Quotation of the Day…

by Don Boudreaux on September 25, 2015

in Complexity & Emergence, Hayek, Prices, Seen and Unseen

… is from page 144 of F.A. Hayek’s 1941 Liberal Review essay, “The Economics of Planning,” as reprinted as chapter four of the 1997 collection, edited by Bruce Caldwell, Socialism and War:

That man did develop the modern industrial apparatus is due to the fact that he stumbled through a slow and gradual process of trial and error on a method which combined decentralization and coordination, a method under which nobody needs to know all the facts which a planner would have to know, and where the most essential information required for a particular decision is conveyed to those who have to make it speedily and simply by an automatic process.  I mean the competitive markets and the price system.

It’s important to understand a reality that many modern economists have either never learned or have forgotten: market prices need not be ‘perfect’ or ‘equilibrium’ to perform the essential task of prompting individuals to act as if they possess an amount of detailed knowledge that, in fact, they do not (and could not possibly) possess.

For example, an improvement in fracking technology increases the supply of petroleum.  To sell more of their product, therefore, oil companies lower the prices they charge for crude; as a further result, crude-oil refiners purchase more crude oil and, as yet another further result, transform more crude into refined gasoline.  In order to sell this greater supply of gasoline, refiners lower the prices they charge to gasoline retailers who, in turn, lower the prices they charge to consumers.  All along the way, individuals – as producers and and as consumers – respond to the improvement in fracking technology as if they are all aware of its reality and of the fact that this technology improvement makes petroleum less precious than petroleum was before this improvement.

At no stage in this process need prices be ‘perfect,’ ‘perfectly competitive,’ or at levels that economists would describe as ‘general equilibrium.’  Instead, the prices need only prompt individuals all along the way to act as if they are aware of the nature of the economic change (in this example, the increased supply of petroleum created by the improvement in fracking technology).  Only that which we might call “directional correctness” – that is, prices prompting countless individuals to adjust their actions in the proper direction so that their actions better conform with underlying realities – is required for prices to perform their vital task of bringing the economic decisions of myriad strangers into fuller coordination with each other and with physical realities.  (Note that I say “fuller coordination.”  Coordination that is more full is superior to coordination that is less full.  And so we should celebrate coordination that is as full as is practically possible.  In a world of imperfect human beings and of constant change, it’s pointless, or absurdly scholastic, to lament the lack of perfect, or completely full, coordination and to attach the label “imperfect” to a process that brings about more coordination among millions of individuals than could possibly be achieved by any other means.)


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