is, only if the system coordinates the specialized activities of the participants.
In this chapter we discuss the market economy with respect to the way it coordinates the activities of its participants. We do not “judge” the degree of success that the market economy attains in this regard either as compared with other economic systems or as to its own “efficiency.” We are concerned with finding out how the patterns of relationships existing in the market process succeed at all in organizing numberless, independently planned actions into a social system that efficiently serves the purposes of its participants.
The general problem of coordination can be reduced, for a market economy, into a number of fairly distinct special problems. First, we will outline these problems, and then proceed in subsequent sections to discuss how these problems are solved by the market.
1. The economy must somehow or other develop a system of “priorities” governing what goods and services should be produced. Resources are clearly insufficient to produce everything that the participants would like to enjoy. There must be some way to decide on the kinds and quantities of products to which resources should be allocated; this involves the notion of “priorities.” If Mr. Smith wants a new coat, and Mrs. Jones wants a new dress, then there must be some method of ranking these two wants so as to guide producers in making their decisions as to what to produce. If one viewed society as having wants that, in principle, can be ranked on a single scale of absolute “importance,” then this problem would be simply that of discovering this ranking. Such a view of things recognizes the possibility of declaring Mr. Smith’s need for a coat to be somehow or other more or less “urgent” from the standpoint of society than Mrs. Jones’s need for a dress. Efficiency in the operation of the economy requires that, in this view of things, the system find out which want is the more urgent and then direct producers to give it corresponding priority.
But even when it has become clear that no objective way exists of determining the relative importance of the wants of different individuals “from the point of view of society” in any such absolute sense (if any meaning at all can be attached to this term), the problem of ranking must and can be solved. For participation in a market economy to be attractive, individuals must be assured that some reasonably satisfactory—and definite—method will be used to assign priorities to the wants of all the different participants. From the point of view of coordination, participants must be assured that the decision of any individual entrepreneur to produce a given commodity is consistent with this priority system. The priority system used need not be able to lay claim to the achievement of ultimate justice or fairness. Participants must merely be convinced that the degrees of importance that the market attaches to different wants are such as to make the market system profitable from their own individual points of view.3
2. A second problem of coordination relates to the way resources are combined to produce those goods or services to which priority in production has somehow been assigned. Once it has been decided that a certain good is to be produced, the next step is to decide on the method of production to be used. Very often there are a number of different methods of production that are technically capable of yielding a desired commodity. Drinking water can be brought from the mountains or extracted from the sea. The economic system requires a device that will guide the producer of the commodity to use the most efficient method of production—efficiency in production being measured with respect to the economy as a whole. The “correct” method of production means the correct combination of resources. The correct combination of resources used to produce a given commodity will leave as a remainder, out of the entire available stock of resources, that body of resources able to produce the greatest quantity of goods in their order of priority. In other words, production is carried on efficiently, from the viewpoint of society, when it interferes least with the rest of production.
Clearly, with innumerable producers making independent decisions as to production techniques, the economy must coordinate these decisions so as to ensure that each producer uses those resources least needed elsewhere in the economy. Just as products can be produced in different ways, so resources can be used to produce different products. It is in the interest of each market participant that each unit of each resource be directed toward the production of that product where it will be used most efficiently—in the sense stated above.
3. The essence of the market economy is specialization and division of labor in production; production, moreover, invariably involves the cooperation of the productive services of several different resources. For both these reasons it follows that, in a market economy, resources are generally used in processes of production which go to satisfy the wants of others than the owners of the resources themselves, and/or do not permit the productive contribution of any particular unit of a resource to be distinguished or identified. A truck driver transports food from one city to another. He himself may need very little of this food; and it is quite impossible to identify what portion of the utility of transportation is attributable to his services, what portion is attributable to the truck, to the highways, and so on. All this creates a problem of compensating each participant in the system for his productive contribution as a resource owner (or entrepreneur). If an individual is to participate in the economy, some definite system must exist, which will ensure that he will receive a share of what is being produced.4 An efficient system will provide sufficient reward to each participant to enable all participants to enjoy the benefits of the widest possible range of resource services.
HOW THE MARKET SOLVES THE PROBLEMS OF COORDINATION
In a market economy these problems of coordination find their solution in the market process. The key role is played by market prices. The reasonable success that a market economy is able to attain in the solution of the three coordination problems outlined in the previous section is the consequence of a market process that determines prices. Market prices guide individual decision makers toward decisions that tend to consider implicitly all the relevant conditions prevailing in the market.
Thus, the single process that determines the course of the various prices in a market continuously works toward the simultaneous solution of the three problems of coordination. These three, analytically distinct tasks are fulfilled as aspects of the same market process market prices emerge from. This will become apparent in the following paragraphs as we discuss the different aspects of the market solution.
1. In a market economy the task of production is carried out by entrepreneurs in search of profits. Where an entrepreneur has the choice of producing two products at equal cost, he will produce that which promises to sell for the highest price. Thus, priorities in a market economy are assigned to different goods by the process that determines their prices. Where equivalent combinations of resources can produce different products, it is the product that can command the highest market price that top priority is automatically assigned to.
Much of our study is concerned with the process by which the market price of products is determined. Generally, it is obvious even at this point, however, that those products for which consumers are prepared to undergo the greatest pecuniary sacrifice will tend (other things being equal) to command the highest prices; so thus, the market tends to consider these products as socially more “important.” Resources will tend to be purchased by entrepreneurs for use in the production of the relatively higher-priced goods. Changes in the urgency with which consumers are anxious to obtain specific goods will tend to be reflected in changes in their prices and hence in the priority that the market attaches to their production. The more responsive the price system is to changes in consumer preferences, the more accurately will the decisions of producers be in conformity with the priority system based on pecuniary sacrifice.
This kind of priority system is frequently described as consumer sovereignty. It is the consumers’ acts of purchase, translated into
