This posting is Part XIII in a series of postings about economic thoughts.
Professor Don Boudreaux of George Mason University, who hails from New Orleans, recently published an article entitled Triumph of the Individual at Tech Central Station in which he discusses Nobel Laureate Friederich Hayek’s contribution to our understanding about how it is individuals – not government or markets – that make things happen in any society:

…Hayek spent most of his career watching the worship of power supplant the love of liberty. Nazism and Stalinism were the two most grotesque forms of this power-worship, but as Hayek warned in his most famous book, The Road to Serfdom (1944), even milder forms are surprisingly dangerous.
…the source of Hayek’s fundamental contributions to our understanding of society comes from the method of doing social theory that he learned from [Austrian economists Carl Menger and Ludwig von Mises].
This method is one of rigorous adherence to the tenets of “methodological individualism” — a fancy name for recognizing that the only units in society who think and act are individual persons. Society doesn’t think or act; the market doesn’t think or act; the United States government doesn’t think or act. Only individuals think and act…
Whatever the topic — war, economic growth, government regulation — the only way to achieve genuine understanding of what’s going on is to trace all actions back to the individuals who take them. The fact that individuals often act in concert — say, as voters — still requires those of us seeking to understand the outcomes of elections to understand the incentives and the constraints that confront the individuals who make up these groups.
Failure to be a consistent methodological individualist leads to misunderstanding. Consider, for example, that politicians and pundits frequently go on about how “we as a nation” did this, or how “we as a nation” must not do that.
“We” who make up the American nation number 300 million people, each with our own preferences, beliefs, and expectations. It’s only an illusion that “we” act — or can act — as one. It’s no less an illusion that “we” act when government acts in our name.
Should “we as a nation” rebuild New Orleans? Asked this question unawares, the typical person says “Yes.” But the student of Hayek responds that a city can be rebuilt only by individuals. Success at such efforts might require the concerted actions of many individuals. But understanding this fact, the Hayekian is instantly aware that successful rebuilding efforts must give each individual an incentive to rebuild — must give each individual appropriate knowledge to perform his part of the rebuilding task effectively — must give each individual the information and ability necessary to coordinate actions with those of countless other individuals.
The Hayekian also understands that the individuals who make up government are spending other people’s money for yet other people’s benefit. So these officials lack both the incentives and the knowledge to spend this money wisely.
…The Hayekian isn’t misled by romantic talk of “we as a nation” rebuilding New Orleans (or doing any other task) because the Hayekian never forgets that only individuals choose and act — and that the market is the only means of harnessing individual knowledge and effort for the greater good.

Part XIV to follow…
For previous postings on Economic Thoughts, refer to:
Part I: What is Economics?
Part II: Myths About Markets
Part III: Why Policy Goals are Trumped by Incentives They Create & the Role of Knowledge in Economics
Part IV: The Abuse of Reason, Fallacies & Dangers of Centralized Planning, Prices & Knowledge, and Understanding Limitations
Part V: The Relationship Between Economic Freedom and Political Freedom
Part VI: More on the Relationship Between Economic Freedom and Political Freedom
Part VII: The Role of Government in a Free Society
Part VIII: The Unspoken, But Very Real, Incentives That Drive Governmental Actions
Part IX: More on the Coercive Role of Government
Part X: The Power of the Market
Part XI: Prices
Part XII: I, Pencil – A Story about the Free Market at Work

This posting is Part XII in a series of postings about economic thoughts.
Years ago, Leonard E. Read of the Foundation for Economic Education wrote a now-famous story entitled I, Pencil. The story describes how, in the production of something as simple as a pencil, the free market naturally brings together many different physical materials and people’s efforts to meet a consumer need:

I am a lead pencil – the ordinary wooden pencil familiar to all boys and girls and adults who can read and write.
Writing is both my vocation and my avocation; that’s all I do.
You may wonder why I should write a genealogy. Well, to begin with, my story is interesting. And, next, I am a mystery – more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background. This supercilious attitude relegates me to the level of the commonplace. This is a species of the grievous error in which mankind cannot too long persist without peril. For, the wise G. K. Chesterton observed, “We are perishing for want of wonder, not for want of wonders.”
I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me – no, that’s too much to ask of anyone – if you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing. I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because – well, because I am seemingly so simple.
Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn’t it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year.
Pick me up and look me over. What do you see? Not much meets the eye – there’s some wood, lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser.
Innumerable Antecedents
Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain all my antecedents. But I would like to suggest enough of them to impress upon you the richness and complexity of my background…

