Hayek in the Classroom

by Russ Roberts on August 25, 2008

in Prices

Over the years I have come to appreciate the depth of Hayek’s insights, particularly in "The Use of Knowledge in Society," his 1945 American Economic Review paper. But how do you bring these insights into the classroom? How do you get students to understand what Hayek meant when he wrote about price adjustment:

Of course, these adjustments are probably never "perfect" in the sense
in which the economist conceives of them in his equilibrium analysis.
But I fear that our theoretical habits of approaching the problem with
the assumption of more or less perfect knowledge on the part of almost
everyone has made us somewhat blind to the true function of the price
mechanism and led us to apply rather misleading standards in judging
its efficiency. The marvel is that in a case like that of a scarcity of
one raw material, without an order being issued, without more than
perhaps a handful of people knowing the cause, tens of thousands of
people whose identity could not be ascertained by months of
investigation, are made to use the material or its products more
sparingly; i.e.,
they move in the right direction. This is enough of a marvel even if,
in a constantly changing world, not all will hit it off so perfectly
that their profit rates will always be maintained at the same constant
or "normal" level.

I have deliberately used the word "marvel" to shock the reader out of
the complacency with which we often take the working of this mechanism
for granted. I am convinced that if it were the result of deliberate
human design, and if the people guided by the price changes understood
that their decisions have significance far beyond their immediate aim,
this mechanism would have been acclaimed as one of the greatest
triumphs of the human mind. Its misfortune is the double one that it is
not the product of human design and that the people guided by it
usually do not know why they are made to do what they do.

Getting people to really appreciate the marvel of our economy is part of the reason I wrote The Price of Everything. But it is hard for most of us to use a novel in the classroom. We can use it in the class. That is, we can assign it. We can lead a discussion in class on the book. We can give an exam question based on the book. But it is hard to teach a novel in the sense of lecturing on it. It is for me anyway. So I wanted a more traditional way to teach Hayek’s insights that would parallel the ideas in my book.

So I came up with this essay, "How Markets Use Knowledge." that tries to integrate supply and demand and Hayek’s description of the price system as a marvel. Ironically, it treats the price system as "perfect" but I hope that I have been able to capture in a traditional supply and demand framework, some of what Hayek was getting at . Any and all reactions are welcome and I will revise it based on feedback I get from you and my students when I use it in class this semester.

If you are a teacher, please feel free to use it with your students.

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wintercow20 August 25, 2008 at 8:48 am

I have a question on the phrasing of your first review question. Do you intend to use the term "demand for graphite by pencil makers" or did you mean "the quantity of graphite demanded by pencil makers"?

I take these to mean two very different things – the former indicating a shift in the demand curve because of a fundamental change in the relationship between prices and how much pencil makers would like to buy, the latter indicating a movement along a demand curve that represents an existing preference mapping.

I can see students justifiably answering No to the former question and Yes to the latter.

Martin Brock August 25, 2008 at 9:08 am

I agree that "perfect knowledge" is a misnomer to say the least. I'm even tempted to say that economic actors hardly know anything. Instead, economic actors believe things, and market forces select the true beliefs from the false beliefs much as Darwin's Creator selects fit genes from unfit genes. The more rapidly this selection occurs, the more it creates an illusion of "visionary foresight" and "perfect knowledge".

In a dynamic, vigorously competitive, efficient, free market, economic actors make (often poorly) educated guesses at best. Some guesses always turn out to be right, but that's beside the point. Some genes are always fittest too. Even very limited knowledge is more valuable than total ignorance, and markets only become efficient as informed traders act, so smart money marginally outperforms the dumbest luck, but this unremarkable fact is also beside the point.

Russ Roberts August 25, 2008 at 9:36 am


Demand. You can't talk about a shift in quantity demanded as an exogenous change.

SteveO August 25, 2008 at 11:21 am

I just want to defend the word "perfect". At the best possible point, accounting for existing conditions, is a perfectly acceptable definition of "perfect".

I think we have gone on the defensive concerning the word "perfect" in economic terms. Some mythical state that exists only in our mind does not qualify as perfect in my opinion.

OT: Since Russ will probably read this; the "remember personal info" check box rarely works. Also, it would be an extraordinary improvement in design if each commenters text were boxed in *with* his signature, in alternating colors, ie. gray and white boxes. (There is often confusion about who wrote what, by new visitors)

Russ Roberts August 25, 2008 at 11:51 am


I don't know why it doesn't remember personal info. It does the same thing to me, too.

Mathieu Bedard August 25, 2008 at 12:32 pm

I'm not sure how credible it is to say that we can't figure out the right price to accommodate everyone while using supply and demand curves to depict the problem.

I'm trying to put myself in the place of a first year student and, well, the answer seems obvious! We only have to look at the demand curves to figure out who gets what at what price… Don't these guys have economists working for them? :)

But it's a great introduction to supply and demand. I could picture myself studying these!

Patrick R. Sullivan August 25, 2008 at 12:56 pm

Here's a news story that pretty much hits all the points you're making. Recovering natural gas from shale beds, thanks to new technology spurred by rising prices.

Vic August 25, 2008 at 4:24 pm

Hayek's essay is good, perhaps even a classic, but it's only an exposition of Mises' much more important ideas on prices.

It still amazes me today that so few people recognize the importance of Mises' contributions and would rather assign greatness to Hayek. Perhaps it's the nobel prize, where his work was again built on Mises' ground breaking ideas.

If you want a magnum opus that you should be bringing to the minds of budding economists it really should be Human Action.

David Peterson August 25, 2008 at 5:14 pm

Interesting. I'm not a teacher of any sort, but I've often thought that getting the subtlety and importance of this point is critical in arguing for the free market and wondered how the best way to do so would be. This looks like an excellent tool for explaining it.

william casey August 26, 2008 at 10:05 am

In your example of graphite used for tennis rackets, you ignored the point that tennis players might still buy as many graphite rackets at a higher price because they are better.

Russ Roberts August 27, 2008 at 12:06 am

william casey,

That would be a vertical demand curve. Very unlikely. Graphite rackets are better than wood. That's why they're more popular. But holding their quality and the price of wooden rackets constant, an increase in the price of graphite rackets will lead to fewer sales. Some people who already have two won't buy a third one. Some people will delay replacing a racket. Some people will be enticed by a different substitute other than wood.

Sam Grove August 27, 2008 at 12:54 pm

Personal info isn't remembered, but if you hit "Post" without entering your info, your info will appear in the preview screen.

You might view it as a 'forced preview'.

Russ Roberts August 27, 2008 at 2:56 pm


Great find! I'll post on it…

Henri Hein August 28, 2008 at 12:12 pm

> I don't know why it doesn't remember personal info.

I looked into it at some point, and I believe it's a typepad bug.

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