these insights into the fundamen­tals of Keynes's multiplier theory to indicate that theory's shortcomings. Specifically Keynes had concentrated his analysis of fixprice markets entirely on the flow relations and, whereas in the 1930s the vast stocks of idle resources made this concentration legitimate, it certainly cannot be so regarded in the postwar period. Therefore in his Crisis in Keynesian Economics Hicks attempts to make good this defect by highlighting the crucial role played by stocks in sustaining the multiplier process and thereby enabling increases in expenditure to be translated into increases in output. Basically an expenditure-induced expansion requires a relatively high level of stocks in fixprice markets because the initial expansionary impact reduces existing stocks and only eventually raises output. 'But there cannot be a fall in stocks unless there are stocks to fall. Thus it is impossible to tell the multiplier story properly in terms of the flow relations between income and saving to which Keynes (in the main) confined himself. The state of stocks . . . must be considered too' (1974). However, he further notes decisions regarding stocks depend crucially on producers' expectations.

By analysing the problems of stocks and of expectations in the multiplier process Hicks offers some illuminating insights into the present debate about the effectiveness of fiscal policy and the 'crowding-out' debate because ultimately this is what the multip­lier theory is all about. (On this point see Coddington, 1979).

This discussion affords a useful introduction to our next topic -liquidity. As Hicks points out, this concept ought also to have been analysed in terms of stocks and flows but Keynes's analysis concentrated narrowly on the stock side of the question. Thus a broader and more meaningful theory of liquidity is feasible if proper account is taken of stock-flow interactions.