New Releases. Kirzner series, Market Theory and the Price System was published in as Kirzner's first and only textbook. This volume presents an integrated view of Austrian price theory. The basic aim of Market Theory is to utilize the tools of economic reasoning to explain the market process.
The unique framework Kirzner develops for microeconomic analysis, following Mises and Hayek, examines errors in decision-making, entrepreneurial profit, and competition as a process of discovery and learning. Please note: This title is available as an ebook for purchase on Amazon, Barnes and Noble, and iTunes. Product details Format Hardback pages Dimensions x x Other books in this series. Add to basket. Economic Point of View: v. It is with deep pleasure that the author dedicated this volume to him upon the attainment of his eightieth year. The author is grateful to his colleagues at New York University, as well as to his students, for stimulating discussions on a number of points.
To Professor L. Lachmann of the University of Witwatersrand, South Africa, he is indebted for several valuable insights that were made use of in exposition. To all these he is grateful; none of them is to be held responsible for all that remains unsatisfactory. This book is devoted to the study of the theory of the market system.
In this first chapter we attempt to obtain a clear notion of what is meant by a market; what is meant by a market system; and how economic theory can throw light on the nature of market processes. Our discussion will clarify the relationship between market theory and other branches of economics.
Moreover, it will indicate the importance of the economic theory of the market for an adequate understanding of the world we live in. Society consists of individual human beings. Each human being is eager to act to improve his position, whenever this appears possible. In order to satisfy his desires, a man may act on his own as, for example, when he paints his house by himself , or he may fulfill his ends indirectly through exchange as when he pays another man to do the painting.
Where an exchange transaction takes place freely, the two individuals involved have both acted to fulfill separately their respective goals. In a predominantly free society, individuals are in most respects at liberty to act as they choose. That is, in such a society an individual is generally at liberty to take advantage of any opportunity as he perceives the existence of such an opportunity in order to improve his position as he understands the idea of improving his position.
He is free to act in isolation, and he is free to engage in acts of exchange with other individuals whenever he and some other individuals both perceive the opportunity of mutual benefit through trade. As we shall find, such opportunities for mutually advantageous exchange arise constantly in society. Moreover, the exploitation by individuals of these opportunities opens up yet further opportunities of the same kind, both to the individuals themselves and to others in the society. A market exists whenever the individual members of a society are in sufficiently close contact to one another to be aware of numerous such opportunities for exchange and, in addition, are free to take advantage of them.
A market economy exists wherever the ramifications of the market become so widespread and the opportunities it offers so numerous and attractive that most individuals find it advantageous to carry on their economic activities predominantly through the market rather than on their own. The market economy is thus to be distinguished, on the one hand, from the autarkic economy, where individuals carry on their economic activity isolated from one another, being unaware or unwilling to take advantage of opportunities for exchange.
On the other hand, it is to be distinguished from the centrally controlled economy where economic activity of individuals is directed by a central authority so that, although transfers of goods among individuals may be ordered by the central authority, individuals are not free to take advantage of exchange opportunities which they themselves may perceive. It is unlikely that any one of these three types of economies will exist historically in its theoretically purest form. To some extent, limited market activity is likely to arise even in the most primitive and autarkic of societies, whereas even the most rigid of centrally controlled economies leaves room, legally or illegally, for some market-type activity between individuals.
Finally, even the most fully developed market economy is incapable of making it advantageous for individuals to seek the satisfaction of all their wants exclusively through the market. Most men, for example, turn to the market for a haircut but not for a shave. In the developed market economy, the conditions of production have become adjusted to the market requirements. Over a period of time, individuals acting through the market have succeeded in setting up an organization of production and exchange which, in turn, has widened the market until it has embraced the bulk of all economic activity in the society.
In such a system, as in any system where the individual is relatively free to act as he pleases, men seek to improve their positions with the means at their disposal. But, whereas the isolated individual can improve his position only by adjusting himself to, and manipulating, the conditions imposed by nature, in the market economy the individual acts to take advantage also of the conditions and opportunities made available by the market. The salient fact that emerges from this discussion is that any description of market activity means the description of individual activity, but also that the activity of each participating individual in the market is conditioned by the actions of other participating individuals either in the past or as anticipated in the future.
