Now, let's consider what is probably Hayek's most famous work
on the use of knowledge in society.
This essay is called "The Use of Knowledge in Society,"
and it was published in 1945
in the flagship journal of the economics profession,
the American Economic Review.
Hayek, here, stresses a very important point,
and it's what he calls in the essay,
"the knowledge of particular circumstances of time and place."
He is referring to a division of knowledge in society.
So, businessmen will know particulars about the best way to run their business
which no one else will know.
Within a business, workers may know the best way of making products,
perhaps, even the boss does not know.
Consumers will have the best sense of how it is they might economize
if they needed to,
and, again, outside observers find it very difficult
to get that same information.
Here's how Hayek expresses that point, and I quote: --
"the knowledge of the circumstances of which we must make use
never exists in concentrated or integrated form,
but solely as the dispersed bits of incomplete
and frequently contradictory knowledge which all the separate individuals possess.
In that sentence, by the way,
you can tell actually that Hayek's native language was German, not English.
Let's consider a specific example of how this might work,
and let's take what Hayek cites and that is the tin market.
So, this here is a picture of a tin mine, --
and imagine that, for some reason,
there is a disruption to the supply of tin on global markets.
That will mean that less tin is supplied to those markets.
Hayek's point is that the effects of this disruption
will spread through markets and be communicated by changes in prices,
and individuals will economize on tin accordingly,
but individuals don't need to know anything about the tin disruption,
where it happened, why it happened, anything else.
All they have to do is see that higher price of tin.
So, pictured here, we have tin sheets.
Well, if there's a disruption to the supply of tin overall,
there will be fewer tin sheets being sold on the market
and, now, we can continue the story.
A decrease in the supply of tin and the supply of tin sheets
means that overall the price of tin will go up.
That's just the law of supply and demand.
This comes about through the bidding for tin,
but, again, most of the individuals in this market;
they don't need to know anything very particular
about those disruptions on the supply side.
And that higher price is going to mean that individuals economize
whether they are businessmen or doing construction,
whatever the case may be,
they will, because of the higher price, look for ways to avoid using tin,
and they will seek out substitutes.
Just to make this concrete:
in grocery stores, there will be less of a use of tin cans,
pictured here on the left,
and perhaps greater use of selling items in bulk
which does not require so much tin.
And we can think of this customization as a marvel of the price system,
that information gets communicated around the world
or individuals are acting as if they knew all sorts of things
about the particular circumstances of time and place
without actually having to know those things at all.
The price communicates the relevant information,
and Alex Tabarrok and I, in our principles textbook,
we wrote the sentence,
"A price is a signal wrapped in an incentive."
That's really what Hayek was getting at in this key essay.
And Hayek stresses that this marvellous feature of the price system;
it doesn't require any human design.
No one needs to plan prices or markets in such a way
that they will carry this knowledge,
but, rather, the spontaneous order resulting from
having a lot of bids of supply and demand,
the spontaneous order resulting from entrepreneurs trying to seek profits
and consumers trying to improve their utility;
that will bring about, as if by Adam Smith's invisible hand, --
the decentralization, and use, and mobilization
of all of this decentralized knowledge.
And here's how Hayek presents his defence of the market economy,
and I quote:
"If we can agree that the economic problem of society
is mainly one of rapid adaptation to changes
in the particular circumstances of time and place,
it would seem to follow that the ultimate decisions
must be left to the people who are familiar with those circumstances."
So, in this essay, Hayek is explaining the role of prices,
he's explaining the importance of knowledge for economic success,
and, most of all, he's presenting what he thinks is
the most important defense of a market economy.