In the next part of the article, the author then describes the efforts of the numerous parties who are involved in producing a pencil. The complexity is striking.
What does all this tell us about how a free marketplace can work? The author continues:

No One Knows
Does anyone wish to challenge my earlier assertion that no single person on the face of this earth knows how to make me?
Actually, millions of human beings have had a hand in my creation, no one of whom even knows more than a very few of the others. Now, you may say that I go too far in relating the picker of a coffee berry in far off Brazil and food growers elsewhere to my creation; that this is an extreme position. I shall stand by my claim. There isn’t a single person in all these millions, including the president of the pencil company, who contributes more than a tiny, infinitesimal bit of know-how. From the standpoint of know-how the only difference between the miner of graphite in Ceylon and the logger in Oregon is in the type of know-how. Neither the miner nor the logger can be dispensed with, any more than can the chemist at the factory or the worker in the oil field–paraffin being a by-product of petroleum.
Here is an astounding fact: Neither the worker in the oil field nor the chemist nor the digger of graphite or clay nor any who mans or makes the ships or trains or trucks nor the one who runs the machine that does the knurling on my bit of metal nor the president of the company performs his singular task because he wants me. Each one wants me less, perhaps, than does a child in the first grade. Indeed, there are some among this vast multitude who never saw a pencil nor would they know how to use one. Their motivation is other than me. Perhaps it is something like this: Each of these millions sees that he can thus exchange his tiny know-how for the goods and services he needs or wants. I may or may not be among these items.
No Master Mind
There is a fact still more astounding: The absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. This is the mystery to which I earlier referred.
It has been said that “‘only God can make a tree.'” Why do we agree with this? Isn’t it because we realize that we ourselves could not make one? Indeed, can we even describe a tree? We cannot, except in superficial terms. We can say, for instance, that a certain molecular configuration manifests itself as a tree. But what mind is there among men that could even record, let alone direct, the constant changes in molecules that transpire in the life span of a tree? Such a feat is utterly unthinkable!
I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies–millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree.
The above is what I meant when writing, “If you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing.” For, if one is aware that these know-hows will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand–that is, in the absence of governmental or any other coercive master-minding – then one will possess an absolutely essential ingredient for freedom: a faith in free people. Freedom is impossible without this faith.
Once government has had a monopoly of a creative activity such, for instance, as the delivery of the mails, most individuals will believe that the mails could not be efficiently delivered by men acting freely. And here is the reason: Each one acknowledges that he himself doesn’t know how to do all the things incident to mail delivery. He also recognizes that no other individual could do it. These assumptions are correct. No individual possesses enough know-how to perform a nation’s mail delivery any more than any individual possesses enough know-how to make a pencil. Now, in the absence of faith in free people – in the unawareness that millions of tiny know-hows would naturally and miraculously form and cooperate to satisfy this necessity – the individual cannot help but reach the erroneous conclusion that mail can be delivered only by governmental “master-minding.”
Testimony Galore
If I, Pencil, were the only item that could offer testimony on what men and women can accomplish when free to try, then those with little faith would have a fair case. However, there is testimony galore; it’s all about us and on every hand. Mail delivery is exceedingly simple when compared, for instance, to the making of an automobile or a calculating machine or a grain combine or a milling machine or to tens of thousands of other things. Delivery? Why, in this area where men have been left free to try, they deliver the human voice around the world in less than one second; they deliver an event visually and in motion to any person’s home when it is happening; they deliver 150 passengers from Seattle to Baltimore in less than four hours; they deliver gas from Texas to one’s range or furnace in New York at unbelievably low rates and without subsidy; they deliver each four pounds of oil from the Persian Gulf to our Eastern Seaboard – halfway around the world – for less money than the government charges for delivering a one-ounce letter across the street!
The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society’s legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand. This faith will be confirmed. I, Pencil, seemingly simple though I am, offer the miracle of my creation as testimony that this is a practical faith, as practical as the sun, the rain, a cedar tree, the good earth.

