What I Didn't Learn in Econ 101

I took Economics 101 in college. Economics was a subject that has always interested me, so I was happy to take a few courses on the subject. Like many of my other classes, I don't remember much. All I can recall from this course is the introduction to Adam Smith's invisible hand, a few graphs, and some details about Keynesian economics.

But what is the nature of economic theory? I had no idea until I read The Use of Knowledge in Society by Friedrich Hayek a few days ago.

A logical answer might be how to make best use of available means to bring economic prosperity. To answer this we have to “possess all relevant information,” “start out from a given system of preferences,” and “command complete knowledge of available means.” This reveals and even more fundamental problem in economics, “the problem of utilization of knowledge which is not given to anyone in its totality.”

How is planning to be done so that the economy operate efficiently? Should it be done by a central authority? Should it be divided among individuals? Should it be done by delegating it to some kind of representative for an industry or group of people?

Hayek points out that the answer to this question will depend on a what kind of knowledge is given the greatest importance. Scientific knowledge is given high value, especially today. With this knowledge it makes sense that a chosen expert or set of experts may be the best to carryout the planning. But what of the “knowledge of general rules: the knowledge of the particular circumstances of time and place.” Given this, every individual possesses some information which can be used to his benefit. Take for example a real estate agent who makes his living off temporary opportunities, he may know of certain high quality leases that will be ending that others do not know.

Often someone who employs theoretical or technical knowledge often values it so high, that when someone who employees this general knowledge to gain an advantage is thought to act dishonorably. Being an engineer myself, this attitude is prevalent among scientists and engineers. Perhaps it is because this general knowledge is so simple in comparison that it should yield no distinct advantage and should be available to all. But if this knowledge was available, then economics would not seek to answer this question. It is the fact that this knowledge is not generally available all that its value comes from. (Hayek goes onto point out that statistical aggregates are unable to draw upon this knowledge, making the job of a central planner incredibly difficult).

This brings us to the price system, a beautiful means of transferring essential information and only to those who are concerned. The consumer doesn't need to concern himself with the details of the means of production, demand, or scarcity of an item. This information is summed up in the price. Should a resource become more scare a consumer will lessen his dependence on the product simply because of a change in price. Individuals will be guided by the change in price. This allows for individuals to act appropriately, with regard to the market, without anyone telling him how to act. Through the price system comes the division of labor and coordinated utilization of resources, all based on the knowledge of each individual.

The problem is precisely how to extend the span of our utilization or resources beyond the span of the control of any one mind; and therefore, how to dispense with the need of conscious control, and how to provide inducements which will make the individuals do the desirable things without anyone having to tell them what to do.

– Hayek

This is the heart of economics: “the problem of utilization of knowledge which is not given to anyone in its totality.” The graphs in Economics 101 made for some pretty pictures, but which Hayek points out, “in effect starts from the assumption that people's knowledge corresponds with objective facts of the situation, systematically leaves out what is our main task to explain.”