It is this insight, we will discover, that is the basis for the economic analysis of the market system and of the processes that take place in the market. To the casual observer, market activity seems to be a bewildering and uncoordinated mass of transactions. Each individual in the market society Edition: current; Page: [ 3 ] is free to buy what and when he pleases, to sell what and when he pleases, to produce or to consume what he pleases, or to refrain altogether from any or all of these activities. Transactions may involve any of innumerable commodities or services, they may involve any of a wide range of quantities and qualities, and they may be concluded at any of a wide variety of prices.
Economic analysis reveals that this seeming chaos in the activity of market participants is only apparent. In fact, analysis shows that the exchanges that take place are subject to definite forces at work in the market. These market forces guide the individuals participating in the market in their decisions. Each market decision is made under the stress of market forces set up by the decisions, past or expected, of all the market participants.
During any given period, therefore, the decisions made by individual market participants constitute an interlocking system embracing the entire scope of the market. This network of decisions constitutes the market system. The end results of all these decisions make up the achievements of the market system; and the tasks which society may seek to fulfill by permitting a market economy are the assigned functions of the market system. The importance of the market system and of its analysis is not simply the discovery that decisions are made under constraints set up by other decisions.
Market system analysis, we will discover, reveals a remarkable feature in the operation of these constraints, and it is chiefly this feature that invests market theory with its importance. The real significance of the market system lies in the fact that the mutual interplay of these constraints makes up a unique process through which the decisions of different individuals who may be quite unknown to one another tend to be brought progressively into greater consistency with each other.
Consistency and correspondence between the decisions made by different market participants are of the first importance in any successful execution by the market of its functions. If all potential members of the labor force decided to train themselves as skilled watchmakers, a catastrophic aberration of individual decisions would exist. After all, a decision to become a watchmaker depends on the confident assumption that some other people will be barbers, tailors, etc.
The free interplay of individual decisions in the marketplace constantly generates new forces modifying and shaping the delicate, sensitive, and interlocking decision network that makes up the system. It is the task of market theory to trace the consequences of these market forces, paying Edition: current; Page: [ 4 ] particular attention to the degree in which they constrain independently made decisions into mutually corresponding and concordant systems. The construction by economists of the body of propositions that make up market theory is founded upon their consciousness of the existence and the nature of economic law.
Acts of individuals in the market are perceived as taken in consequence of definite acts, prior or anticipated, of other individuals.
Market Theory and the Price System by Israel M. Kirzner
What goes on in the market at any one time is to be ascribed to what has gone on in the past, or to past anticipations as to what will go on in the future. While the essential concept of a law of economics is thus quite parallel to that of a law of physical nature, the two kinds of law have little further in common. Laws of physical nature are inferred from the observation of sequences of physical events.
Economic laws, as we shall see, are founded on our understanding of the influence that a given event will have upon the actions of individuals. To be sure, the laws of physical nature are also operative in the spheres of human activities. A heater raises room temperature, and ice lowers the temperature in the ice box; human beings are more comfortable at some temperatures than at others, and food keeps better at some temperatures than at others.
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These elements, in the absence of an economic theory, would have to be considered as undetermined by any causal forces. The recognition of economic law means the perception of determinate causal chains constraining the course of events insofar as these are left undetermined by physical, physiological, or psychological laws. Consider, for example, the consequences upon the price of ice of a sudden sharp reduction in the quantity available for sale. The most complete application of the physical sciences while it might throw a Edition: current; Page: [ 5 ] great deal of light on why such a reduction in the supply has occurred, or upon the possible alternative ways consumers might be able to do without ice can in itself tell us nothing about why subsequent ice purchases are carried out at higher prices.
Our explanation of the higher prices being the consequence of the reduced supply thus invokes the concept of economic laws, which we understand as explaining the result of the particular change that has occurred when other aspects of the situation have remained unchanged. The nature and existence of economic law, and its manifestation in the interplay of market forces, must now be briefly traced back to the actions of the individual human being. The possibility of perceiving chains of cause and effect uniquely economic is due to the presence in human action of categories that have no parallel in the realm of physical laws.
And because the mind of the individual investigating causation in economic affairs is capable of directly understanding these categories since, as we shall see, they are self-evident to the human mind , he is capable of directly grasping the existence of economic laws.