Part XIII to follow…
For previous postings on Economic Thoughts, refer to:
Part I: What is Economics?
Part II: Myths About Markets
Part III: Why Policy Goals are Trumped by Incentives They Create & the Role of Knowledge in Economics
Part IV: The Abuse of Reason, Fallacies & Dangers of Centralized Planning, Prices & Knowledge, and Understanding Limitations
Part V: The Relationship Between Economic Freedom and Political Freedom
Part VI: More on the Relationship Between Economic Freedom and Political Freedom
Part VII: The Role of Government in a Free Society
Part VIII: The Unspoken, But Very Real, Incentives That Drive Governmental Actions
Part IX: More on the Coercive Role of Government
Part X: The Power of the Market
Part XI: Prices

This posting is Part XI in a series of postings about economic thoughts.
The excerpts in this posting are taken from Chapter 3 in Thomas Sowell’s book Basic Economics: A Citizens Guide to the Economy and discusses prices, a key structural element in a competitive capitalistic economy.

Prices play a crucial role in determining how much of each resource gets used where. Yet this role is seldom understood by the pubic and it is often disregarded entirely by politicians.
Many people see prices as simply obstacles to their getting the things they want…
Prices are like messengers conveying news…prices convey…the end results…
Prices not only guide consumers, they guide producers as well. When all is said and done, producers cannot possibly know what millions of different consumers want…
While a free market economic system is sometimes called a profit system, it is really a profit-and-loss system – and the losses are equally important for the efficiency of the economy, because they tell manufacturers what to stop producing. Without really knowing why consumers like one set of features rather than another, producers automatically produce more of what earns a profit and less of what is losing money…Although the producers are only looking out for themselves and their companies’ bottom line, nevertheless from the standpoint of the economy as a whole the society is using its scarce resources more efficiently because decisions are guided by prices…
What this all means as a general principle is that the price that one producer is willing to pay for milk (or any other ingredient) is the price that other producers are forced to pay for that same ingredient. Since scarce resources have alternative uses, the value placed on one of these uses by one other individual or company becomes a cost that has to be paid by others who want to bid some of these resources away for their own use…this means that resources tend to flow to their most valued uses…
Prices coordinate the use of resources, so that only that amount is used for one thing which is equal in value to what it is worth to others in other uses…The efficient allocation of scarce resources which have alternative uses is not just an abstract notion of economists. It determines how well or how badly millions of people live…
…prices convey an underlying reality: From the standpoint of society as a whole, the “cost” of anything is the value that it has in alternative uses.…
Different economic systems deal with this underlying reality in different ways and with different degrees of efficiency, but the underlying reality exists independently of whatever particular economic system is used…
The consequence was that far more resources were used to produce a given amount of output in the Soviet economy as compared to a price-coordinated economic system, such as that in the United States…
The Soviet Union did not lack for resources…What it lacked was an economic system that made efficient use of scarce resources…Soviet enterprises were not forced to economize – that is, to treat their resources as both scarce and valuable in alternative uses. While such waste cost these enterprises little or nothing, they cost the Soviet people dearly, in the form of a lower standard of living than their resources and technology were capable of producing…
While history can tell us that such things happened [in the transitional years of Communist China to a less politically controlled economy], economics helps explain why they happened – what there is about prices that allows them to accomplish what political control of an economy can seldom match. There is more to economics than prices, but understanding how prices function is the foundation for understanding much of the rest of economics.
In a society of millions of consumers, no given individual or set of government decision-makers sitting around a table can possibly know just how much these millions of consumers prefer one product to another, much less thousand of products to thousands of other products – quite aside from the problem of knowing how much of each of thousand of resources should be used to produce which products. In an economy coordinated by prices, no one has to know…
Knowledge is one of the most scarce of all resources and a pricing system economizes on its use by forcing those with the most knowledge of their own particular situation to make bids for goods and resources based on that knowledge, rather than on their ability to influence other people…
In a price-coordinated economy, employees and creditors insist on being paid, regardless of whether the managers and owners have made mistakes. This means that capitalist businesses can make only so many mistakes for so long before they have to either stop or get stopped – whether by an inability to get the labor and supplies they need or by bankruptcy…
When people try to quantify a country’s “need” for this or that product or service, they are ignoring the fact that there is no fixed or objective “need.” The fact that people demand more at a lower price and less at a higher price may be easy to understand, but it is also easy to forget. Seldom, if ever, is there a fixed quantity demanded…
Likewise, there is no fixed supply…
When people projects that there will be a shortage…in the years ahead, they usually either ignore prices or implicitly assume that there will be a shortage at today’s prices. But shortages are precisely what cause prices to rise…Price fluctuations are a way of letting a little knowledge go a long way…
There are all kind of prices. The prices of consumer goods are the most obvious examples but labor also has prices called wages or salaries, and borrowed money has a price called interest…Prices produce incentives to conserve…
…So long as people are free to spend their money for what they see fit, price changes in response to supply and demand direct resources to where they are most in demand and direct people to where their desires can be satisfied most fully by the existing supply…
To treat prices as resulting from greed implies that sellers can set prices where they wish, that prices are not determined by supply and demand…
The fact that prices fluctuate over time, and occasionally have a sharp rise or a steep drop, misleads some people into concluding that prices are deviating from their “real” values…But their usual level under usual conditions is no more real or valid than their much higher or lower levels under different conditions…
Prices not only ration existing supplies, they also act as powerful incentives to cause supplies to rise or fall in response to changing demand…
…In short, people tend to do more for their own benefit than for the benefit of others. Freely fluctuating prices can make that turn out to be beneficial to others…

