What Do Prices “Know” That You Don’t?

According to Prof. Michael Munger, prices (as in, the price of a carton of milk, or a new car) are akin to magic. Prices “magically” convert countless pieces of dispersed, complex information into a single signal that conveys to sellers what they should do to best benefit society. By ignoring the price system, you’re really ignoring the needs of those whom you want to serve.

Prof. Munger illustrates this through an example of two farmers trying to decide whether to plant corn or soybeans. One farmer is purely altruistic; he refuses to acknowledge the role of prices and instead sets about to determine which crop would help society most. He pores over data but finds himself overwhelmed with his impossible task. He makes a guess and plants corn. Unfortunately, there is already too much corn on the market. Not only is society not much better off, but his business fails.

The other farmer cares only about profits. A variety of world events have driven up the need for soy, so the price is higher. He sees the increased price and produces soybeans in order to maximize his profits. He doesn’t care why the price is high, and he doesn’t need to know. All that matters is that he was motivated to produce exactly what humanity wanted. This is the “magic” of the price system – it merges the needs of society with each seller’s desire for profit.

 

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