Thursday, May 24, 2012

Notes on Economy — Part III

Link to Part II

Importance of knowledge in an economy

Knowledge is the most scarce resource of all. In an economic system, millions of consumer buy millions of different product at any specific point in time. As predicting a future demand-supply curve requires absolute knowledge of all these millions of event, it is extremely difficult to conjure.

Any economic system which can handle this flow of market knowledge efficiently, will be the best economic system for the material satisfaction of humans.

There are two ways of managing knowledge, the first is a centralist model (communism) and the second is consumerism (capitalism). In a centralist economic model, knowledge flows from top to bottom, while in a price-coordinated economy, knowledge flows from bottom to top.

The flow of market knowledge in communist and capitalist systems can be understood using the idea of supplying petrol to different petrol pumps across a country. In Pakistan there are about 3,400 CNG pumps. Let us assume that there are 10,000 petrol pumps in the country (I tried to get a figure from APPRA (All Pakistan Petroleum Retailers Association), but no one picked up the phone). All these pumps spread out over a very large surface area, from Karachi to Gilgat. It is near to impossible for a centralist planner to gain all bits of knowledge, and than supply fuel accordingly. The planner won't be able to predict peak-time petrol usage in a specific area; the political conditions in a specific area, which might decrease or increase petrol consumption; how much petrol will be required on daily bases, et cetera. The central planner, to the best of his knowledge, would allocated fix rations of petrol for all areas, and therefore, petrol supply won't vary with consumer demand. There will be excess surplus in some regions, while a shortage will be recorded in others. Maybe, violence in Quetta might halt all traffic, while a motor-race festival in Karachi would inevitably increase petrol demand. A central planner can never have a precise knowledge of such intricacies, forcing the system to follow the personal whims of the central planner.

On the other hand, in a price-coordinated economy, demand-supply transcends central decisions. The dynamics of demand and supply would automatically be managed by petrol pump dealers. If a motor-cross event is going to take place in Karachi, the petrol pump owner would simply purchase more oil from the company, while in case of violence in Quetta, the petrol dealer won't make a oil transaction for tomorrow. Hence, knowledge in a capital system is dynamically controlled. The system automatically synchronizes without any central effort. All petrol pumps receive a dynamic amount of petrol and CNG according to their local knowledge. Intricacies in demand and aberances in supplies are all handled by the petrol pump owners, not by a central planner. This increases efficiency, and surplus petrol finds the best alternative use rather than filling petrol tanks for no use.

Surplus and shortages in an economy

The idea of surplus or shortage of goods has a direct relationship with the importance of market knowledge.

Sowell writes that in a rigid-planned economy, i.e. a centralist system, demands are rationed on static principles — such as the example of petrol described above. The absolute majority of good in a region either results in a surplus or a shortage. It is a frequent event in a rigidly planned economy to find the same product to be in surplus in some regions and to record a shortage in others.

In a free market, demand causes prices to rise when goods are in short supply and vice versa. The price tags around a product would urge a capitalist to sell his products in an area where prices are higher. This movement of products from area of low price tags to an area of high price tags creates a dynamic balance and uniformity in prices across the whole country. This phenomenon is visible in Pakistan. Oil prices only vary around 5% across the whole country signifying the benefits of free-market.

Link to Part IV

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