How Markets Use Knowledge

by Russ Roberts on September 20, 2011

in Complexity & Emergence

If you are teaching Microeconomics or Principles this semester, please feel free to share this visual essay of mine with your students. It is my attempt to convey the lesson of Hayek’s Use of Knowledge in Society using supply and demand.

Be Sociable, Share!

Comments

comments

14 comments    Share Share    Print    Email

{ 14 comments }

Edwar Escalante September 20, 2011 at 10:04 pm

Thanks Russ! Excellent resource…

wintercow20 September 20, 2011 at 10:55 pm

Russ, I’ve been using this since you posted it a couple of years ago – just a very well done piece, really. It takes a little more time to cover the topic doing it this way, but I am not of the opinion that getting a few ideas right is far more important than encyclopedic coverage.

Avigdor Loeb September 21, 2011 at 9:02 am

This leads me to a question: my high-school senior daughter is taking Macro, is there one place that systematically critiques what’s taught on an intro level ? Or do I have to be less lazy and do it myself?

Andrew September 21, 2011 at 12:35 pm

Isn’t this a bit simplistic? This doesn’t talk about money and distribution of money. Allowing the market to dictate how decisions should be made is the same as saying that those that have money should make these decisions, right? To assume that this is a reasonable way to make decisions about use of resources is a big assumption. It also supposes that there are sufficient supplies to meet demand, when often there are not. Take, for example, beachfront real-estate in Miami. The same argument does not work.

J. W. September 23, 2011 at 12:58 am

“This doesn’t talk about money and distribution of money.”

The paper “talks” quite a bit about money. And it isn’t about the “distribution of money,” nor does it require a discussion of such a topic in order to make the point that it does, so I don’t know why it would cover that.

“Allowing the market to dictate how decisions should be made is the same as saying that those that have money should make these decisions, right?”

No. “The market” is a bunch of people making exchanges, some of which include money. If a person with money wants to exchange some of his money for someone else’s property or labor, he doesn’t make that decision on his own. Market exchanges occur with the mutual agreement of the parties involved.

“To assume that this is a reasonable way to make decisions about use of resources is a big assumption.”

Perhaps, but the paper makes an argument for this rather than simply assume it.

“It also supposes that there are sufficient supplies to meet demand, when often there are not. Take, for example, beachfront real-estate in Miami. The same argument does not work.”

If demand for Miami beachfront real estate increases (that is, if people in general become willing to pay more for the same amounts of Miami beachfront real estate than they were before), then current owners who did not have their properties up for sale may enter the market, thus increasing the supply of Miami beachfront real estate. Prices may increase, too, which means that some people who were seeking Miami beachfront property may end up purchasing substitutes (perhaps beachfront property elsewhere). In other words, this example is not so different from the graphite example in the paper.

That you did not think of this suggests to me that you did not actually read the paper, or you do not understand what economists mean by the terms “supply” and “demand.” That’s fine, but please recognize that the limitation is your own and not the paper’s. I recommend Robert Murphy’s Lessons for the Young Economist, a fine introductory text that provides good explanations of terms that economists use.

Ken September 21, 2011 at 12:52 pm

Andrew,

“Allowing the market to dictate how decisions should be made is the same as saying that those that have money should make these decisions, right? ”

No. Allowing markets (there isn’t one market as you imply with your “the market”) to dictate how resources get allocated. Resources, not money. Money is earned by creating wealth, which usually involves tranfroming resources. Money is simply a fungible resource that humans use to make trading (market transactions) easy. For example, I sell labor that produces computer programs. How many car dealers are interested in the particular computer program I’ve written to such an extent that I can get a car for it? Not many, so money is used. This way I can sell those programs directly to those that want it, but from whom I have need or want of THEIR products. Instead of a barter trade, they give me money that I can use somewhere to get items that I want. The use of money alone is responsible for staggering gains in wealth and living standards.

The way you posed your question simply showcases how little you understand money and its relation to wealth and resources.

“To assume that this is a reasonable way to make decisions about use of resources is a big assumption.”

The only assumption being made is that people who voluntarily participate in a transaction is superior to being coerced to participate in a transaction. A market transaction, at its simplest, two people making a mutually beneficial trade. I trade my labor for money that can be used to claim resources. I and my employer engage voluntarily in this trade.

You want to impose YOUR preferences onto me and my employer. If you don’t like the terms of our agreement, you are saying that YOU or your government representative have the moral right to unilaterally change that agreement to suit YOUR preferences, ignoring mine and my employers.

“It also supposes that there are sufficient supplies to meet demand, when often there are not.”