Part XII to follow…
For previous postings on Economic Thoughts, refer to:
Part I: What is Economics?
Part II: Myths About Markets
Part III: Why Policy Goals are Trumped by Incentives They Create & the Role of Knowledge in Economics
Part IV: The Abuse of Reason, Fallacies & Dangers of Centralized Planning, Prices & Knowledge, and Understanding Limitations
Part V: The Relationship Between Economic Freedom and Political Freedom
Part VI: More on the Relationship Between Economic Freedom and Political Freedom
Part VII: The Role of Government in a Free Society
Part VIII: The Unspoken, But Very Real, Incentives That Drive Governmental Actions
Part IX: More on the Coercive Role of Government
Part X: The Power of the Market

This posting is Part XI in a series of postings about economic thoughts.
The excerpts in this posting are taken from Chapter 3 in Thomas Sowell’s book Basic Economics: A Citizens Guide to the Economy and discusses prices, a key structural element in a competitive capitalistic economy.

Prices play a crucial role in determining how much of each resource gets used where. Yet this role is seldom understood by the pubic and it is often disregarded entirely by politicians.
Many people see prices as simply obstacles to their getting the things they want…
Prices are like messengers conveying news…prices convey…the end results…
Prices not only guide consumers, they guide producers as well. When all is said and done, producers cannot possibly know what millions of different consumers want…
While a free market economic system is sometimes called a profit system, it is really a profit-and-loss system – and the losses are equally important for the efficiency of the economy, because they tell manufacturers what to stop producing. Without really knowing why consumers like one set of features rather than another, producers automatically produce more of what earns a profit and less of what is losing money…Although the producers are only looking out for themselves and their companies’ bottom line, nevertheless from the standpoint of the economy as a whole the society is using its scarce resources more efficiently because decisions are guided by prices…
What this all means as a general principle is that the price that one producer is willing to pay for milk (or any other ingredient) is the price that other producers are forced to pay for that same ingredient. Since scarce resources have alternative uses, the value placed on one of these uses by one other individual or company becomes a cost that has to be paid by others who want to bid some of these resources away for their own use…this means that resources tend to flow to their most valued uses…
Prices coordinate the use of resources, so that only that amount is used for one thing which is equal in value to what it is worth to others in other uses…The efficient allocation of scarce resources which have alternative uses is not just an abstract notion of economists. It determines how well or how badly millions of people live…
…prices convey an underlying reality: From the standpoint of society as a whole, the “cost” of anything is the value that it has in alternative uses.…
Different economic systems deal with this underlying reality in different ways and with different degrees of efficiency, but the underlying reality exists independently of whatever particular economic system is used…
The consequence was that far more resources were used to produce a given amount of output in the Soviet economy as compared to a price-coordinated economic system, such as that in the United States…
The Soviet Union did not lack for resources…What it lacked was an economic system that made efficient use of scarce resources…Soviet enterprises were not forced to economize – that is, to treat their resources as both scarce and valuable in alternative uses. While such waste cost these enterprises little or nothing, they cost the Soviet people dearly, in the form of a lower standard of living than their resources and technology were capable of producing…
While history can tell us that such things happened [in the transitional years of Communist China to a less politically controlled economy], economics helps explain why they happened – what there is about prices that allows them to accomplish what political control of an economy can seldom match. There is more to economics than prices, but understanding how prices function is the foundation for understanding much of the rest of economics.
In a society of millions of consumers, no given individual or set of government decision-makers sitting around a table can possibly know just how much these millions of consumers prefer one product to another, much less thousand of products to thousands of other products – quite aside from the problem of knowing how much of each of thousand of resources should be used to produce which products. In an economy coordinated by prices, no one has to know…
Knowledge is one of the most scarce of all resources and a pricing system economizes on its use by forcing those with the most knowledge of their own particular situation to make bids for goods and resources based on that knowledge, rather than on their ability to influence other people…
In a price-coordinated economy, employees and creditors insist on being paid, regardless of whether the managers and owners have made mistakes. This means that capitalist businesses can make only so many mistakes for so long before they have to either stop or get stopped – whether by an inability to get the labor and supplies they need or by bankruptcy…
When people try to quantify a country’s “need” for this or that product or service, they are ignoring the fact that there is no fixed or objective “need.” The fact that people demand more at a lower price and less at a higher price may be easy to understand, but it is also easy to forget. Seldom, if ever, is there a fixed quantity demanded…
Likewise, there is no fixed supply…
When people projects that there will be a shortage…in the years ahead, they usually either ignore prices or implicitly assume that there will be a shortage at today’s prices. But shortages are precisely what cause prices to rise…Price fluctuations are a way of letting a little knowledge go a long way…
There are all kind of prices. The prices of consumer goods are the most obvious examples but labor also has prices called wages or salaries, and borrowed money has a price called interest…Prices produce incentives to conserve…
…So long as people are free to spend their money for what they see fit, price changes in response to supply and demand direct resources to where they are most in demand and direct people to where their desires can be satisfied most fully by the existing supply…
To treat prices as resulting from greed implies that sellers can set prices where they wish, that prices are not determined by supply and demand…
The fact that prices fluctuate over time, and occasionally have a sharp rise or a steep drop, misleads some people into concluding that prices are deviating from their “real” values…But their usual level under usual conditions is no more real or valid than their much higher or lower levels under different conditions…
Prices not only ration existing supplies, they also act as powerful incentives to cause supplies to rise or fall in response to changing demand…
…In short, people tend to do more for their own benefit than for the benefit of others. Freely fluctuating prices can make that turn out to be beneficial to others…

Part XII to follow…
For previous postings on Economic Thoughts, refer to:
Part I: What is Economics?
Part II: Myths About Markets
Part III: Why Policy Goals are Trumped by Incentives They Create & the Role of Knowledge in Economics
Part IV: The Abuse of Reason, Fallacies & Dangers of Centralized Planning, Prices & Knowledge, and Understanding Limitations
Part V: The Relationship Between Economic Freedom and Political Freedom
Part VI: More on the Relationship Between Economic Freedom and Political Freedom
Part VII: The Role of Government in a Free Society
Part VIII: The Unspoken, But Very Real, Incentives That Drive Governmental Actions
Part IX: More on the Coercive Role of Government
Part X: The Power of the Market

This posting is Part X in a series of postings about economic thoughts.
Milton and Rose Friedman, in Chapter 1 of their 1979 book, Free to Choose: A Personal Statement, discuss the power of the market:

…we know of no society that has ever achieved prosperity and freedom, unless voluntary exchange has been its dominant principle of organization. We hasten to add that voluntary exchange is not a sufficient condition for prosperity…but…is a necessary condition…
THE ROLE OF PRICES
The key insight of Adam Smith’s Wealth of Nations is misleadingly simple: if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it. Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.
This key insight is obvious for a simple exchange between two individuals. It is far more difficult to understand how it can enable people living all over the world to cooperate to promote their separate interests.
The price system is the mechanism that performs this task without central direction, without requiring people to speak to one another or to like one another…the price system enables people to cooperate peacefully in one phase of their life while each one goes about his own business with respect of everything else…
…It was a startling idea then, and it remains one today, that economic order can emerge as the unintended consequence of the actions of many people, each seeking his own interest.
The price system works so well, so efficiently, that we are not aware of it most of the time. We never realize how well it functions until it is prevented from functioning, and even then we seldom recognize the source of the trouble…
Prices perform three functions in organizing economic activity: first, they transmit information; second, they provide an incentive to adopt those methods of production that are least costly and thereby use available resources for the most highly valued purposes; third, they determine who gets how much of the product – the distribution of income. These three functions are closely interrelated…
Transmission of Information
The price system transmits only the important information and only to the people who need to know…
A major problem in transmitting information efficiently is to make sure that everyone who can use the information gets it without clogging the “in” baskets of those who have no use for it. The price system automatically solves this problem. The people who transmit the information have an incentive to search out the people who can use it and they are in a position to do so. People who can use the information have an incentive to get it and they are in a position to do so…
The transmission of information through prices is enormously facilitated these days by organized markets and by specialized communication facilities…
Anything that prevents prices from expressing freely the conditions of demand or supply interferes with the transmission of accurate information. Private monopoly…is one example…Price controls on oil and other forms of energy by the U.S. government [are another.]…
Important as private distortions of the price system are, these days the government is the major source of interference with a free market system – through tariffs and other restraints on international trade, domestic action fixing or affecting individual prices, including wages, government regulation of specific industries, monetary and fiscal policies producing erratic inflation, and numerous other channels…
Incentives
The effective transmission of accurate information is wasted unless the relevant people have an incentive to act, and act correctly on the basis of that information…One of the beauties of a free price system is that the prices that bring the information also provide both an incentive to react to the information and the means to do so.
This function of prices is intimately connected with the third function – determining the distribution of income – and cannot be explained without bringing that function into the account…
Prices also provide an incentive to act on information not only about the demand for output but also about the most efficient way to produce a product…
We have discussed the incentive effect so far in terms of producers and consumers. But it also operates with respect to workers and owners of other productive resources…
Distribution of Income
In countries like the United States the major productive resource is personal productive capacity – what economists call “human capital.” Something like three-quarters of all income generated in the United States through market transactions takes the form of the compensation of employees (wages and salaries plus supplements) and about half the rest takes the form of the income of proprietors of farm and nonfarm enterprises…
The accumulation of physical capital…has played an essential role in economic growth…
