W. E.

DIE WERT

WALRAS' THEORY OF CAPITAL FORMATION AND

THE EXISTENCE OF A TEMPORARY EQUILIBRIUM*

If nineteenth century France, which was the cradle of the

new science [of economics], has completely ignored it, the
fault lies in the idea, so bourgeois in its narrowness, of
dividing education into two separate compartments:
One turning out calculators with no knowledge whatso-
ever of sociology, philosophy, history or economics; and
the other cultivating men of letters devoid of any notion
of mathematics. The twentieth century, which is not far
off, will feel the need, even in France, of entrusting the
social sciences to men of general culture who are accust-
omed to thinking both inductively aDd deductively and
who are familiar with reason as well as experience. Then
mathematical economics will rank with the mathematical
sciences of astronomy and mechanics; and on that day
justice will be done to our work.
LEON WALRAS, 1900

1. INTRODUCTION

In an earlier paper [13], the present author developed an econometric

model of Canadian manpower markets which was based on neoclassical
producer and consumer theory. In this model, many variables (such as
industry outputs, nonlabour income, the price of capital services, etc.)
were taken to be exogenous when in fact they should be endogenously
determined within the model. (In fact in the neoclassical framework, the
only exogenous variables are tastes, technological knowledge, the initial
distribution of resources and perhaps various demographic variables.)
Thus the main task of this paper will be to develop a framework for an
econometrically implementable model of producer and consumer behav-
ior which has only tastes, technology, distribution of resources and popul-
ation as exogenous variables.
A possible framework for our model might be the "pure futures
economy" (Hicks [24; p.140]) where there are well developed futures
markets for all goods and services which may be bought and sold during
the current period but are delivered during some future period of time.

G. SchwOdiauer (ed.), Equilibrium and Disequilibrium in Economic Theory, 73-126.

All Rights Reserved. Copyright © 1977 by D. Reidel Publishing Company, Dordrecht, Holland.
74 W.E. DIE WERT

This model has been extensively developed by Debreu [12; ch. 5]. How-
ever, since futures markets do not exist in our economy (except for a few
agricultural products and metals), we can only concur with Hicks [24;
140], Saito [39; 233] and Malinvaud [29; 217-218], that such a pure
futures economy can have no claims to be a good approximation to
reality.
If the pure futures economy model is unsuitable, why not use a 'pure
spot economy' model where each producer and consumer has a time
horizon of only one period and all trading is in currently produced goods
and services? The problem with this latter model is that there is no role
for saving or capital accumulation.
Thus we are led to follow Hicks' example [24; pp. 126-127] and we
assume that no futures markets exist but that producers and consumers
form definite expectations about what spot prices will be in future periods.
These expected prices plus the current spot prices are then used by
individuals in order to form expenditure plans. A temporary equilibrium
is roughly speaking a situation where demand equals supply for each
good which is currently being produced or demanded and the aggregate
demand to hold assets for purposes of consumption in future periods
equals the existing supply of assets. Again roughly speaking, current
prices and wages are thought of as equating the demand and supply for
currently produced goods and services and the interest rate is thought of
as equating the demand to hold assets to the existing supply. The equilib-
rium prices and interest rate last only for one period and the prices which
are expected to prevail next period need not turn out to be the equilibrium
prices for the next period's temporary equilibrium. Thus incorrect ex-
pectations of prices can lead to an inefficient intertemporal allocation of
resources; i.e., 'booms and busts' are perfectly consistent with this tempor-
ary equilibrium model.
The temporary equilibrium model has been developed by Hicks [24],
[25; ch. VI], Morishima [31; pp. 83-92], [32; ch. VIII, IX], and Arrow [3].
For a survey of recent developments of the model, see Radner [39;
Section 2] and the references to the work of Grandmont, Green, Radner,
Sondermann and Younes. However, Walras [43; Part V] seem to have
been the first to work out a relatively complete model of the temporary
equilibrium in his model of capital formation and credit. In fact, in some
ways, Walras' model goes beyond that of Hicks since Walras carefully