Thursday, January 13, 2011

How Can Goods be Allocated Without a Price System?

Yes, that is an image of a Soviet breadline. Less than a century ago, Ludwig von Mises described in his book Socialism why any centrally planned economy would be doomed to failure. The problem lies in the fact that only through voluntary exchange and cooperation can the demand of people be known and adequate amounts of the right goods can be produced. You would also know whether a project is worth the scarce resources available to make it. This is known as the Economic Calculation Problem.

Where should wood be used? Should it be used to build more homes? Should it be used to make paper? What about pencils? Maybe desks? How can you know without a price system? It is profit which tells us which projects are worthwhile. A profit is nothing but a signal. Profit tells us that there is more demand than production can keep up with. If there is no profit, then enough is being made. If there is a loss, then too much is being made and production needs to be curtailed.

The price that we pay represents how much we demand a product. If I am willing to pay $4 for a chicken dinner and $1 for a pencil, then it means I value the dinner more than the pencil. If I had to choose between $2 for a pencil and $3 for a dinner, I will always choose the dinner. Thanks to the price system, companies can know how much of something to make. I vote with my dollar.

The price system is the only way that goods can be allocated rationally. This is the central problem of economics: scarcity. Knowing how to do distribute goods best only can be done by an omnipotent being. The price system is the best system ever devised to deal with the issue.

But some say that there are exceptions and that sometimes prices need to be set. What do you think? Are there any goods that the market cannot provide? Goods that the government has to provide because the market cannot price them correctly?


  1. So few people understand. Yet it is so basic. The company I use to work for sent me to Russia shortly after the collapse of the Soviet Union to investigate the investment potential in gold mining. I spent several weeks in western Siberia visiting mines that were looking for foreign investors.Every time I asked what their production cost were I received blank stares. So I tried asking the costs for the various consumables that all mines have. Again the blank stares. The concept of cost was completely foreign to them. Here is how things work under the communist regime. The central government agency in-charge of mining would tell the mine management each year what their production target should be. The mine would then send back a budget that listed all the consumables they would need to reach the requested target. The mine either received what they needed or they didn't (99.9% of the time they didn't receive what they needed). The mine produced what they could with what they had to work with. The mine manage didn't know if they were profitable or not . Again, they were not sure what profit meant. From the data my team was able acquire, we calculated that two of the three mines we visited were operating at a serious loss. They didn't know and we didn't tell them. Ignorance is bliss under centralized state control.

  2. Funny, that sounds exactly like how our government budgets money to its departments. Why do we think that we're different and that these programs that we have aren't doomed to failure like the Soviet Union?