Market Theory and the Price System. Israel M. Kirzner
of a body of productive resources. The economic problem facing the society is, once again, that of securing efficiency. The problem consists in constructing an organized social system that will most efficiently utilize the limited resources of “society” for the satisfaction of the desires of “society” for consumer goods and services. Once again a successful solution of this problem calls for “consistency”—a pattern of activity and production that should faithfully reflect the respective weights assigned to each of the goals that it is desired to satisfy.1
The limitations surrounding this use of the term “economic problem” arise from the fact that society is made up of numerous individuals. Each individual can be viewed as independently selecting his goal program. And in a market economy especially, each individual adopts his own courses of action to achieve his goals. It is therefore unrealistic to speak of society as a single unit seeking to allocate resources in order to faithfully reflect “its” given hierarchy of goals. Society has no single mind where the goals of different individuals can be ranked on a single scale.
Nevertheless, there is a sense where one form of societal organization can be termed “more efficient” than another. For example, a market economy, as we shall see, is unquestionably more “efficient” than a system of self-sufficient individual “economies,” because each individual shows by his voluntary participation in the market that he is better off under the former than the latter. Thus, each individual finds he can most efficiently solve his own economic problem by cooperating with other individuals through division of labor and the market. Any form of voluntary social cooperation emerges only because each participant seeks in this way to further his own goals. If he participates in a social system of any kind, he does so in the interests of his own efficiency; his participation is a method of solving his own economic problem.
We will be speaking of the efficiency or inefficiency of a social system in this sense. We are not invoking the notion of a society having its goals in any sense apart from the goals of the individuals making up the society. Efficiency for a social system means the efficiency with which it permits its individual members to achieve their several goals.
However, when individuals seek to fulfill their purposes through some form of social cooperation, the efficiency of the social system in the above sense depends on the degree of coordination with which the separate activities of the participants are carried on. The cooperation of individuals requires that their actions fit into an overall pattern of organization. The fundamental point is that the source of the advantages of social cooperation over individual autarky exists in the possibilities that social cooperation opens up for specialization and division of labor. It is efficient, for example, to participate in a market economy (instead of being a self-sufficient Robinson Crusoe) because the value of one’s specialized services to the market is higher than the value of all that one could produce by spreading one’s efforts over numerous branches of production for one’s own consumption.2
Now, the very factor specialization, which can make social cooperation “efficient” for each of the cooperating individuals, itself introduces problems upon whose successful solution the worthwhileness of specialization depends. Clearly, if everyone specialized in the same kind of production, specialization would be worse than useless. A social system will emerge only if the system promises individuals a way of cooperating with others in an efficient way; that is, only if the system coordinates the specialized activities of the participants.
In this chapter we discuss the market economy with respect to the way it coordinates the activities of its participants. We do not “judge” the degree of success that the market economy attains in this regard either as compared with other economic systems or as to its own “efficiency.” We are concerned with finding out how the patterns of relationships existing in the market process succeed at all in organizing numberless, independently planned actions into a social system that efficiently serves the purposes of its participants.
The general problem of coordination can be reduced, for a market economy, into a number of fairly distinct special problems. First, we will outline these problems, and then proceed in subsequent sections to discuss how these problems are solved by the market.
1. The economy must somehow or other develop a system of “priorities” governing what goods and services should be produced. Resources are clearly insufficient to produce everything that the participants would like to enjoy. There must be some way to decide on the kinds and quantities of products to which resources should be allocated; this involves the notion of “priorities.” If Mr. Smith wants a new coat, and Mrs. Jones wants a new dress, then there must be some method of ranking these two wants so as to guide producers in making their decisions as to what to produce. If one viewed society as having wants that, in principle, can be ranked on a single scale of absolute “importance,” then this problem would be simply that of discovering this ranking. Such a view of things recognizes the possibility of declaring Mr. Smith’s need for a coat to be somehow or other more or less “urgent” from the standpoint of society than Mrs. Jones’s need for a dress. Efficiency in the operation of the economy requires that, in this view of things, the system find out which want is the more urgent and then direct producers to give it corresponding priority.
But even when it has become clear that no objective way exists of determining the relative importance of the wants of different individuals “from the point of view of society” in any such absolute sense (if any meaning at all can be attached to this term), the problem of ranking must and can be solved. For participation in a market economy to be attractive, individuals must be assured that some reasonably satisfactory—and definite—method will be used to assign priorities to the wants of all the different participants. From the point of view of coordination, participants must be assured that the decision of any individual entrepreneur to produce a given commodity is consistent with this priority system. The priority system used need not be able to lay claim to the achievement of ultimate justice or fairness. Participants must merely be convinced that the degrees of importance that the market attaches to different wants are such as to make the market system profitable from their own individual points of view.3
2. A second problem of coordination relates to the way resources are combined to produce those goods or services to which priority in production has somehow been assigned. Once it has been decided that a certain good is to be produced, the next step is to decide on the method of production to be used. Very often there are a number of different methods of production that are technically capable of yielding a desired commodity. Drinking water can be brought from the mountains or extracted from the sea. The economic system requires a device that will guide the producer of the commodity to use the most efficient method of production—efficiency in production being measured with respect to the economy as a whole. The “correct” method of production means the correct combination of resources. The correct combination of resources used to produce a given commodity will leave as a remainder, out of the entire available stock of resources, that body of resources able to produce the greatest quantity of goods in their order of priority. In other words, production is carried on efficiently, from the viewpoint of society, when it interferes least with the rest of production.
Clearly, with innumerable producers making independent decisions as to production techniques, the economy must coordinate these decisions so as to ensure that each producer uses those resources least needed elsewhere in the economy. Just as products can be produced in different ways, so resources can be used to produce different products. It is in the interest of each market participant that each unit of each resource be directed toward the production of that product where it will be used most efficiently—in the sense stated above.
3. The essence of the market economy is specialization and division of labor in production; production, moreover, invariably involves the cooperation of the productive services of several different resources. For both these reasons it follows that, in a market economy, resources are generally used in processes of production