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How Expectations Coordinate Markets

January 2, 2018 in Economics

By Richard M. Ebeling


By: Richard M. Ebeling

Open, competitive markets have a resilient capacity to successfully coordinate the actions of, now, billions of people around the world. With an amazing adaptability to changing circumstances, the actions and reactions of multitudes of suppliers and demanders are brought into balance with each other. Yet, none of this requires government planning, regulation or directing control. But how does this all come about?

The key to this coordinating process is often assigned to the pricing system of the market economy. All the minimal information that anyone needs to bring his own actions as supplier or demander into balance with multitudes of others with whom he is interdependent is provided by the changing pattern of relative prices for finished consumer goods and the factors of production (labor, land, raw materials and capital).

Types and Uses of Knowledge in Society

Austrian economist Friedrich A. Hayek explained how this came about almost 75 years ago in his famous article, “The Use of Knowledge in Society,” first published in the American Economic Review in September 1945. He emphasized that matching the division of labor is an inescapable division of knowledge. Specialization necessarily means that each of us knows things that others do not.

Each of us possesses different types of knowledge in different complementary combinations. For instance, all of us, to one degree or another, have acquired what Hayek referred to as scientific or “textbook” knowledge. This is the type of knowledge we learned in school, and while we all learned many of the same things in our classroom experiences, especially in college or university we focused on and acquired far more specific and detailed knowledge about some subject in which we majored than many others who selected different majors at the same and different institutions of higher learning. The medical doctor knows many things that the criminal lawyer does not, just as the lawyer has a detailed knowledge of his area of the law that the biologist or the architect do not possess based on their classroom and assigned textbook learning, and so on.

Localized Knowledge of Time and Place

But Hayek pointed out that there is also another type of knowledge that we each possess in different ways, what he called “the localized knowledge of time and place.” This is the particular knowledge that is only learned, appreciated, and useable based on an individual working and interacting with others in a specific corner …read more


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