Freedom and Economic Order

by Linda C Raeder

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  We previously noted that the language of prices is relied upon not only by producers but also individuals in their role as consumers. However little they may be aware of the fact, price considerations play a crucial role in orienting human action in daily life. Prices guide such action at every level, and a moment’s reflection makes clear that price considerations of one kind or another are never far from the human mind. As always, the starting part of economic analysis begins with the fundamental fact from which all economic behavior and reasoning flow—the fact of scarcity. In the case of the consumer, it is clear that the resources held by any individual, like the resources of society at large and of nature itself, are characterized by scarcity. No human being possesses unlimited resources. Consequently, each individual confronts a personal economic problem similar to the economic problem of society as a whole. That is, the scarcity of individual resources forces each individual to choose—to decide among the myriad goods and services available on the market which he will actually purchase. Resources are limited; no one can have it all. Every individual must decide how to employ his personal scarce resources in a manner that will best meet his individual needs and preferences, with minimum expense. Such can only be achieved if the individual possesses relevant knowledge of available possibilities, knowledge again transmitted through the language of price. No one wants to pay more for an item than necessary. The less one spends on any particular item, the more is available to purchase other goods and services, to fulfill other needs or desires. Such a fact may seem mere common sense, insultingly simple and elementary. It is only common knowledge, however, because everyone knows how to read the language of prices, whether they know anything of the laws of economics or not.

  To further highlight the indispensable role of prices in guiding human action, consider the role of price considerations in one of the most fundamental of all life decisions—the choice of profession or career. In the absence of the information conveyed by a society’s prevailing structure of relative prices, individuals would have little means of determining the best use of their talents and abilities in a manner compatible with the facts of social existence, that is, the relative scarcity and abundance of limited resources and the value placed upon such resources by their fellow men. When considering possible career choices, most persons attempt to find a profession they will enjoy and that permits development of their individual potential. Various options, however, always exist; rarely are a person’s abilities so specialized that there is only one possible choice of profession open to him or her. Most people, moreover, not only want to find enjoyment in their work but also enjoy a secure income. To do so requires the development of skills that can be sold or traded on the market. Individuals entering the workforce must have something to offer to others, a good or service that other persons sufficiently value to be willing voluntarily to offer their own resources in exchange. An individual’s choice of profession, then, is greatly facilitated by possessing knowledge of the value that other people place on various skills and services. Such information is embodied in relative prices, in particular, the salaries typically earned in various professions. Should a person aim for a career as a dishwasher at McDonald’s or an accountant at Price Waterhouse? Such a question may seem silly—everyone knows the latter position would not only be more fulfilling but also more lucrative. Again, however, how does everyone know this? They know it because everyone understands the language of price. Everyone knows that accountants earn more than dishwashers precisely because they have more or less effortlessly learned to read and speak the language of prices.

  In the absence of the information conveyed by market prices, individuals would have no way of knowing the relative financial reward of developing the skills of a dishwasher or an accountant. They would have no way of knowing how their particular talents and abilities can be employed in a manner compatible with the values of their fellows, as indicated by the amount the latter are willing to pay for the skill in question. Nor would they have any way of knowing how their particular talents and skills mesh with the facts of existence, in this case, the relative scarcity or abundance of dishwashing and accounting skills. They would have no way of knowing how to incorporate their own abilities into the more comprehensive economic and social order within which each person necessarily exists; no man is an island. A salary is a price like any other price, and the labor market a market like any other market. Relative salaries reflect both the scarcity or abundance of particular skills and the value placed on them by members of society; the higher the salary, the greater its value to one’s fellows or the greater its scarcity. Moreover, certain types of work are essential for human survival. In the absence of relative price signals that serve to guide individuals into professions of greatest value to their fellows, individuals would have to be directed toward essential professions or occupations by some external authority. In other words, there could be no free or voluntary choice of profession without the indispensable guidance provided by the prevailing structure of relative prices.

  Prices, then, represent a universal language that guides every individual’s personal and professional decisions in a profound manner. They are a means of enabling individuals to exercise freedom—voluntary choice—with respect to both everyday needs and wants and larger concerns such as choice of profession. In the absence of freely forming relative prices in a world characterized by scarcity, people would be unable to orient their individual actions in a manner consistent with either the facts of existence or the values and actions of their fellows. Price considerations cannot be avoided. Every person, like the world as a whole, has limited resources and an interest in choosing the least-cost means of satisfying his needs and desires. The information conveyed by prices permits human beings to do so with minimum effort and in a manner that takes account of the relative scarcity or abundance of resources. The price system not only permits individuals to make sound economic decisions regarding their own limited resources but also serves a wider social function. Through its operation, individuals, whether acting as consumers or producers, are led, quite without conscious awareness, to behave precisely as they should behave from the point of view of society as a whole, that is, efficiently employing scarce resources in the production of goods and services that people subjectively value. Last but not least among such considerations, the guidance of relative prices also permits them to do so in freedom.

