Thinking back on world history 70 years ago, no one can ignore World War II. The impact of such a global conflict in economies was huge, and, therefore, it was without surprise, studied at the light of most macroeconomic theories. World Wars always introduced innovations in many fields: military features, more efficient production processes and distribution chains, scientific knowledge, etc. It would be an enormous exception if they introduce nothing new in microeconomics.
In fact the different dimensions of the war may provide answers for some unanswered or not clear microeconomic aspects. Economists tend to like extreme cases in order to understand how agents behave under certain conditions. I have been hearing for years about Mr. Friday who one day arrives at an island and starts trading with Mr. Crusoe, basing the market upon commodities fallen from the sky. But that’s not real!
Indeed WW II may provide real and suitable support of these theories. In 1945 Radford, a prisoner of war wrote about the economy inside a Prisoner of War Camp (POW Camp) – http://www.jstor.org/stable/2550133. Every prisoner inside that closed economy was given a certain similar quantity of food and other commodities in a regular basis by Red Cross or German troops. Furthermore, unlike concentration camps, in POW camps there was no production, so endowments and wealth were completely exogenous. In addition prisoners receive a small range of products: tinned milk, jam, butter, biscuits, sugar, etc. These conditions are the assumptions for the basic analysis of a pure exchange economy, which is crucial to understand convergence until de competitive equilibrium.
In this real case, prisoners were initially endowed with the same quantities. However they realized there would be gains from trade since preferences were not equal. As Radford denotes “the essential interest lies in the universality and the spontaneity of this economic life; it came into existence not by conscious imitation but as a response to the immediate needs and circumstances”.
The interest of this case for microeconomic theory concerns both the formation of a market from scratch and the economy reaching the equilibrium. General equilibrium analysis in POW Camps constitutes an important benchmark in this matter.
Radford describes that the starting point was the direct barter in which non-smokers gave smoker friends their cigarettes in exchange for a chocolate piece. Rapidly people realized it would be undesirable to consume exactly the amount of goods that they were given. More complex changes became accepted customs. “Cheese for seven”, for instances, was a commonly heard statement of prisoners advertising their cheese endowment for seven cigarettes.
In addition they did not only create a market but also the concept of relative price in their transactions, once again one characteristic of general equilibrium analysis. This relative price of goods measured in terms of cigarettes arose due to the divisibility of this commodity and its general acceptance. This description of how the economy achieves the competitive equilibrium is much more close to the reality than the idea of Walras’ Auctioneer, which was until now the usual response to the question. According to Walras, prices are settled in a way that an auctioneer announces a price, then supply and demand sides announce their net trade and the relative price equilibrium is reached when both sides have equal net trades.
Every basic and fundamental tool on the basis of microeconomics can be visibly applied to this context: relative prices depending on the preferences, the basic law of supply and demand, the impact of uncertainty and expectations on prices (imagine the uncertainty associated with that time of war) and even intertemporal choices. Moreover as the time went on, prisoners started to use their labor providing services and making several small productive operations, which turned the economy inside POW Camps much more complex. Production side arose, but economy remained in equilibrium, as expected. Walras’ Law always held.
This article is a simple discussion on the fundamental microeconomic foundations, more specifically in what concerns the observation of an environment where general equilibrium appears from the scratch. World War II was an extreme and horrible case but it was real and, therefore the mechanisms through which economy reaches the equilibrium may be understood from the observation of the small social environments that it created. Everyone knows that World Wars are completely pernicious, so what should we do? Firstly we should take from them everything that we can learn in all sciences: microeconomics is not an exception; Secondly we should learn how to not repeat them.
# 86 Diogo Mendes