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Book Review: Prices & Knowledge

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Prices & Knowledge: A Market-Process Perspective
by Esteban F. Thomsen (New York: Routledge, 1992); 150 pages.

In spite of the repudiation of Soviet-style socialist central planning, the free market has not triumphed. A good part of the reason for this is the ideological prejudice of our times. The entire world in the 20th century has swallowed the socialist critique of capitalism. The market economy is viewed by a majority of the intellectuals and many in the general public as unjust, immoral and cruel.

But part of the resistance to unregulated market economy comes from economists, who spin out hypothetical models of “perfect competition” and “market failures,” and conclude that the market just cannot be left to its own devices. Several generations of economists have now been trained in this way, and they then go about their business of teaching these ideas at colleges and universities and designing policy proposals for various levels of government, with these models serving as the foundations of their analysis.

Esteban F. Thomsen argues in his recent book, Prices & Knowledge: A Market-Process Perspective, that many economists hold these views about the supposed failure of an unregulated market because they are not always aware of the purpose and function of prices in a market economy. As a consequence, the fundamental importance of leaving prices completely free is not fully appreciated.

Since Austrian economist Friedrich A. Hayek received the Nobel Memorial Prize in Economic Science in 1974, a growing number of economists have come to understand that prices are a market vehicle for communicating information. In a complex social system of division of labor, some method must exist for market participants to communicate and find out what others in the market are doing so their respective plans can be successfully coordinated for the mutual satisfaction of their various individual ends.

Prices serve this role, Hayek explained, and Dr. Thomsen elaborates. But Dr. Thomsen argues that not all of the implications of seeing prices as a communications system for market coordination have been understood. Prices economize on information by saving individuals the need to know directly all the other people in the market with whom their own plans are connected. Prices, in other words, summarize and encapsulate a vast amount of information about changing supply and demand conditions that ultimately arise from the changing actions of a vast multitude of people.

Prices also bring markets into balance. The responses of people to the changes in prices result in their individual plans being brought into harmony with the actions of this vast number of market participants. The individual responses to these changes in prices bring about adjustments in production decisions, allocations of resources and distribution of products in markets, with the end result being that consumer demands are more fully and efficiently satisfied.

But what Dr. Thomsen believes has not been widely understood is the role of prices in a world of imperfect knowledge and ever-existing ignorance about market possibilities. In critiquing a number of alternative theories concerning the importance of prices, he develops Hayek’s and Israel Kirzner’s ideas about market competition being a discovery procedure.

Changes in market prices bring about potential profit opportunities between the costs at what a product can be produced and the price at which it can be sold. But these profit opportunities must be discovered, because if they were immediately obvious to everyone, they would be eliminated almost as quickly as they emerged, as everyone tried to take advantage of them. It is also the case that many profit opportunities can be created through the freedom that markets permit for people to experiment with new ways of producing, marketing and pricing both resources and finished goods for consumers.

Or, as Dr. Thomsen expresses it, the importance of prices in an ever-changing world is their power in creating incentives for people to be alert to possible emerging profit opportunities in conditions of market disequilibrium — precisely those situations when markets are not in balance and need to be brought into a new and better pattern of mutually coordinated plans. But what responses and avenues of adjustment are the most efficient, “optimal” or least costly can never be found out independent of allowing individuals the freedom to try. In other words, we don’t know what is possible other than through the competition between participants in the market in pursuit of the profit opportunities that those price changes may have created. Indeed, those individuals will creatively discover what they themselves are capable of only in an environment in which they must compete for those profits against others who are trying to do the same.

But a market economy can fully take advantage of this creative discovery process only when prices are completely left free from state control. Market competition can work and coordination can come about only when profit opportunities are not taxed away and when price changes are not regulated or manipulated by the government.

Profits discovered and earned are not proofs of “market failures.” To the contrary, they demonstrate that markets are functioning efficiently, with various individuals finding price-created opportunities and creatively taking advantage of those opportunities to pocket a profit by better satisfying the consuming public.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).