No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Ten: It’s all About the Institutions! 232 or expectation of how potential competitors may react, but until the competition takes place, they don’t know. The Austrian economist F.A. Hayek called this competitive market process a discovery procedure. This competitive discovery process enables each market participant to gain the required knowledge of other market participants’ actions such that they can modify their plans to more effectively coordinate their plans. This process is not a once-only step; it is a continual motion as new knowledge is gained and plans change. Preferences and tastes are continually on the move and must be rediscovered daily as entrepreneurs compete to serve. Those that can most efficiently align their plans with those of their customers will make profits. Those that do not will fail. So if competition is a discovery procedure—discovering new knowledge to more effectively coordinate actions and plans—what is the principle mechanism to communicate knowledge? I’m glad you asked. As we talked about earlier in this text, the crucial information that is transmitted is that of the price system in goods and services markets, as well as profits and losses that are transmitted in capital markets. Let’s see how this happens. Imagine you are an entrepreneur trying to sell your AirPods replica after the factory sabotage we discussed in chapter 4. To maximize profit you want your total revenues to exceed your total costs at the greatest amount (where MR=MC), so you estimate the prices and quantities that will result in an estimated revenue stream (we’ll look at costs in a moment). If your estimate of the price that you could charge is greater than what will actually sell the output you have made, you will see a buildup of inventory. Best Buy and other retailers will not order additional AirPods replicas, since they already have stock sitting on the shelf at the price you are demanding. At a certain point you will either have to cease production or discount your price to get buyers to purchase your good. You are in the competitive process of discovering true consumer preferences. As time moves on, you receive more sales data and learn more and more what the underlying consumer preferences are. With this information, your action to either lower prices or curtail production allows you to dovetail (or coordinate) your plans with the plans of many other market participants. While your initial pricing decision may have been in error (in the sense that it did not coordinate well with potential buyers), as you learn more and modify your plans accordingly, your plans will increasingly fit in with the plans of both buyers and other producers. If your plans do not dovetail with others’ plans, you will suffer losses and go out of business. This process of discovery is continual; you are constantly forced to assess consumer demand through sales and marketing data to ensure you are serving customers well. Consumers are fickle, with constantly changing tastes and preferences, and if you are not on top of meeting their needs they will not buy your AirPods clone. While tastes and preferences constantly change, the nature of the product and need it satisfies will determine the magnitude of the change. The ups and downs of the market process may not look that dramatic for some products while for other businesses it may mean life or death.