But the accumulation of human capital – in the form of increased knowledge and skills and improved health and longevity – has also played an essential role. And the two have reinforced each other. The physical capital enabled people to be far more productive by providing them with the tools to work with. And the capacity of people to invent new forms of physical capital, to learn how to use and get the most out of physical capital, and to organize the use of both physical and human capital on a larger and larger scale enabled the physical capital to be more productive. Both physical and human capital must be cared for and replaced…
The amount of each kind of resource each of us owns is partly the result of chance, partly of choice by ourselves or others…
The price that the market sets on the services of our resources is similarly affected by a bewildering mixture of chance and choice…the price we receive for the services of our resources through the market also depends on our own choices – where we choose to settle, how we choose to use those resources, to whom we choose to sell…services, and so on.
In every society, however it is organized, there is always dissatisfaction with the distribution of income…In a command system envy and dissatisfaction are directed at rulers. In a free market system they are directed at the market.
One result has been an attempt to separate this function of the price system – distributing income – from its other functions – transmitting information and providing incentives. Much government activity during recent decades…has been directed at altering the distribution of income generated by the market in order to produce a different and more equitable distribution of income…
However we might wish it otherwise, it simply is not possible to use prices to transmit information and provide an incentive to act on that information without using prices also to affect, even if not completely determine, the distribution of income. If what a person gets does not depend on the price he receives for the services of his resources, what incentive does he have to seek out information on prices or act on the basis of that information?…If prices are prevented from affecting the distribution of income, they cannot be used for other purposes. The only alternative is command. Such authority would have to decide who should produce what and how much…
A BROADER VIEW
Adam Smith’s “invisible hand” is generally regarded as referring to the purchases or sales of goods or services for money. But economic activity is by no means the only area of human life in which a complex and sophisticated structure arises as an unintended consequence of a large number of individuals cooperating while each pursues his own interests.
Consider, for example, language…
How did language develop? In much the same way as an economic order develops through the market – out of the voluntary interaction of individuals…One or another meaning was attributed to a word, or words were added as the need arose. Grammatical usages developed and were later codified into rules. Two parties who want to communicate with one another both benefit from coming to a common agreement about the words they use…As a wider and wider circle of people find it advantageous to communicate with one another, a common usage spreads and is codified in dictionaries. At no point is there any coercion, any central planner who has power to command…
Another example is scientific knowledge. The structure of disciplines [within science] was not the product of a deliberate decision by anyone…
Within any discipline the growth of the subject strictly parallels the economic marketplace. Scholars cooperate with one another because they find it mutually beneficial. They accept from one another’s work what they find useful. They exchange their findings…The esteem or approval of fellow scholars serves very much the same function that monetary reward does in the economic marketplace….
A society’s values, its culture, its social conventions – all these develop in the same way, through voluntary exchange, spontaneous cooperation, the evolution of a complex structure through trial and error, acceptance and rejection…
The structures produced by voluntary exchange…develop a life of their own. They are capable of taking many different forms under different circumstances. Voluntary exchange can produce uniformity in some respects combined with diversity in others. It is a subtle process whose general principles of operation can fairly readily be grasped but whose detailed results can seldom be foreseen.
These examples may suggest not only the wide scope for voluntary exchange but also the broad definition that must be attached to the concept of “self-interest.” Narrow preoccupation with the economic market has led to a narrow interpretation of self-interest as myopic selfishness, as exclusive concern with immediate material rewards…That is a great mistake. Self-interest is not myopic selfishness. It is whatever it is that interests the participants, whatever they value, whatever goals they pursue…all are pursuing their interests, as they see them, as they judge them by their own values.

