The key issues in any consideration of the operation of the market mechanism can be revealed by the answers given to two questions. The first question is whether the determination of relative prices in a market economy involves determination of the size and composition of output and, in particular, whether the level of output is such that labor is fully employed (in the sense that, at the going wage, all workers willing to offer labor would be able to find employment). The second question is whether variations in relative prices are associated with variations in output, such that the economy tends toward a level of output compatible with the full employment of labor. Each of these questions can be supplemented with a further question: if not, why not?
The significance of these questions can be illustrated in terms of the most elementary piece of orthodox neoclassical analysis. This analysis involves the argument that the price of a commodity is determined by the relationship between demand and supply. According to this account, equilibrium, determined at the intersection of a function relating price to quantity demanded and another function relating price to quantity supplied, is defined as “market clearing,” When this view of price determination is extended to the economic system as a whole, the equilibrium position of the economy is characterized by a set of market-clearing prices, with associated quantities (levels of commodity output and levels of factor utilization) such that the markets for all commodities and all factors of production clear. In particular, the labor market clears at the