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King for a Day

Tags Free MarketsProduction Theory


Appearing on July 9, 1999

If voters named you economic czar, what would you do? Let's say you got rid of the market economy. You had to plan all output yourself. Could you do it? Well, let's make your task a little easier. You just have to plan the production of this year's wheat crop.

You have to get it to market at the lowest possible cost. You've got to use as few resources as possible. That way land and labor and other things will be available to make other goods.

Let's make it even easier. You can take it as given that this year's demand for wheat will equal last year's. You don't have to guess how much to grow. Just grow what the nation did last year.

So how do you grow it as cheaply as possible?

Economist Steven E. Landsburg offers some help.

"Suppose that Farmer Brown's marginal cost is $4 per bushel, while Farmer Smith's marginal cost is $9 per bushel," he wrote in The Armchair Economist.

The marginal cost is the cost of growing one more bushel. Marginal costs tend to increase as volume does. That's because farmers start with the most productive land, then move on to less- productive land. They grow wheat there by working the land harder, using more chemicals and fertilizer. So their costs go up.

"Then here is something clever you can do: Tell Farmer Smith to grow one fewer bushel (reducing his costs by about $9) and tell Farmer Brown to grow one more bushel (increasing his costs by about $4). Between them, the farmers grow just as much wheat as before, but their total costs are reduced by $5," Landsburg wrote.

Now that Smith is growing less wheat, his marginal costs should fall. That's because he cut that bushel by taking less productive land or labor out of the mix.

Keep doing that until their marginal costs are equal. Then you're growing your wheat at the lowest possible total costs.

Now if that seems like a tough task, it is. But the market does that each day, without any guidance from a central planner. The profit motive leads farmers to grow wheat until their marginal costs equal the prices they receive. And that happens in every industry.

We made your job pretty easy. We gave you just one good to produce. We gave you the amount of wheat you had to grow. And we limited the number of farmers you had to control to two.

Imagine trying to plan real-world wheat production. How much should you grow? How many farms should you use? You'd have a hard time figuring those things out.

The biggest help we gave you was keeping the price system for all other goods.

Remember, all you had to do was grow your wheat at the lowest average marginal cost. Then you knew you were growing your wheat in the most efficient way.

But those marginal costs were made up of the prices of other goods: labor, land, fertilizer.

How would you plan if you didn't know these costs?

That's what economists Ludwig von Mises and F.A. Hayek asked in the 1920s.

They said that a socialist system that got rid of free-floating prices could not work. Planners just wouldn't have the facts they needed.

How would they know how much wheat to grow? How would they know to grow wheat rather than corn? How would they know to make tractors rather than trucks?

Without prices, they couldn't answer any of these prices. With prices, planners aren't needed. Each firm and worker figures it out in the market.

Socialists came up with all sorts of schemes they said would let them plan without prices. And for many years economists thought the socialists had won the debate. But the fall of the Soviet Union proved Mises and Hayek right.

So what should you do if you get named economic czar? Maybe you should abdicate.

(C) Copyright 1999 Investors Business Daily, Inc.


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