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The human mind is immediately conscious of the fundamental and all-pervasive category embedded in the web of all conscious human action. This category is purpose. Actions are undertaken for specific purposes. We are aware of the purposive character of our own actions, and we understand that the conscious actions of other human beings also are purposive.
However much we may either despise or fail to understand the particular purposes behind the actions of our fellows, we do not doubt that their actions aim at securing for themselves some situation that they prefer over what they expect to prevail in the absence of their actions. Moreover, because we assume all action to be purposive, and because we live in a world which offers at each instant the possibility of many different kinds of action, we are immediately aware, too, that every human action must be the embodiment of a choice among alternatives. At each instant man must choose between the courses of action including inaction that are open to him.
Any such adopted course, we understand, has been adopted as preferable to the rejected courses of action. Thus, human action involves the categories of purpose, of alternatives, of choice among these alternatives, of the preferred that is, the adopted alternative, and of the rejected alternatives. These categories Edition: current; Page: [ 6 ] suffuse all transactions of men, both in isolation and in the market. They are the categories upon which economic theory depends for its very existence.
Economic theory approaches complex social and market phenomena by searching for the individual actions from which these phenomena arise. Any such individual action is understood as having involved the adoption of one alternative and the rejection of others. The adopted alternative is understood as having been compared with, and preferred over, the other alternatives; that is, it was considered as being either the means to the attainment of the most cherished possible purpose or the most efficient of the available means to the attainment of a specific purpose.
Economic theory understands that each action inevitably involved a cost. The adopted alternative has been adopted at the expense of the rejected alternatives. The rejected alternatives, which in themselves may have been highly desirable, have been renounced for the sake of the adopted alternative.
Changes in the patterns of human action are traced in this way either to changes in the terms on which alternatives are available relative to each other, or to changes in the framework of purposes within which the worthwhileness of the relevant costs are valued. Market phenomena lend themselves readily to analysis in this way as soon as it is realized that the terms on which alternatives are offered to an individual are, in a market economy, determined in large part by the actions of other individuals rather than merely by natural events.
It becomes illuminatingly possible to view every transaction in the market as, on the one hand, a consequence of the particular complex of alternatives presented to the individual by the market before the action was undertaken, and, on the other hand, as in some way affecting the complex of alternatives that will be subsequently faced by the individual market participants. Even the most intricately entangled web of market phenomena can be reduced to the elementary actions that they consist of.
To revert to an example mentioned several pages previously, a sharp decrease in the quantity of ice supplied to the market can easily be linked, by this kind of reasoning, to a subsequent price rise. As ice purchasers find the availability of ice sharply reduced other things being unchanged , they find it necessary to restrict the obtainable limited quantities of ice to only the most important of the uses to which the previously larger quantity of ice had been put.
Thus, any additional ice block that they contemplate to purchase after the decrease in supply involves the potential fulfillment of a purpose held more important than the purpose whose fulfillment, before the decrease in supply, depended on the purchase of an additional ice block. It follows that some of the alternatives that, before the decrease in supply, were more important than an additional ice block may now be less important than an additional ice block. Further examination of the machinery of a competitive market would then readily explain the subsequent higher market prices for ice.
The simple causal chain shown thus to link a decrease in supply with a subsequent price rise has been adduced merely as an illustration of the concatenation of decisions that make up any period of market history, and of the kind of reasoning that can reveal the operation of economic law in this way. The theory of the market that we study in this book applies this kind of reasoning to the isolation of the principal types of causal chains that express themselves through market forces and that make up the skeleton of the market system of economic organization.
Our ice block illustration, at the same time, is able to clarify the relationship between the world of economic theory and the world of economic reality. This relationship must be kept firmly in mind throughout what might otherwise appear as the unrealistic or abstract chapters that make up the bulk of this book. Our theory of ice prices, it will be observed, did not depend upon the particular physical properties of ice.
In fact, everything which we were able to conclude concerning the price of ice can be asserted with equal validity concerning economic goods in general. Thus, abstractness and generality are the twin aspects of economic theory that emerge from our illustration.
