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- [Alex] A modern economy depends on the cooperation
of vast numbers of strangers,
but how is this cooperation coordinated?
Let's revisit the economics behind roses,
but this time, let's go back to 1973.
In the 1970s, the price of oil skyrocketed so it made sense
to economize -- but oil has many uses.
So which uses should we cut back and which should we maintain?
In a market economy, no one person decides these questions
or perhaps more accurately, everyone does.
A price is a signal wrapped up in an incentive.
So when the price of oil increased, it signaled that oil
had become more scarce and it gave everyone
an incentive to listen to that signal.
It said, "Find ways to economize on oil
or develop substitutes and you will profit."
When the price of oil first increased,
most roses bought in the United States were grown
in greenhouses in New Jersey, in Pennsylvania.
The increased price of oil meant that it cost more
to heat those greenhouses, which meant a shift upwards
in the supply curve for flowers and an increase in the price.
The result was that it encouraged people
to turn to substitutes.
Such as chocolate and Teddy bears to give to their loved ones
at Valentine's Day -- but the story doesn't end there.
Seeing the higher price of oil, entrepreneurs began to think
about other ways to produce flowers.
Instead of heating a greenhouse, why not use the natural heat
of the sun and transport the roses.
Entrepreneurs encouraged farmers in Kenya and Ecuador
to start growing roses.
And they began to invest in a new global infrastructure
to deliver roses around the world.
Who could have predicted it?
That one way of adjusting to a reduced supply of oil
was greater consumption of chocolate?
And another way, was by importing roses.
In fact, no one could have predicted,
let alone plan all the myriad ways in which people responded
to the increased price of oil.
That's because no one knows all the information
that the market uses.
Everything from the cost of growing greenhouses,
to the demand for roses versus chocolate,
to the value that a particular piece
of land in Kenya has for growing flowers versus coffee.
No single individual knows all of this information.
It's dispersed.
So when oil becomes scarce, we want people all over the world
to use this dispersed information, their information
and their ingenuity to figure out how best to economize on oil.
The price system does this in a remarkably efficient way.
The Kenyan farmer doesn't have to know anything about oil
to have an incentive to do the right thing.
He just sees that the price paid for roses has increased
and so following his self interest, he starts to produce more roses.
Ultimately, that frees up more oil to be used in the production
of jet fuel where there are fewer substitutes.
Millions of decisions like this made all over the world,
rearrange and reallocate the world's production.
Taking oil from where it has low value and moving it
to where it has high value so that we produce the most value
from our limited resources.
That is the invisible hand in action.
If it had been invented, the price system
would be one of the most amazing creations of the human mind.
But like language, it wasn't invented,
and it worked long before anyone had any understanding
of its principles.
As Nobel Prize winning economist, Vernon Smith, has put it,
"The pricing system is a scientific mystery as deep,
fundamental, and inspiring as that of the expanding universe
or the forces that bind matter."
We'll be exploring more about the mystery
and the marvel of the price system in the next video.
- [Narrator] If you want to test yourself,
click "Practice Questions."
Or if you're ready to move on, just click "Next Video."
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