  The Market Process in Action

  We have said that the market provides a solution to the economic problem arising from scarcity. It should be clear, however, that such can only be true in a metaphorical sense. The market is not a “thing” or a conscious, willing entity capable of devising solutions or, indeed, of any form of agency. It is rather a metaphor for an impersonal social process that unfolds over time within a framework of general rules and institutional arrangements and leads individual human beings to contribute to the solution of the economic problem.

  The operation of such a process may be further elucidated by considering a second hypothetical (if fanciful) example of how market relations lead market participants to solve the economic problem in practice, spontaneously, without conscious direction by central or political authority. Imagine that the American people awake one morning to news of an astonishing scientific breakthrough: it has been discovered that persons who drink eight ounces of orange juice a day will live to the age of 150 while maintaining the beauty and vigor of a thirty-year-old. Assume that such a finding is now regarded as established, unquestionable, scientific fact; the “fountain of youth” has at long last been discovered, and it is orange juice. This is certainly an unexpected change of circumstance. New knowledge has been acquired which, like most forms of knowledge, will entail significant economic consequences.

  The remarkable scientific discovery will significantly impact the social process called the market, both immediately and over time, in both the short-run and long-run. Consider, first, the immediate and short-run effects
. As news of the discovery gradually spreads throughout the nation, more and more people learn of the newfound benefits of orange juice. Local stores will soon be swamped with customers seeking to buy a gallon or two; demand for orange juice suddenly and dramatically increases. If the market is permitted to operate, the unanticipated increase in demand will initially be expressed through upward pressure on the retail price of orange juice. The rise in price can be initiated in several ways. Suppose a crowd of people descend on the local Walmart to purchase orange juice. Everyone wants to purchase the juice, but the shelves are rapidly emptying and immediate supply is limited (Walmart and other retailers had no advance warning of the sudden and huge increase in demand). Further suppose the existence of a customer who is particularly eager to obtain a gallon of juice. He wants the juice today but is concerned about the rapidly diminishing supply. In order to ensure that he will be obtain a gallon, he offers the salesclerk a price higher than the listed or asking price. The seller has no reason to reject such an offer. Other people follow suit and offer even higher prices for the juice. The price will continue to rise until it reaches a level beyond which there are no further bids; no one is willing to pay more. Alternatively, the increase in price can arise from the seller’s side. An alert store clerk may notice that juice at the initial (pre-news release) price is disappearing from the shelves. He may decide to raise the price of the existing supply and observe whether customers continue to purchase it. If buying proceeds despite the price rise, he will continue to raise the price up to the point beyond which it no longer sells. No one—buyer or seller—knows in advance the ultimate price of the juice, only that it will be higher than the initial price. Precise quantitative changes in relative prices can never be predicted with certainty but only general patterns, in this case, that increase in demand will manifest as increase in price.

  In the short run, the existing supply of orange juice is necessarily limited. Producers cannot snap their fingers and instantaneously produce more at will; the production of any particular good or service, like the market order more generally, is also a process, that is, unfolds over time. Consequently, not everyone who wants orange juice in the short run will be able to buy it. The existing (limited) supply of orange juice will be obtained by the highest bidders, that is, those persons who place the greatest value on the juice as demonstrated by their willingness to pay a higher price for it. Recall, again, that economic value is always subjective value. What is the value of a gallon of orange juice? It depends. In the case under consideration, the perceived subjective value of the juice may be lower for a twenty-year-old than for a person of advanced years. The elderly may long to recapture youth as soon as possible and thus willing to pay more for the juice than young adults. In any event, the existing juice supply will be distributed to those persons who value it most highly, as they themselves subjectively evaluate the good and as evidenced by their willingness to pay the highest price.