Economic theory is abstract, in the sense that the reasoning does not depend on the numerous particular properties of the data we are theorizing about. Economic reasoning throws light, for example, on situations that human beings associate with specific sensations. The demand for food has to do with feelings of hunger or of satiety; the demand for reading material has to do with the thrills of exploration, suspense, or learning; the supply of labor has to do with feelings of weariness and fatigue.
It is emphasized that economic theory does not refer to these specific sensations. Economic theory abstracts the element of preference —bare and colorless—that emerges in each of these situations. In geometry a proposition may throw light on properties of rectangular objects, including restaurant tables, milk cartons, and billboards. Geometry, however, has nothing essentially to do with eating in restaurants, drinking milk, or advertising.
Economic theory is in similar case: it abstracts from actual situations those elements to which it is relevant. Economic theory is, as a consequence, general, in that its conclusions have validity for sets of data that may be widely different from each other in every particular aspect other than the economic. To relieve the abstractness of the reasoning, numerous concrete examples are given of situations that may be quite general; these examples will serve only as illustrations of general propositions. Since our theory of ice prices did not depend on any particular physical properties of ice, nor upon any particular psychological attitudes toward ice except that it be considered an economic good , our theory required no laboratory experiments upon ice nor any psychological observations of behavior.
Our theory depended only on the logic of choice; that is, it required only that we understand what human beings will do when they find that the Edition: current; Page: [ 9 ] use that can be made today of a block of ice is more important than the use that could have been made of it yesterday. We are able to develop propositions of this kind because we are acting human beings. We know, without empirical observations, how a change in the attractiveness of the terms on which a human being is free to choose will tend to affect the choice of any being whose behavior is guided by reason similar to our own.
Economic theory is founded on this kind of knowledge that we possess. We can analyze the effects of changes upon human action, in the abstract, because we are immediately aware of the logic that governs all human action. The logic that governs human action is the same logic that the economic theorist applies in analyzing this action.
If molecules had preferences and acted purposefully to achieve them, then the physicist would have a source of knowledge concerning the behavior of physical matter quite independent of any empirical findings that he might make. This source would be his own immediate understanding of how purposeful beings tend to behave under changing patterns of alternatives. The economic theorist finds himself in precisely such a favored position. Now, the logical validity of a proposition of economic theory does not mean that the real world presents any instances of the truth of the proposition.
In mathematics, for example, it does not follow from the geometrical proposition that states that the base angles of an isosceles triangle are equal, that we will ever be able to find such a triangle. All that a proposition can assert is that, if given changes occurred under given conditions, then certain consequences would follow. It is clear, then, that if the economic theorist is to be of any assistance in understanding the real world, he must develop theorems concerning situations that do occur.
The economist who analyzes concrete economic problems applies propositions of far-reaching generality to particular situations in which he recognizes the dominance of conditions similar to those governing the relevant propositions. The application of economic theory in this way certainly cannot be done without careful, accurate, and complete factual and statistical descriptions of the real world situations in which it is proposed to detect the operation of the economic laws that are expounded by theory. The theorist makes assumptions and uses his reasoning to develop the consequences implied in his assumptions.
He may take his assumptions from wherever he pleases, including the real world. Economic theory refers to the reasoning out of consequences from assumptions, not to the task of selecting assumptions.
Economic theory emerges then as a tool that can be used in understanding the external world. A proposition of economic theory is, to repeat, very much like a theorem in geometry: we prove its truth, and then we may be able to discover in the real world a situation that illustrates its truth. These pronouncements on the chains of causation, which he claims to have detected in the real market, may certainly be properly judged for their realism. If a decrease in the supply of one good was found to have been followed by a rise in the price of a second good, the economist, applying theory, may perhaps explain the chain of events by saying that the second good is a close substitute of the first.
The theory on which he bases his explanation is unquestionably true: the restriction of the supply of one good, other things being unchanged, leads to a rise in the price of substitutes. In carrying out his task of explaining what has happened in the real world, or in predicting the likely consequences in the real world of a particular event, the economist thus combines theory with empirical fact.
For these purposes it is frequently quite unnecessary to analyze his final report into its theoretical component on the one hand, and its factual component on the other hand.
