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 market forces, which determine market prices, and thus give directions to the producers as to what should be produced. Changes in consumer preferences, which are responsible for the price changes, compel producers to alter their production processes. Any non-market obstacles placed in the way of the pricing process thus necessarily interfere with the priority system that consumers have set up. It must always be borne in mind that such a priority system cannot necessarily lay claim to any kind of ethical excellence. All that can be claimed for the priority system is that it offers potential market participants more attractive alternatives than are available to them otherwise.
2. That production in a market economy is undertaken for profit also has definite consequences with respect to the second task of coordination. When a given product can be produced by different methods of production, it is most profitable to use the cheapest method of production. The entrepreneur will therefore tend to use this method of production. The cheapest method of production is that which requires the smallest expenditure for the resources used. Whether or not one production process is cheaper (and therefore more likely to be employed) than another depends not only on the quantities of resources required for the processes, but also on their prices. The market value of different resource combinations influences the decisions of producers to use more machinery or less, more skilled labor or less, a larger plant or a smaller, and so on.
Now, as with the prices of products, the analysis of the determination of the prices of resources must wait until later chapters in this book. But generally it is not difficult to see what factors are at work in the determination of resource prices, and to appreciate how these factors relate to the coordination problem of securing the use of “socially efficient” methods of production. Market prices are the basis of cost calculation by producers. The price of each resource tends toward the point where all supplies of the resource available at this price are bought by producers.5 Producers tend to bid up resource prices in order to secure resources for the production of given products for as long as it is profitable to do so; thus, at the market price, the resource will be used by producers of those products in whose production the resource yields greatest profits. Producers bidding for the resource to produce a product in which the resource will be relatively less profitable will soon find it impossible to compete with the producers of more valuable products. In buying the cheapest resources (among all those resources that are for him technically equivalent), the producer will therefore tend to be buying those resources least valuable elsewhere in the economy—“valuable,” that is, in the sense of being able to cater to consumer wants having higher (pecuniary sacrifice) priority.
It cannot be expected, to be sure, that at any one time the market process should have succeeded in securing complete coordination of decisions concerning methods of production. Inevitably, at any one time, certain processes of production will be carried on using resources some units of which could be used more valuably in other production processes. So long as the market is competitive, however, the existence of such opportunities for increased efficiency will tend to be discovered and exploited by profit-seeking entrepreneurs. The market process will constantly tend to rearrange and reshuffle the allocation of productive resources so as to conform more closely with the most recent changes in the patterns of available resources and consumer preferences.6
3. The price system a market economy has its setting in is responsible also for the solution of the third problem of coordination, that of determining the individual rewards to be received by each of the resource owners cooperating in the productive process. This function is fulfilled as a different aspect of the same pricing process that determines resource allocation and the organization of production. Resource owners selling the services of their resources in the market secure prices that are determined by the interaction of resource supply and entrepreneurial demand. Acting in their capacity of consumers, the resource owners will in turn use the money prices, which they receive in the resource markets (their “incomes”), to buy goods in the product markets. Thus, the market value of the goods and services a consumer can buy with his income is determined by the value that the market places upon the services that, in his capacity of resource owner, he has furnished to the production process.
The real incomes received by consumers are therefore determined by the prices that emerge in the market for the services of the various resources. In general, the price of a resource depends on its productivity in the different branches of production. When a resource owner is otherwise indifferent to the use his resource will be applied to, he will sell its services to the highest bidder. The highest bidder will tend to be that entrepreneur to whose profit calculations the services of additional quantities of the resource add most. The market process therefore tends to ensure the apportioning of rewards among cooperating resource owners in a way that attracts resources to their most productive uses. At the same time each individual resource owner participating in the market process is able to enjoy the fruits of the production of the market to an extent depending on the usefulness to the market