Tuesday, 26 August 2008

Cool essay

Russ Roberts tells us he has been trying to get Hayek's insights, particularly in "The Use of Knowledge in Society," his 1945 American Economic Review paper across to students. He asks 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.
Robert's answer is this essay, "How Markets Use Knowledge" (pdf). The essay 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 with luck Roberts has been able to capture in a traditional supply and demand framework, some of what Hayek was getting at.

Read and enjoy.

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