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The skillful economic commentator will combine keen observation of events with statements revealing the theoretical interdependency of these events. A particular case of local unemployment may be linked to a shift in consumer tastes or to the emergence Edition: current; Page: [ 11 ] of new, cheaper resource markets elsewhere; an outflow of gold may be linked to particular governmental monetary policies; a particular pattern of industrial organization may be traced back to the tax structure, and so on. It would not be necessary, nor even helpful, in these cases, to separate economic theory from economic fact.
In studying a book such as this one, however, it is imperative that the distinction between theory and fact be kept clear. This book deals essentially with theory. It presents the kinds of logical procedures that must be used to understand the operation of a market economy. It presents the basic tools that the trained economist will use repeatedly in interpreting events in the real world. If these tools are to be used with success, they must first of all be forged as ends in their own right. Economic theory must first be recognized for what it is in and of itself: a body of abstract propositions deduced from hypothetical assumptions.
We are now in a position to state how the subject matter of this book relates to economic theory as a whole and, even more generally, to the entire discipline of economics. The theory that we study in this book makes up the core of economic theory, but by no means exhausts it.
We investigate here the structure and operation of a market economy in its broadest theoretical outline; and it is within this general body of theory that most other branches of economic theory find their place. We are provisionally able to refrain from paying attention to these other branches of theory only by drastically simplifying the hypothetical market economy we deal with. Once the theory of the simplified market process has been mastered, then more complex and particular market situations can be dealt with by logical extensions of the theory. In our study, for example, we ignore the possibility of trade between two separate market economies; we therefore do not study the theory of international trade with its impact on the market process within each country.
Again, in our study, we almost completely ignore the special role played by the government as an economic agent; we therefore do not study the theory of public finance and the modifications brought about in the market process by governmental taxation, expenditures, or debt. We do not consider, in our study, the numerous complexities that are introduced into the market process by the various possible institutions connected with money; we therefore do not study monetary theory.
In the same way Edition: current; Page: [ 12 ] and partly as a result of these simplifications we do not consider the possibility that market forces might arise that can disrupt periodically the smooth operation of the market process; in other words we ignore the necessity to construct a theory of the trade cycle; and so on.
In our study, therefore, we construct the theoretical framework within which all aspects of the economic theory of a market economy must be set. We follow through the fundamental market forces upon which and through which the impact of any special, additional economic forces will be felt.
The theoretical attack upon any particular economic problem in the market must then be carried out against the background of this general and widely accepted theory of the market. Economic theory thus embraces a range of theorems covering many more problems than are treated in this book. Moreover, as we have seen, the subject economics in turn customarily involves much besides economic theory. The study of an economic problem will typically involve much more than theory, and even for the purely theoretical aspect of such a study, the propositions of general market theory will be only partially satisfactory.
The skilled economist must scan the data, using his theoretical competence to suggest or to detect matters requiring further explanation. In seeking such explanation he must apply his theoretical tools to the masses of data he believes to be relevant. It is not the task of market theory to set forth the methods by which the economist can most successfully use the empirical data at his disposal or the methods by which he can most skillfully apply theoretical tools to such data.
Market theory provides the basic tools required for even the most preliminary approach to economic problems. More specialized tools, in the form of the propositions of particular branches of economic theory, may be required to analyze specific problems. These tools, too, depend on the availability and quality of the basic tools we are about to assemble. The scope of market theory, within economic theory generally and within economics as a whole, is indeed narrow. Despite its narrowness, however, it is market theory that nourishes these wider fields. And in this lies its paramount importance.
Chapter 1 clarifies the relationship between the theory of the market and other branches of economics. Society consists of individuals seeking to act to improve their positions. A market exists where the individuals are in close enough contact with one Edition: current; Page: [ 13 ] another to be aware of mutually profitable opportunities for exchange.
A market system exists where the individuals in a society conduct their economic activities predominantly through the market. Economic analysis reveals chains of cause and effect linking together and coordinating the mass of transactions taking place in the market. Market theory investigates these chains of cause and effect.
Market theory is made possible by the unique properties of human actions. Economic theory is abstract, selecting only the key features of an economic situation for use in subsequent reasoning. Economic theory is general; its conclusions have validity for a wide range of possible real situations. Market theory provides the general framework for the analysis of a market system. Within this broad framework the various specialized branches of economic theory deal with more complex special cases.
