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									    “The Price System As A
     Mechanism For Using
– Friedrick Hayek, AER, 1945
  • “What is the problem we wish to solve when we try
    to construct a rational economic order? On certain
    familiar assumptions the answer is simple enough. If
    we possess all the relevant information, if we start
    out from a given system of preferences, and if we
    command complete knowledge of available means,
    the problem is purely one of logic. That is, the
    answer to the question of what is the best use of
    available means is implicit in our assumptions.
     • The conditions which the solution of this
       [optimization] problem must satisfy have been fully
       worked out and can be stated best in mathematical
       form: put at their briefest, they are that the marginal
       rates of substitution between any two commodities
       or factors must be the same in all their different
• By “rational economic order” Hayek means
  Pareto efficient
• Marginal rate of substitution is a technical
  condition that must hold for an efficient
  state of the world
            Back To Hayek
• So “if we possess all the relevant
  information, if we start out from a given
  system of preferences, and if we command
  complete knowledge of available means,”
  then all we have to do is make sure that
  everyone is consuming where his or her
  marginal rate of substitution between any
  two goods is the same as everyone else’s
• But...
• “This ... is emphatically not the economic
  problem which society faces. And the
  economic calculus which we have
  developed to solve this logical problem,
  though an important first step ..., does not
  yet provide an answer to it. The reason for
  this is that the data from which the
  economic calculus starts are never for the
  whole society given to a single mind, and
  can never be so given.”
     What Does Hayek Mean?
• Pareto efficiency/equality of MRS is merely
  a state of being
• Is there an institutional arrangement, an
  economic framework, which would bring
  about a state of efficiency?
• If perfect information holds, then a central
  planner, using his or her perfect knowledge,
  could simply organize production and
  consumption so as to achieve efficiency
• But perfect information does not exist
   Capitalism Uses Available
Information To Reach Efficiency
• The market-based capitalist system (when it
  works right) does not require perfect
• All any one person needs to know is
  information about his or her own
  preferences and circumstances
• Price signals provide the rest
    Final Comments on Hayek
• Similar mechanisms occur on the
  production side
   – intuition simple: say you are a producer who
     uses tin as an input. Something happens to tin
     production making it more scarce. Tin users
     must somehow be induced to use less tin.
     Markets automatically respond to the greater
     scarcity by making tin prices go up. How will
     tin users respond?
– No such mechanism exists under planned
   – someone would have to tell tin users to cut back
• The conclusion is that there is a mechanism
  in capitalism that automatically brings about
  an efficient outcome
  – at least under ideal conditions
• There is no such mechanism in planned
• Thus, we conclude that capitalism is, in
  principle, a more efficient system

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