False. Believing in free markets is the explicit belief that ALL resources are scarce, that wants ALWAYS exceed supply. Markets use prices to allocate resources to places they are needed most. Prices have proven over and over again to be THE MOST efficient way to allocate resources.

“Take, for example, beachfront real-estate in Miami. The same argument does not work.”

It absolutely does, for the argument given above.

Regards,
Ken

Andrew September 21, 2011 at 3:15 pm

The paper does assume that resources are not scarce. It assumes that more miners can be hired and more graphite can be dug while scarcity is often an issue.

You’re discussing your beliefs about efficient markets. I was making a comment on the paper, which didn’t take scarcity into account, and assumed much about the distribution of money.

Ken September 21, 2011 at 3:27 pm

Andrew,

So you didn’t read Russ’s or Hayek’s papers? The second sentence in Russ’s paper is “Prices are traffic cops that signal to buyers and sellers what is SCARCE and what is valuable.” (emphasis added).

And this taken from Hayek’s:

“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.” (emphasis mine).

And yes you do seem to make a LOT of (wrong) assumptions on the distribution of money.

Regards,
Ken

Andrew September 22, 2011 at 2:26 pm

Hmm,

That’s a nice sentence, but it isn’t taken into account in the rest of the paper, as far as I can tell.

You tell me I make lots of wrong assumptions. What are those wrong assumptions?

Ken September 22, 2011 at 3:05 pm

Andrew,

You assume energy policy has nothing to do with creating/destroying jobs or at best temporary jobs (Quotation of the Day at 12:39pm).

You assume that the FDA, Obamacare, minimum wage laws, income tax, capital gains tax, the DOE and the EPA don’t reduce employment (Same post at 12:35pm).

You assume that government involvement in the housing market isn’t responsible for the current recession (same post at 1:23pm).

You assume a person who just graduated high school has no capital, completely ignoring or misunderstanding what human capital is (same post at 12:42pm).

You assume that a high school graduate will have $100,000 to go to college, but not $10,000 to travel Europe (same post at 1:11pm).

You assume macro economic activity isn’t the result of micro economic activity (same post at 1:20pm).

You assume policy recommendations aren’t solutions (same post at 3:55pm).

You assume that government can provide and should provide housing, food, and clothing, in the process you assume beauracrats and politicians have the same knowledge that everyone has, something that is impossible (same post 10:41am).

You assume democratic processes weren’t responsible for the tyranny of Soviet Russia (same post at 2:57pm).

You assume money and wealth are the same thing (same post same time).

You assume I was getting underpaid in 2003 (My Challenge to Tyler at 10:27am).

You assume that the government properly computes inflation (doesn’t overstate), despite tons of data to the contrary (same post at 10:34am).

You assume government doesn’t make bad assumption with regard to economic policy that have enormous detrimental affects on the economy (same post at 4:25pm).

You assume that living standards haven’t improved since the 1970′s (same post at 10:29am).

You seem to be assuming that the distribution of money should be uniform, or are at least assuming that YOU know what the proper distribution should be (this post at 12:35pm).

You assume markets are only good for people that all ready have money (same post same time).

You assume that markets aren’t about equalizing supply and demand, assuming that markets only work when supply and demand are all ready at equilibrium (same post same time).

You assume there are some resources exist in an economy that are NOT scarce (same post at 3:15pm).

You assume Russ’s and Hayek’s paper are NOT about scarce resources (same post same time). Note: the ENTIRE discipline of economics is how scarce resources are allocated, so both papers are ENTIRELY about scarce resources.

Regards,
Ken

Andrew September 22, 2011 at 5:00 pm

I don’t know where to start. You impute to me many, many things I did not say. In order to have a conversation, you have to continue on a topic, and this is all over the place. If you want, write me at abellinbox@gmail.com and we can try again.

Ken September 22, 2011 at 5:28 pm

Andrew,

I prefer public conversations and anonymity. We’ll discuss things in the comments section here or not at all. Thank you for your offer, though.

Regards,
Ken

g-dub September 23, 2011 at 1:25 am

“I was making a comment on the paper, which didn’t take scarcity into account,…”

There is no need to economize if there is no scarcity. Economics is the study of scarcity.

If you find a paper on economics that doesn’t mention scarcity, you should assume it, because it isn’t an “economics” paper without it.

If you calculate the velocity of propagation and it comes out faster than the speed of light, you should question yourself first. Analogously, an economics paper without scarcity.

VPrime September 23, 2011 at 5:38 am

Perfect timing, Russ! We’re just touching on the price mechanism next week and I was looking for exactly such an article.

Thanks,as always!

VP

Previous post:

Next post: