Economics Hayek

August 29th - Weekly Assignment

1. “The peculiar character of the problem of a rational economic order is determined precisely by the fact that 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 (H.3)”

1. What does Hayek mean by a “rational economic order”?

Hayek means the use of knowledge in a rational form by “rational economic order”. The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality. In other words, all decisions have a cost.  If I make a decision to buy a house, then the money spent cannot be used for something else. There is an opportunity cost for every decision made.

1. What does Hayek mean by “dispersed bits of incomplete and frequently contradictory knowledge”?

Hayek means that people from different walks of life will have specific knowledge that they will utilize when needed to make decisions in the market.  The knowledge of the circumstances of which one individual must make use never exists in concentrated or integrated form. It only exists solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. In other words, it is impossible for one individual or system to know every piece of information available and also, that what one individual may know can contradict another individual’s knowledge.

1. Why is Hayek critical of the common assumptions in economic analysis that buyers, sellers, producers and the economist all know every relevant thing about the economy?

Hayek is critical of these common assumptions because it is impossible for anyone to have every relevant piece of information due to the inability to capture “particular circumstances of time and place” unless “decisions depending on it (specific circumstantial knowledge) are left to him (person with the knowledge) or are made with his active cooperation. Even though the assembled data is important, it leaves out small variations and cannot be transmitted to individuals who plan the best allocation of available resources.

1. What, in summary, does Hayek mean by the quoted statement?

Hayek means that even though prices have become quite rigid, the forces which would operate through changes in price still operate to a considerable extent through changes in the other terms of the contract.) The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. Hayek refers to the ideal situation of an “economic order” where a person or persons can make the best possible decision based on all the available information. Even if we wanted to have a system available to capture all available information and accessible by all, it is impossible due to the circumstantial knowledge that individuals possess and which is extremely difficult, if not impossible, to capture and/or quantify.