A simple morning commute generates a good metaphor for how markets work.
One morning last week, I left my house and found cars on Raymond were backed up to the light at Como. I slipped down Scudder instead, hooking a left at the very end and turning on Raymond just in time to duck under the railroad bridge. Most of the traffic seemed to be turning right on Energy Park, so I went straight across the viaduct.
The traffic at the light on University seemed bad, so I dog-legged right on Territorial till I reached the KSTP building, hooked over to University and drove west to 27th. But there already were several cars waiting to take a left there, so I took advantage of a gap in oncoming traffic to turn a block early, then went right on Essex, left onto 27th ahead of the schnooks still waiting for a turn arrow, cruised over I-94 and through the six-way intersection onto the Franklin Avenue bridge.
Safely across the Mississippi, I took a right onto Riverside. It was only 8:15, so I was sure I’d find a free parking spot on the west side of the football field that is no parking until 8 a.m. I slipped into one of the three open spaces, walked across the park and was ready to teach.
My wife acts similarly. Coming home from work, if the road conditions sign shows a stoppage at 280, she gets off 94 early, onto Lex or Dale, so she can come across on Energy Park. If she waits till Snelling or Vandalia, she knows she will get caught in long lines of people with the same idea.
Even if you don’t know any of these streets, you get the idea. Drivers react to day-to-day traffic conditions. We gauge traffic patterns and sequentially choose between alternatives to reach our destination most efficiently. Nobody at MnDOT needs to give us directions on what route is best for us.
That is how markets work. People react to changing conditions daily.
Whole fryers are on sale, so get one and skip the ground beef. July soybeans are up to $10.25. It might be a good idea to sell a least two mini-contracts. Gas is up 20 cents at the BP, so wait to fill until you see what it is at the One-Stop. Someone else at work got a promotion you wanted, so maybe you’d better bite the bullet and enroll in that evening MBA program to burnish your resume a bit.
In traffic and markets, millions of people process billions of bits of information about what is stopped and what is flowing, what is scarce and what is plentiful. We react to traffic in a way that minimizes the time or distance or hassle of getting to work. We react to prices so as to satisfy as many of our family’s needs and wants as we can with the limited time and money we have.
In both cases, the amount of information is so huge and conditions change so quickly that it would be impossible for some central planner to calculate the optimal choices for each of us, no matter how big his computer or how sophisticated his optimization model. Not only are individuals better off making decisions for themselves, but also society as a whole is better off. Resources go to meet needs more efficiently.
That does not mean decentralized decision-making results in perfect outcomes. Sometimes we get stuck in a traffic jam. Sometimes market outcomes disappoint us. Often, an option that looks like the right choice turns out to have been a mistake. We are still better off with a decentralized decision process than with central planning.
Note also that adjustments to new conditions are not instantaneous. When the Interstate 35W bridge collapsed, it pushed a lot of traffic onto 280. Raymond, a residential street near my home, parallels 280 and is one of the few alternatives for crossing a tangle of railroad lines. But not many people know of it. At first, there was little change in traffic on Raymond. As weeks went by, it grew steadily as more people learned it was an option.
In the same way, when oil prices spiked in 1974, people made few changes immediately but bought cars with better mileage, insulated their homes and made myriad other adjustments as time went on.
In traffic and markets, some things may change little. A few years ago, I took exactly the same route to work every day. We may buy exactly the same quantities of milk and bread each week. But in both situations, the test is how the system reacts to an external shock. When a bridge falls or wheat becomes scarce, an adjustment based on decentralized decision-making beats central planning every time.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.