The theory in this book thus proceeds by drastic simplification. In this chapter and in the next, we survey the market, its overall operations and achievements. Later we will analyze, separately, the different functional sectors that compose the market, and how these various sectors interact within the market. Here, we will contemplate the forest in its entirety, before scrutinizing the separate trees, and then examine the consequences for the other trees of the existence and growth of each separate tree.
We are considering the theoretical operation of a market system. The model of the market we will be working with can be characterized by the set of ideal conditions governing the model, which we construct for the purpose.
Market Theory and the Price System
In a market system each member of the society is free to act, within very wide limits, as he sees fit. Moreover, the system operates within a framework of law which recognizes individual rights to private property. This means that each individual is free at each moment to employ the means available to him for the purpose of furthering his own ends, providing only that this should not invade the property rights of others. At the same time each individual can plan his activities with the assurance provided by the law, first that the means available to him at any one time are secure against appropriation by others, and, then, that he will not be prevented by others from enjoying the fruits of his productive activities.
The system recognizes the rights of individuals to enter into arrangements with one another which they believe will be of mutual benefit. Individuals may act cooperatively either by pooling their resources to produce jointly, or by each agreeing to specialize in one kind of production and to exchange parts of their production, or by the one agreeing to furnish productive services to the other in return for finished products or their equivalent.
Our ideal system may be thought of as, in one way or another, ensuring the smooth fulfillment of such cooperative arrangements. Contracts are made in good faith, and contractual obligations are fulfilled to the letter. Members of the system, being human beings, at any one time have likes, dislikes, and preferences; each follows his own moral standards. Each member has more or less imperfect knowledge of the facts surrounding his field of action; each, in some degree, possesses curiosity, intelligence, determination; each has potential or actual talent for some or other activities, depending on his natural or acquired physical and other qualities.
Members of the system need not be aware of the entire scope of the market system or of the theory of its operation, but we may assume them to be generally content to seek to achieve their purposes within the framework of the system as they find it. In other words, while we make no other assumptions concerning the nature of the actions of individual members, we are assuming that no activity is expended with the sole purpose of replacing the market system by some system of societal organization governed by conditions substantially different from those outlined here.
The system is thus consistent with the existence of the political and coercive apparatus associated with government, only to the extent necessary to ensure the maintenance of the conditions of a market system. A society based on these conditions, starting from a previous state of individual autarky, without any specialization or exchange, can be seen as rapidly developing into an intricate exchange system. For such a successful development to occur it is however necessary that some commodity emerge in the market which is a generally accepted medium of exchange.
With exchange confined to direct barter of goods or services for other goods or services, there can be only a limited scope for market activity. It can be confidently assumed however that the existence of market activity, even if limited, will create numerous opportunities for individuals to improve their positions by engaging in indirect exchange. An individual would give goods or services in return for goods that he does not himself desire, in hope of being able to exchange these goods later on for others that he does desire but that cannot be had in exchange for his original goods or services.
Widespread activity involving such indirect exchange can in turn aid the emergence of a commodity generally accepted as a medium of exchange. Individuals will readily accept this commodity money in exchange for their goods or services, having complete confidence in their ability to use this commodity whenever they wish, to buy other goods or services at prices in terms of the money commodity more or less definitely known in advance. The market has become completely adjusted to a system of money; all economic calculation is carried out in terms of money values, all prices are money prices, and all market transactions are exchanges of goods or services against money.
Nevertheless, for our purposes, we assume that the market operates exactly as it would operate without the existence of a money supply, but simply enjoys freedom from the inconveniences connected with direct barter. In other words money is assumed to succeed in lubricating the wheels of exchange, without itself actively directing exchange activity into channels other than those that would in principle be used in the absence of money. With the conditions governing the market system firmly in mind, we may turn to observe the different roles within the market process that can be filled by individual market participants.
Classification of roles as carried out by the economic theorist is quite different from classifications carried out from other points of view. A difference between two individuals is significant for the theorist only as it corresponds to a difference in market function. Market theory is organized within a conceptual framework that recognizes distinctly several such market functions.
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This volume presents an integrated view of Austrian price theory. The basic aim of the book is to utilise the tools of economic reasoning to explain the market process. The unique framework Kirzner develops for microeconomic analysis, following Mises and Hayek, examines error in decision-making, entrepreneurial profit, and competition as a process of discovery and learning.