|Montréal, February 16, 2002 / No 98|
by Edward W.Younkins
Information means specific things that a person needs to know in order to make decisions affecting his own well-being. The relevant question is which among a number of options will optimize the satisfaction of the decision-maker. A continuing flow of information about the relative costs and benefits of doing or choosing one thing or another is needed to answer this question. Such knowledge can be extremely costly and is often widely scattered in uneven fragments. The communications and coordination of these scattered fragments is one of the basic problems of society.
The crucial information-transmitting process is the market with its continuing
flow of signals which allows decision-makers to review a constantly changing
mix of options and resulting trade-offs and respond in a fine-tuned fashion
by making a series of incremental adjustments based on the information
attained. If decisions are to be incremental and flexible, they are best
made by economic institutions rather than by political, administrative,
or judicial ones.
Better decisions are made through the market process as opposed to the political process because markets economize on the knowledge needed by any one person to make good decisions and because they convey a sharper sense of constraints, trade-offs, and incentives (rewards and penalties). In addition, people can generally make a better choice out of numerous options than by following a single prescribed process.
Price as feedback mechanism
Another virtue of the market is the promptness and effectiveness with which it transmits feedback thus enabling decision-makers to correct errors and adapt to changing conditions. Feedback mechanisms (including incentives to act on that information) are critical in a world in which no decision-maker is likely to have enough knowledge to be consistently right the first time in his decisions. There is an independent reality which each person sees only imperfectly, but which can be understood more fully with feedback that can validate or change what was previously believed. Effective feedback is the implicit transmission of others' knowledge in the explicit form of effective incentives to the recipient.
Nobody needs to have complete information in order for the economy to convey relevant information through prices and achieve the same adjustments as if everyone had such knowledge. Prices are a mechanism for carrying out the rationing function and are a fast and effective conveyor of information through a society in which fragmented knowledge must be coordinated. Accurate prices resulting from voluntary exchanges allow the economy to achieve optimal performance in terms of satisfying each person as much as he can be satisfied by his own standards without sacrificing others' rights to act according to their own respective standards. Prices maintained by force convey misinformation. Regulatory measures such a price-fixing obscure the true cost of a course of action compared to its alternatives, inhibit the feedback that permits transactors to communicate, and create distortions that harm rather than help consumers.
Prices are guiding instruments for consumption and investment decisions. They provide information regarding the availability of goods and services and the relative values of goods and services to competing would-be consumers. Prices furnish the required signals to direct production into various products and services in the proportion that people desire them. In a free market, the price system communicates information to all parties with respect to opportunity costs and the relative scarcity of goods and services.
Prices measure market conditions and price changes affect and reflect market conditions. Prices change to reflect changes in demand, supply, costs, and so on. Not only are prices, supply, demand, and cost interrelated, the prices of all goods and services are related to each other. Prices and price relationships are constantly changing with changes in one price affecting an indeterminate number of other prices. The pricing process is a social process in which all members of society take part.
By examining market prices and by adding one's personal knowledge of his own circumstances, individuals make decisions regarding the cost and benefits of various courses of action. Market prices are thus instrumental in reducing the complexity of making economic decisions in a constantly changing world.
Information, as a precious economic good, is scarce and valued. Individuals do not possess perfect information regarding their options or their means to reach them. There is nothing wrong with this. Information asymmetries are built into the nature of reality and exist in all markets. Participants in a market always have different kinds and incomplete levels of information. Fortunately, people do not require perfect information. The free-market pricing system works well to supply the vital information needed by traders. Market prices are the requisite signals that provide direction to the market economy.
Government quick-fix solution vs. the market
People do not need government-determined prices, regulations, or directives. Decisions are best left with individuals in their particular circumstances of time and place. An individual's action should be based on his knowledge which consists of information obtained through the discovery process of a decentralized market system plus the individual's own judgment.
Government officials tend to have good but misdirected intentions when they impatiently override market prices with government actions such as wage and price controls, minimum wage laws, rent controls, interest rate regulations, tariffs, etc. Their "quick-fix" solutions to economic problems inevitably result in inefficiencies and disrupt and distort economic calculations. When the government intervenes it destroys the most important source of people's planning information – the relative prices of all the various products and services. Prices and their relationships to one another enable society to resolve the problem of allocating production among commodities and services. Although some people may complain that markets work too slowly, the truth is that the government's "shortcut" programs only ostensibly save time by making wasteful and hasty adjustments that repress flexible and creative market responses.
Price controls distort supply and demand. They introduce rigidity into the natural flexibility of the market. Artificially low prices (e.g., rent controls) reduce the supply of goods and decrease the motivation to provide goods. Shortages arise when prices are held below what the market will bear. For example, rent control laws keep rental prices below market levels, foster the wasteful use of scarce housing space, and discourage the construction of additional housing units. Artificially high prices such as minimum wage rates are also false price signals that result in a surplus of resources supplied. In the case of minimum wage rates, there would be a surplus of the resource of human labor. Prices should be determined by the market. Government should refrain from setting either maximum or minimum prices for any good or service. As a recent Bob Dylan song put it, "Try to make things better for someone, sometimes you only end up making them a thousand time worse."
When the government tampers with prices, wages, and interest rates, it robs people of their role as guides of the market process. Such government intercession limits people's freedom and enlarges the power of government officials and politicians.
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