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Over the years I have come to appreciate the depth of Hayek’s insights, particularly in "The Use of Knowledge in Society," [2] 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 [3]. 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." [4] 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.