  The initial rise in the retail price of orange juice, however, only begins the story of how the market process spontaneously adapts to the ever-changing circumstances of existence, including discovery of knowledge. The market, again, is a process, and processes, unfolding over time, necessarily involve both short-run and long-run considerations. Day One of the new discovery will be followed by Days Two and Three and so on, into the long-run. On Day One, as we have seen, the sudden increase in demand will put upward pressure on the price of orange juice at the retail level, and the existing supply of orange juice will be obtained by those who value it most highly. At the end of Day One, the shelves are empty of orange juice. Every retail store that carries the product is in more or less the same situation as Walmart, and all of them will try to replenish their stocks. Most retailers do not themselves produce orange juice but rather purchase it from a wholesaler or distributor; they will undoubtedly be contacting their suppliers to order more juice to restock their shelves. No one must command or force them to do so. Sellers are in business to make a profit, and, ceteris paribus, an increase in the price of the products they sell leads, in the short run, to increase in their profits.[13] Retail sellers of orange juice thus have every personal incentive to meet the increased demand for orange juice by increasing their supply: they personally stand to benefit through increased profit.

  The actions of individual retailers are motivated by individual self-interest, but such self-regarding actions nevertheless, unwittingly and simultaneously, also serve both the interests of their particular customers and the common interest of society as a whole. That is, retailers, along with all others involved in the production and distribution of orange juice, are led by impersonal market forces to do precisely what they should do, not only for their own benefit but also that of their customers and the community at large, namely, increase the supply of orange juice to meet the newly increased demand. Indeed, one of the many celebrated achievements of a market economy is the spontaneous coincidence of individual and social well-being, a feature notably highlighted by Adam Smith and explored more thoroughly in a following section.

  On Day Two of the market process, the experience of the retailers on Day One will be duplicated in the experience of wholesale sellers of orange juice. Wholesalers will experience an unexpected increase in demand for their product, suddenly receiving far more orders than usual. As occurred with retail sales of the previous day, the increase in demand at the wholesale level will lead to an increase in the wholesale price of orange juice. Again, either potential buyers (Walmart, et al.) will offer more than the seller’s asking price or sellers will raise the price in the face of the sudden increase in demand. However initiated, the wholesale price of orange juice will rise. Moreover, the existing supply of orange juice at the wholesale level, like that at the retail level, is limited in the short run. The retailers who will obtain a portion of this limited supply will be those willing to pay the highest price for it, the price that reflects their subjective judgment of its value. Those who value the juice more highly will offer a higher price than those who value it less. At the end of Day Two, the wholesalers, like the retailers on the preceding day, will find their warehouses empty of orange juice. The wholesalers, motivated like the retailers by the possibility of increased profit, can thus be expected to contact their suppliers, perhaps firms that specialize in bottling orange juice.

  On Day Three, the bottlers will thus experience, like the retailers and wholesalers on Days One and Two respectively, an unexpected increase in demand for their product, which will lead to an increase in the price of bottled orange juice. Motivated by the possibility of profit, these producers will try to increase the existing supply of bottled juice to meet the increased demand. On Day Four they will be placing additional orders with their suppliers, say, firms that produce concentrated orange pulp to make into juice. Such increased demand will lead to an increase in the price of orange pulp, just as previously occurred for orange juice at the retail and wholesale levels and for bottled juice. Motivated by the possibility of profit, producers of orange pulp will try to meet the increased demand for their product by increasing production. They will no doubt place additional orders with orange growers (oranges are of course a major input in the production of orange pulp), and the price of oranges will tend to rise. Orange growers, motivated by the possibility of increased profit due to the rise in the price of their product, will attempt to expand production of oranges, perhaps purchasing additional farmland or hiring additional workers which, in turn, will lead to a rise in the price of those factors of production. The initial rise in price at the retail level will engender similar changes all along the complex chain of production typical of modern capitalist production processes.

  An extensive and intricate process has been set in motion that spreads itself spontaneously throughout the market economy. The initial impetus was the discovery of the health benefits of orange juice. This led to an increase in demand for orange juice, manifested and communicated throughout the chain of production via the simple
language of prices, first at the retail and later at the wholesale level, through the bottlers and other intermediaries, down to the orange growers and field hands themselves. At every link in the chain of production, producers know precisely how to read this language—an increase in the price of their respective product means an increase in their respective profit. The possibility of further profit motivates producers and leads each firm to do precisely what it should do—take steps to increase the quantity of its particular product. The overarching goal is to increase the supply of retail orange juice in order to meet increased consumer demand. The extensive specialization and division of labor that characterize a market economy, however, means that such a goal can only be realized by the cooperation of many different producers, as well as a rational coordination of their individual activities (e.g., the quantity of orange juice should not exceed or fall short of the available number of plastic jugs). At every stage of the market process, each individual producer of any input involved in the production of a gallon of orange juice is led by impersonal market forces (price movements) and his individual self-interest (profit) to behave precisely as he should behave from the point of view of consumers and society at large, that is, direct scarce resources toward production of goods most highly valued by consumers, in this case, the various inputs involved in the production and distribution of orange juice.