Tuesday, June 26, 2012

The Role of Prices in a Free Market: The Hayekian Knowledge Problem

F. A. Hayek wrote about the importance of using the price system as a coordination tool.  "Far from being appropriate only to comparatively simple conditions," Hayek writes in The Road to Serfdom, "it is the very complexity of the division of labor under modern conditions which makes competition the only method by which such coordination can be adequately brought about."  Then Hayek adds:  "This is precisely what the price system does under competition, and which no other system even promises to accomplish.  It enables entrepreneurs, by watching the movement of comparatively few prices...to adjust their activities to those of their fellows."  (all emphasis mine)

 Richard M. Ebeling, in an article entitled Austrian Macroeconomics:  Review of Roger W. Garrison's Time and Money, writes a very concise definition of "the role of prices."  I want to put this up because I think it clearly explains why communism is impossible, i.e., why it is impossible to eliminate prices.

The role of prices under conditions of imperfect knowledge in markets with continual change is precisely to have an institutional mechanism that enables actors to coordinate their activities WITHOUT their needing to possess ALL "the data" of the market as a whole. Market actors can use their special and localized knowledge of time and place in the division of labor WITHOUT ANY OF THEM POSSESSING THE GLOBAL KNOWLEDGE OF THE ENTIRE ECONOMIC SYSTEM. (emphasis mine)

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