Ludwig Lachmann’s journal article examines what determines the responsiveness of expected prices to actual price changes. Its three sections move from a criticism of existing explanations, through an analysis of expectations as a range of possible outcomes, to a positive account of expectation formation as interpretation. Lachmann accepts the usefulness of Hicks’s elasticity of expectations as a classificatory measure and engages closely with Lange’s analysis of price flexibility and employment. His central objection is that measuring a relationship does not explain it: an explanation must reconstruct how people understand observed changes in relation to their previous judgments about economic forces.
As the most elaborate thermometer can tell us nothing about the causes of the fever from which the patient is suffering, so the elasticity of expectations, being a measure, can tell us nothing about what causes the magnitude of our object of measurement.
The thermometer analogy establishes the distinction governing the article. An analytical instrument may register differences without identifying their causes. Hicks’s appeal to individuals’ psychological “sensitivity” does not, for Lachmann, resolve this difficulty. Treating sensitivity as a stable disposition would imply that the same person responds identically to equal price changes at different times. What matters instead is the situation in which the change occurs and the significance attributed to it.
Section I locates the missing explanatory element in a familiar feature of expectations: people ordinarily envisage several possible future prices, with differing degrees of probability, rather than one certain outcome. Lange’s “practical range” excludes possibilities considered too improbable to affect decisions. Lachmann objects to the subsequent compression of this range into a certainty-equivalent. Such compression makes actual and expected prices easier to compare, but removes information necessary to explain reactions.
By contrast, we shall try to show that by substituting single-value expectations for the uncertainty range of expected prices we stand to lose more than we gain, because reaction to price change will largely depend on the location of the prices affected within the scale of expected prices.
Section II develops this claim through a range of expected prices extending from $80 to $150, with an initial market price of $109. Movements through the middle of the range need not alter expectations: they remain consistent with what people already regarded as possible. Near either boundary, however, expectations tend to become inelastic. People anticipate that an upward or downward movement cannot continue much further and expect a reversal. Once the price crosses a boundary, the situation changes again. Outcomes previously dismissed as practically negligible have become actual, forcing reconsideration of the basis of prediction; during this adjustment, expectations are likely to become elastic.
The width of the range therefore has a double significance. A narrow range brings stabilising expectations into play sooner, but, if the movement continues, also brings forward the moment at which existing expectations break down. Lachmann does not identify narrow expectations with unconditional stability. His argument describes different reactions at different positions within—and eventually outside—the same range.
Within limits the economic system has a good deal more stability than appears.
This qualified conclusion follows from the tendency of continued price movements to encounter resistance near the boundaries. Expected reversal encourages selling near the upper limit and purchasing near the lower one. Lachmann retains Lange’s qualification concerning the monetary effect rather than presenting stabilisation as an unrestricted law. A movement strong enough to overcome these pressures will probably depend on an unexpected force originating outside the market. An unanticipated change in the monetary system’s responsiveness is his example. “Explosive” change matters both through its violence and through its destruction of the prevailing distinction between probable and highly improbable outcomes.
Lachmann then considers the objection that his reasoning assumes an expectation range that does not shift with actual prices. He replies that movement within an already anticipated range supplies no evident reason for shifting it. More fundamentally, requiring every actual price change to produce a proportionate expected change imposes a mechanical relationship where the explanatory problem concerns meaning. A familiar fluctuation and a complete surprise cannot sensibly be treated as equivalent merely because their numerical magnitudes coincide.
Section III supplies the positive alternative: expectations arise from diagnoses of situations, not from automatic reactions to price observations.
The formation of expectations is always incidental to the diagnosis of the situation in which we find ourselves; no prognosis without diagnosis.
A forecast embodies an assessment of the forces expected to operate between the present and a future date, including obstacles to their operation. The subjectivity of expectations consequently reflects divergent judgments about the identity and strength of those forces. When an expected event fails to occur, people reconsider their diagnosis: they may have misjudged a force or overlooked one altogether. The uncertainty range expresses how complete they believe their relevant knowledge to be, while its widening indicates greater uncertainty about that completeness.
Price movements thus test the diagnosis underlying a forecast. Movements within the range confirm its adequacy without necessarily supplying relevant new information; a movement beyond its limits exposes inadequacy and requires a new diagnosis. The article’s lasting conceptual contribution is to make the elasticity of expectations conditional on this interpretive distinction. Lachmann preserves the measure’s usefulness only insofar as it remains connected to a meaningful account of human action. Detached from interpretation, it substitutes a reaction equation for an explanation of why expectations persist or change.
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