(more…)

This posting is Part X in a series of postings about economic thoughts.
Milton and Rose Friedman, in Chapter 1 of their 1979 book, Free to Choose: A Personal Statement, discuss the power of the market:

…we know of no society that has ever achieved prosperity and freedom, unless voluntary exchange has been its dominant principle of organization. We hasten to add that voluntary exchange is not a sufficient condition for prosperity…but…is a necessary condition…
THE ROLE OF PRICES
The key insight of Adam Smith’s Wealth of Nations is misleadingly simple: if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it. Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.
This key insight is obvious for a simple exchange between two individuals. It is far more difficult to understand how it can enable people living all over the world to cooperate to promote their separate interests.
The price system is the mechanism that performs this task without central direction, without requiring people to speak to one another or to like one another…the price system enables people to cooperate peacefully in one phase of their life while each one goes about his own business with respect of everything else…
…It was a startling idea then, and it remains one today, that economic order can emerge as the unintended consequence of the actions of many people, each seeking his own interest.
The price system works so well, so efficiently, that we are not aware of it most of the time. We never realize how well it functions until it is prevented from functioning, and even then we seldom recognize the source of the trouble…
Prices perform three functions in organizing economic activity: first, they transmit information; second, they provide an incentive to adopt those methods of production that are least costly and thereby use available resources for the most highly valued purposes; third, they determine who gets how much of the product – the distribution of income. These three functions are closely interrelated…
Transmission of Information
The price system transmits only the important information and only to the people who need to know…
A major problem in transmitting information efficiently is to make sure that everyone who can use the information gets it without clogging the “in” baskets of those who have no use for it. The price system automatically solves this problem. The people who transmit the information have an incentive to search out the people who can use it and they are in a position to do so. People who can use the information have an incentive to get it and they are in a position to do so…
The transmission of information through prices is enormously facilitated these days by organized markets and by specialized communication facilities…
Anything that prevents prices from expressing freely the conditions of demand or supply interferes with the transmission of accurate information. Private monopoly…is one example…Price controls on oil and other forms of energy by the U.S. government [are another.]…
Important as private distortions of the price system are, these days the government is the major source of interference with a free market system – through tariffs and other restraints on international trade, domestic action fixing or affecting individual prices, including wages, government regulation of specific industries, monetary and fiscal policies producing erratic inflation, and numerous other channels…
Incentives
The effective transmission of accurate information is wasted unless the relevant people have an incentive to act, and act correctly on the basis of that information…One of the beauties of a free price system is that the prices that bring the information also provide both an incentive to react to the information and the means to do so.
This function of prices is intimately connected with the third function – determining the distribution of income – and cannot be explained without bringing that function into the account…
Prices also provide an incentive to act on information not only about the demand for output but also about the most efficient way to produce a product…
We have discussed the incentive effect so far in terms of producers and consumers. But it also operates with respect to workers and owners of other productive resources…
Distribution of Income
In countries like the United States the major productive resource is personal productive capacity – what economists call “human capital.” Something like three-quarters of all income generated in the United States through market transactions takes the form of the compensation of employees (wages and salaries plus supplements) and about half the rest takes the form of the income of proprietors of farm and nonfarm enterprises…
The accumulation of physical capital…has played an essential role in economic growth…
