I've been sitting in on Christopher Coyne's Micro Theory class. Tonight's lecture was particularly good. The topic was Hayek's theories on the market and the use of knowledge. At one point, Coyne referred to the old joke about the economist who sees a $20 bill on the sidewalk but his economist friend insists it couldn't actually be there. In my first of what will probably be a few posts attempting to explain Austrian theory, I'll use that joke to illustrate a bit about knowledge in the market.
The second economist in the joke is meant to be a subscriber to the perfect markets idea. The joke - playing a bit fast and loose with the word, if you ask me - highlights how ridiculous it is to assume perfect knowledge. I've encountered a few people who triumphantly confront me with the point that "economics is silly because it thinks people are perfect and know everything and markets are infallible." The beauty of Hayek's theory is that it recognizes humans are not perfect, do not know everything, and do make mistakes...and that free markets are necessary for this very reason. Perhaps it is petty of me, but I do love responding to the aforementioned straw man by calmly noting that sound economics makes no such assumption, but that this only strengthens the case for markets.
There are, obviously, $20 bills on the sidewalk. They are not strewn about on every corner of every block, but they do exist. This is, I believe, precisely what Hayek meant in saying that knowledge is acquired over time as individual preferences and circumstances change, and when someone acquires the right information at the right time AND recognizes the opportunity, they are able to offer something new in the market. When an entrepreneur recognizes the opportunity to use new knowledge to create wealth, a $20 has been found. Sometimes no one acquires sufficient knowledge to recognize an opportunity to create wealth, or the knowledge is there but the individual makes a mistake in valuing the opportunity and it is therefore unfulfilled. In this case, no $20. As one might guess, the number of times a proverbial 20 is found pales in comparison to the number of times it isn't. Humans aren't perfect, and there is a lot of information out there, so it shouldn't come as a surprise that $20's aren't carpeting the pavement.
Some find it difficult to swallow the fact that humans are imperfect, and like to think that intervention in the market can make things better. In my opinion, though, it is pretty wonderful, even awe inspiring, that markets emerge so that people can interact, exchange information, and help each other find as many 20's as possible.
The second economist in the joke is meant to be a subscriber to the perfect markets idea. The joke - playing a bit fast and loose with the word, if you ask me - highlights how ridiculous it is to assume perfect knowledge. I've encountered a few people who triumphantly confront me with the point that "economics is silly because it thinks people are perfect and know everything and markets are infallible." The beauty of Hayek's theory is that it recognizes humans are not perfect, do not know everything, and do make mistakes...and that free markets are necessary for this very reason. Perhaps it is petty of me, but I do love responding to the aforementioned straw man by calmly noting that sound economics makes no such assumption, but that this only strengthens the case for markets.
There are, obviously, $20 bills on the sidewalk. They are not strewn about on every corner of every block, but they do exist. This is, I believe, precisely what Hayek meant in saying that knowledge is acquired over time as individual preferences and circumstances change, and when someone acquires the right information at the right time AND recognizes the opportunity, they are able to offer something new in the market. When an entrepreneur recognizes the opportunity to use new knowledge to create wealth, a $20 has been found. Sometimes no one acquires sufficient knowledge to recognize an opportunity to create wealth, or the knowledge is there but the individual makes a mistake in valuing the opportunity and it is therefore unfulfilled. In this case, no $20. As one might guess, the number of times a proverbial 20 is found pales in comparison to the number of times it isn't. Humans aren't perfect, and there is a lot of information out there, so it shouldn't come as a surprise that $20's aren't carpeting the pavement.
Some find it difficult to swallow the fact that humans are imperfect, and like to think that intervention in the market can make things better. In my opinion, though, it is pretty wonderful, even awe inspiring, that markets emerge so that people can interact, exchange information, and help each other find as many 20's as possible.
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