16 Jul ANALYZING MANAGERIAL DECISIONS:
ANALYZING MANAGERIAL DECISIONS: Nobel Prize–Winner F. A. Hayek on the “Miracle” of the Price System
It is worth contemplating for a moment a very simple and commonplace instance of the action of the price system to see what precisely it accomplishes. Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is significant that it does not matter— which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the entire economic system. This influences not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all things made of
tin, and their substitutes, and so on. All this takes place without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. The whole acts as one market, not because any of its members surveys the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all. The mere fact that there is one price for any commodity—or rather that local prices are connected in a manner determined by the cost of transport, etc.—brings about the solution which (if conceptually possible) might have been arrived at by one single mind possessing all the information which is in fact dispersed among all the people involved in the process. Some people (e.g., Hayek) argue that decentralization of economic decisions in the economy leads to an efficient resource allocation. What differences exist within the firm that make the link between decentralization and efficiency less clear?
Source: F. Hayek (1945), “The Use of Knowledge in Society,”
• Synopsis: Hayek contends that the market system is an extremely efficient pricing mechanism, similar to Adam Smith and Milton Freidman. In Brickley, Smith, and Zimmerman (2016) the authors used tin and its cost to highlight how quickly market participants will react to changes in market prices (i.e. they will use less tin when market prices increase). The ‘miracle’ is that they do not have to know why tin’s price moved, what else the tin is being used for, or anything else about the price of tin; their reaction is in response to the price and nothing else. The tin will finds its way to the person that can use it to its maximum productive capability. The decreased demand for tin will mean the demand for some other resource will increase and eventually the change in tin demand will reverberate throughout the entire economic system.
1. Hayek argued that decentralization of economic decisions in the economy leads to an efficient resource allocation.
2. What differences exist within the firm that make the link between decentralization and efficiency less clear?
Economic concepts from Chapter 3 that you could integrate into your response: (a) The Price Mechanism, (b) The Coase Theorem, (c) Externalities, (d) Market versus Central Planing, (e) Allocation of decision rights, and (f) Asymmetric Information.
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