To appreciate why market prices are essential to human well-being, consider what a fix we
would be in without them. Suppose you were the commissar of
railroads in the old Soviet Union. Markets and prices have been banished. You and your comrades. Passionate communists all. Now, directly plan how to
use available resources. You want a railroad from city A to city B,
but between the cities is a mountain range. Suppose somehow you know that
the railroad once built. Will serve the nation equally well. Whether it goes through the mountains or
around. If you build through the mountains,
you'll use much less steel for the tracks. Because that route is shorter. But you'll use a great deal of
engineering to design the trestles and tunnels needed to cross the rough terrain. That matters because engineering is also
needed to design irrigation systems, mines, harbor installations and
other structures. And you don't want to tie up
engineering on your railroad if it would be more valuable designing
those other structures instead. You can save engineering for
other projects. If you build around
the mountains on level ground. But that way you'll use much more steel
rail to go the longer distance and steel is also needed for other purposes. For vehicles, girders, ships, pots and
pans and thousands of other things. Which route should you choose for
the good of the nation? To answer, you would need to
determine which bundle of resources is less urgently needed for
other purposes. The large amount of engineering and
small amount of steel for the route through the mountains,
where the small amount of engineering and large amount of steel for
the roundabout route. But how could you find out the urgency
of need for engineering and steel in other uses? Just one way engineering is used
is to build irrigation systems. To assess the importance of a particular
irrigation system, you would need to know what the farmers know about how irrigation
would increase the yield of their fields. And to know the value of that increased
yield, you'd need to know what grocers know about their customers eagerness for
that produce. That in turn depends on what customers
know about the better meals they could fix with that produce. How would you find all this out? Just one way to use steel
is to build new trucks. To assess the importance of a particular
new truck, you would need to know what the trucker knows about the capacity
of his current truck, and how much more quickly he could make the deliveries his
customers want with a new bigger truck. To know the importance of those
deliveries, you would need to know what his customers know about the value
of getting goods delivered. That in turn depends on what still others
know about the uses of those goods at their destinations. To reason about where
to route the railroad, you need this kind of information for all
possible uses of engineering and steel. That's a massive amount of knowledge, held
by millions of people throughout society. How might you get it? You might try surveys, but think how
many people you would need to survey. All those who prepare meals with produce,
and all those who take delivery by truck for
starters. The numbers would be staggering. And often people don't even know what they
prefer until they face an actual choice. So they might not be able to answer
survey questions accurately. Even if they could,
by the time the surveys were returned and processed, much of the information
would be out of date. And even if you could get complete and
timely information about what everyone knows, that's relevant
to every use of steel in engineering, you would still need to deduce from
it where to build the railroad. How would you begin to make
sense of that mountain of data? In the words of Ludwig von Mises,
you would be groping in the dark. You would face what is known as
the knowledge problem of central planning. The reason why comprehensive
socialism inevitably fails. Central planners cannot get the knowledge
they need in order to plan effectively. You, commissar, simply cannot know on what
projects scarce resources should be used for the good of the nation. But now change the thought experiment. Imagine that somewhere in the market
economy part of the world, you are the chief operating
officer of a railroad company. You work not for the good of the nation,
but to generate profits for your firm. You want to run a railroad
line from city C to city D. Again, there's a mountain
range between them. Now, how do you decide on the route? You choose what's cheapest. You would calculate the total
cost of each route for each one, multiplying the amount of engineering
required by the price of engineering, and adding that to the amount of steel
required times the price of steel. Then, you would choose whichever
cost your company less. You might give no thought at all to the
good of the nation or society as a whole. But, and here's the marvel,
by choosing the route that is cheapest for your company you would thereby choose
the route that's best for society. You would use the bundle of resources
that's least urgently needed for other purposes. Why? Because those market prices you calculate
with reflects the urgency of need for engineering and
steel in all their alternative uses. For example, suppose customers wanting
to taste your meals, would buy better, more expensive produce, if it were
on the shelf of their local grocery. In effect,
they're offering grocers more for produce. So the grocers will offer farmers more for
produce. So the farmers who feels would be
sufficiently improved by irrigation will offer more for irrigation systems. And those who build irrigation systems
will offer engineers more to design them. Now that designing irrigation
systems pays engineers better, people who want to hire engineers for
other projects, such as railroads, will have to offer them at least as
much to make it worth their while. The higher price tells everyone who
uses engineering that it's become, for some reason, more valuable so
maybe they should use less. In this way, the market prices of
resources represent the particular knowledge and preferences of
millions of people who directly or indirectly use those resources. And the prices communicate
that knowledge and those preferences to everyone interested. Only with market prices to communicate
this vast amount of human knowledge to us. Can we calculate the least costly
ways of producing the things we want, coordinator activities with the activities
of others, use resources where society values the most, and thereby satisfy
as many human wants as possible?
TL;DR; The economic calculation problem.