Thursday, April 15, 2010

CUE CARD ECONOMICS: Price signals

One of the first lessons children learn as they grow up is that they can’t have everything they want.  Reality just isn’t built that way. Sadly, too many people forget that when they reach adulthood.  Some of those people become planners or, worse, politicians, who think a mere wish is the same as a promise to deliver.

But resources are not infinite. If they’re being used for one thing, they can’t be used for another. Children know this.  Planners (and politicians) still don’t.  Nonetheless, there is a prodigiously fertile means by which a market easily and simply puts resources to their best, most highly-valued use—just as long as people are left free to exercise it.

The mechanism is known by the name “price signals.”

In a dispersed division-of-labour economy, price signals are the preeminent form of conveying important information right across a market: for those who are alert to them they convey the information, from moment to moment, of what is most highly valued by buyers—and they offer the extra profits that encourage more sellers to supply more of what is most demanded most, and less of what is demanded less.

Put simply, fewer buyers chasing more goods or services push those prices down; and more buyers chasing fewer goods or services push those prices up. And the extra profits made in selling the higher-priced goods pays producers to shift their resources to producing the most highly-valued goods and services.

In that respect, there is a beneficent “self-levelling” that happens within a free market of self-interested participants—pushing more production to where it is demanded more, and removing it from where it is demanded less—that couldn’t be replicated by one grandstanding politician or a whole army of central planners.

This is  the “prodigiously ingenious mechanism” of spontaneous order by which people's wants are supplied and great cities are fed and watered, a process which to some people still appears to be a miracle. If it is, it’s a miracle that is the product of human action, not of human design.

Richard Cantillon explained the elegantly simple process of self-correction as far back as 1755:
    _quote For if some of the farmers sowed more grain than usual on their land they would have to graze a smaller number of sheep, and have less wool and mutton to sell.  Then there will will be too much grain and too little wool for the consumption of the inhabitants.  Wool will therefore be dear, which will [require] the inhabitants to wear their clothes longer than usual; and there will be too much grain and a surplus for next year… the farmers … will take care the next year to have less grain and more wool, for farmers always take care to use their land for the production of those things which they think will fetch the best price at market.  If, however, next year they have too much wool and too little grain for the demand, they will not fail to change from year to year the use of the land until they arrive at proportioning their production more or less to the consumption of the inhabitants.  So a farmer who has adjusted more-or-less his output to the demand will have part of his farm in grass, for hay, another part in grain, another in wool and so on, and he will not change his plan unless he see some considerable change in the demand…”
People often say that without planners there is no planning.  The truth is quite the opposite.  Entrepreneurs allocate their resources on the basis of what price signals tell them about demand, adjusting their plans to meet the plans and desires of buyers.  Thus do buyer and seller fall into a natural harmony.
"The consideration of prices is what integrates and harmonizes the plans of each individual with the plans of all other individuals and produces a fully and rationally planned economic system under capitalism" - George Reisman, Capitalism, Pg. 137
As Frederic Bastiat used to say, It is not so much “planning” as the natural process of harmonisation of interests that occurs when people are left free.



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4 Comments:

Blogger Sally said...

Should be compulsory reading for all council employees and councillors. Look at the pickle their long term community plans have put communities in. They are a disaster!

4/15/2010 10:46:00 pm  
Anonymous LGM said...

PC
Great post. Should be compulsory reading!

Price signals is a very important subject. Pity people don't seem to care much for learning of it.

Price signals are the way that the requirements of individuals are signalled to other individuals. They are a result of the ultimate participatory democracy (not ever to be confused with the sham of representative democracy).

Thanks for the post
LGM

4/16/2010 08:19:00 am  
Anonymous Anonymous said...

The roll of price in directing resource use should be the starting point of any teaching purporting to be economics or environmental studies.
This understanding of the roll of price is what those who justify regulation and planning with notions of sustainability and finite resources have not grasped.
I suspect this is an ignorance well entrenched in 'education'
Price is a natural phenomena, that conveys knowledge, regulation is man interfering with nature.

Ken

4/16/2010 08:43:00 am  
Anonymous LGM said...

"The capitalist system of production is an economic democracy in which every penny gives a right to vote. The consumers are the sovereign people. The capitalists, the entrepreneurs, and the farmers are the peoples mandatories."
- Ludwig Von Mises

4/18/2010 05:39:00 pm  

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