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Quotation of the Day…

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… is from page 117 of Vol. II (“The Mirage of Social Justice” [2] [1976]) of F.A. Hayek [3]’s indispensable work, Law, Legislation, and Liberty:

The sum of information reflected or precipitated in the [market] prices is wholly the product of competition, or at least of the openness of the market to anyone who has relevant information about some source of demand or supply for the good in question.  Competition operates as a discovery procedure not only by giving anyone who has the opportunity to exploit special circumstances the possibility to do so profitably, but also by conveying to the other parties the information that there is some such opportunity.

DBx: To understand the nature of the competitive discovery process here described by Hayek is to understand at a deeper level than is conveyed in ECON 101 textbooks the damage done by government-dictated price controls – be these controls price ceilings (such as prohibitions on so-called “price gouging”) or price floors (such as minimum wages).  Without a doubt, the ECON 101 explanation is sound.  This explanation is also sufficient to throw a heavy burden of persuasion onto those who endorse government-imposed price controls.  But contrary to the misguided arguments of non-economists such James Kwak [4] and Michael Hiltzik [5], when we go beyond ECON 101 we find that the argument against price controls not only does not weaken, it strengthens.

The knowledge that the modern economy must make use of at any time is inconceivably vast in amount and in its details.  This knowledge is dispersed across the globe, with only tiny bits of it held in the mind of any one of the billions of economic actors.  Each of us, as an economic actor, has unique knowledge not only of our preferences as a consumer and of our talents as a producer, but also of our local setting.  Each of us, at any moment, does – or might – notice an opportunity to improve our well-being – an opportunity from the mundane (such as my finding an unexpected bargain on a pair of socks) to the grand (such as Steve Jobs figuring out how to arrange for the profitable production of a smartphone that will be widely desired by consumers around the world).

Prices expressed in monetary terms and set by the voluntary bargains of buyers and sellers incorporate in a simple numerical forms the information of the buyers and sellers whose bargains set these prices.  This information, in this simple form, is then conveyed to thousands or millions or billions of others who use this information along with their unique knowledge of their local preferences, circumstances, and opportunities to change their consumption and production plans.  These changes further change prices.  Importantly, when someone of an entrepreneurial bent notices a large enough difference between the price of some output and the prices of inputs that can be used to produce that output, that person becomes a buyer of those inputs and a producer and seller of that output.  His or her actions push up the prices of the inputs and push down the price of the output.  These changing prices are information to others throughout the economy about the now-changed relative scarcity of different inputs and of different outputs.

Price controls do more than just distort consumers’ and producers’ incentives.  Price controls also distort the market’s system of gathering and of conveying information.  Price controls thereby distort information about demands and supplies.

A price ceiling on, say, bottled water prevents consumers from expressing their valuation of water by spending money; a price ceiling diverts consumers instead into bargaining for water by making non-monetary expenditures such as waiting in long lines.  (Note that consumers who wait in long queues are still spending resources in their attempts to get the goods in short supply; they’re just spending different resources.)  But long queues of consumers seeking to buy bottled water, while they do signal that bottled water is in short supply relative to its demand, not only give to no one any economic incentive to rush more bottled water to those consumers, they also do not tell anyone by just how much currently available quantities supplied fall short of demand.  Even if a fabulously rich philanthropic soul sought to satisfy all of these demands for bottled water without earning a profit from doing so, he or she would have no good way to know just how much additional bottled water to bring to the area – or, more precisely, he or she would have less accurate information about how much additional water to bring to the area than he or she would have if the current price of bottled water in that area were not controlled by government diktat.  If too little water is brought in, the problem is not adequately ‘solved.’  If too much water is brought in, people elsewhere (and perhaps some people even in the area devastated by a natural disaster) suffer because resources have been diverted from higher-valued to lower-valued uses.

An ECON 101 supply-and-demand graph correctly shows that a price-ceiling on bottled water causes the quantity demanded of bottled water to exceed the quantity supplied.  But that graph incorrectly (for careless interpreters) suggests that the amount by which quantity demanded exceeds quantity supplied is known.  But the size of this excess of quantity demanded over quantity supplied is not known and cannot practically be known.  Allowing people in search of items to buy to spend money as they individually see fit in that search, rather than diverting their expenditures into non-monetary forms – such as waiting in queues or calling in political or personal favors – creates far more accurate and nuanced information about which particular needs are currently greatest.

Pointing out the many ways in which the price system isn’t perfect is child’s play (and often indeed is childish).  Explaining how that which emerges in the price-system’s place when it is suppressed is quite another matter.  Imagining an allocation of resources superior to that which the price system gives rise is also child’s play (and nearly always childish).  Devising a method that will work in reality to achieve this superior allocation of resources has yet to be done.

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