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The Market Process in Action

August 4, 2008

Tags Free MarketsEntrepreneurship


A quick scan of any newspaper suggests that high fuel prices have disrupted our daily affairs. While politicians and pundits across the political spectrum are fretting about the need for a national energy policy, wringing their hands about the apparent un-American-ness of our dependence on foreign oil, and worrying that the massive run-up in gas prices in recent months will lead to an economic downturn, market forces are quietly adjusting so as to soften the blow and solve the problems that arise.

In a market economy, profits and losses are the signals that tell entrepreneurs whether they are choosing wisely or choosing poorly in their undertakings. Profits and losses also tell entrepreneurs how to adjust these undertakings to ever-changing conditions. The changes Toyota is making to its car and truck lineup illustrate this important principle.

When you do a lot of driving, $4 gas eats up a pretty big chunk of your disposable income and requires a few adjustments to the way you live. So how does the market coordinate these changes? Toyota is responding in a predictable fashion: their plant in Blue Springs, Mississippi (which is under construction) will produce the gas-sipping hybrid Prius, not gas-guzzling SUVs. They are also going to consolidate their truck production operations in their San Antonio plant. Paraphrasing an analyst quoted in the July 11 Memphis Commercial Appeal, no one, not even Toyota, is immune from the pressure of gas prices hovering at or above $4 per gallon.

The myriad adjustments to expensive gas show us how market processes change our activities and behavior. We use less of some things and more of others, and we innovate. In more concrete terms, we drive less and walk more, and we invest in alternative sources of energy. Perhaps we telecommute instead of driving to the office. The number of venture capital firms focusing on alternative energy sources has increased rapidly in the last few years, and blueprints for do-it-yourself solar iPod chargers, solar lawnmowers, and other solar technologies are all over the Internet. Some students at my institution made a solar iPod charger as part of a year-end project this past semester. The list of innovative responses to high gas prices goes on and on.

Some of these ideas will work well and some will not. It is not the specific technologies and ideas that are important; rather, it is the process that matters. Some ideas will work and others will fail; it is the profit-and-loss mechanism of the market process that helps us separate the good ideas from the bad. Scholars like F.A. Hayek have referred to "competition as a discovery procedure," and in an article that appeared in the Business and Society Review in 2006, Walter Block, Stephen W. Carson, and I referred to the market as a "discovery process." Competition in the market economy separates the good ideas from the not-so-good and helps us economize on scarce resources. We cannot predict which technologies will emerge or how problems will be solved, but we can understand the institutional conditions under which this process will emerge.

Toyota's decision to consolidate truck production in San Antonio and to produce the Prius in Blue Springs is one way to adjust to higher gas prices. Whether this is a wise choice or not will be determined over time. Toyota announced the changes on Thursday. The stock ticked upward slightly and then back down again the day after, suggesting that we can't draw too much information about how the market is assessing the move right now. The market, though, is a process by which information about successes and failures will be revealed.

"The market" is not an outcome, nor is it an end unto itself. Rather, the market is a process by which people discover effective (and not so effective) ways to satisfy our needs and wants. Entrepreneurship is essential; this consists of appraising the factors of production in the market and undertaking new production plans based on the expectation that such an endeavor will be profitable. Those who choose wisely are rewarded with profits. Those who choose poorly are punished with losses.

Toyota did not need to follow the diktat of a centralized bureau of automobile construction and distribution. They made their decision based on their expectations of the future structure of prices for inputs and outputs, complements and substitutes. They decided that their resources were better spent improving and building hybrids rather than larger vehicles. Money talks, and firms have to listen.

Even a large concern like Toyota has to yield to the wants and wishes of consumers. Consumers are the ones who pay the piper and are therefore the ones who call the tune. As gas gets more expensive, people want to purchase smaller, more fuel-efficient vehicles. Any company that wishes to remain profitable must listen and respond, and any company that refuses to listen to consumers does so at its peril.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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