But the accumulation of human capital – in the form of increased knowledge and skills and improved health and longevity – has also played an essential role. And the two have reinforced each other. The physical capital enabled people to be far more productive by providing them with the tools to work with. And the capacity of people to invent new forms of physical capital, to learn how to use and get the most out of physical capital, and to organize the use of both physical and human capital on a larger and larger scale enabled the physical capital to be more productive. Both physical and human capital must be cared for and replaced…
The amount of each kind of resource each of us owns is partly the result of chance, partly of choice by ourselves or others…
The price that the market sets on the services of our resources is similarly affected by a bewildering mixture of chance and choice…the price we receive for the services of our resources through the market also depends on our own choices – where we choose to settle, how we choose to use those resources, to whom we choose to sell…services, and so on.
In every society, however it is organized, there is always dissatisfaction with the distribution of income…In a command system envy and dissatisfaction are directed at rulers. In a free market system they are directed at the market.
One result has been an attempt to separate this function of the price system – distributing income – from its other functions – transmitting information and providing incentives. Much government activity during recent decades…has been directed at altering the distribution of income generated by the market in order to produce a different and more equitable distribution of income…
However we might wish it otherwise, it simply is not possible to use prices to transmit information and provide an incentive to act on that information without using prices also to affect, even if not completely determine, the distribution of income. If what a person gets does not depend on the price he receives for the services of his resources, what incentive does he have to seek out information on prices or act on the basis of that information?…If prices are prevented from affecting the distribution of income, they cannot be used for other purposes. The only alternative is command. Such authority would have to decide who should produce what and how much…
A BROADER VIEW
Adam Smith’s “invisible hand” is generally regarded as referring to the purchases or sales of goods or services for money. But economic activity is by no means the only area of human life in which a complex and sophisticated structure arises as an unintended consequence of a large number of individuals cooperating while each pursues his own interests.
Consider, for example, language…
How did language develop? In much the same way as an economic order develops through the market – out of the voluntary interaction of individuals…One or another meaning was attributed to a word, or words were added as the need arose. Grammatical usages developed and were later codified into rules. Two parties who want to communicate with one another both benefit from coming to a common agreement about the words they use…As a wider and wider circle of people find it advantageous to communicate with one another, a common usage spreads and is codified in dictionaries. At no point is there any coercion, any central planner who has power to command…
Another example is scientific knowledge. The structure of disciplines [within science] was not the product of a deliberate decision by anyone…
Within any discipline the growth of the subject strictly parallels the economic marketplace. Scholars cooperate with one another because they find it mutually beneficial. They accept from one another’s work what they find useful. They exchange their findings…The esteem or approval of fellow scholars serves very much the same function that monetary reward does in the economic marketplace….
A society’s values, its culture, its social conventions – all these develop in the same way, through voluntary exchange, spontaneous cooperation, the evolution of a complex structure through trial and error, acceptance and rejection…
The structures produced by voluntary exchange…develop a life of their own. They are capable of taking many different forms under different circumstances. Voluntary exchange can produce uniformity in some respects combined with diversity in others. It is a subtle process whose general principles of operation can fairly readily be grasped but whose detailed results can seldom be foreseen.
These examples may suggest not only the wide scope for voluntary exchange but also the broad definition that must be attached to the concept of “self-interest.” Narrow preoccupation with the economic market has led to a narrow interpretation of self-interest as myopic selfishness, as exclusive concern with immediate material rewards…That is a great mistake. Self-interest is not myopic selfishness. It is whatever it is that interests the participants, whatever they value, whatever goals they pursue…all are pursuing their interests, as they see them, as they judge them by their own values.

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