I pointed out in my first economics article, economists tend to believe that the free market, i.e., decentralized control of un-coerced transactions, is the best method to produce goods/services that maximize the satisfaction of both the producer and consumer. The free market does this through the price system which gives important and constant feedback that cannot be effectively collected and digested by a central power. As Hayek famously described, a market economy conveys vital information to producers and consumers alike through the price system. Market prices enable producers to know the relative value of different goods and services, and determine how much consumers value their products. Under socialist central planning, by contrast, there is no substitute for this vital knowledge. As a result, socialist planners often had no way to know what to produce, by what methods, or in what quantities. This article digs deeper into this idea.

The complex task of feeding me eggs
Here is an example of the feedback that comes from the price system:
1) What people value: I buy scrambled eggs, so the restaurant knows I like eggs
2) The relative value of products/services: I prefer eggs over easy, but that requires the eggs be made at the time of sell instead of in a large batch all at once an hour prior to me buying the eggs. Since eggs over easy requires more resources than scrambled eggs, they cost more. If the scrambled eggs are 25% cheaper than the eggs over easy, I will buy the scrambled eggs because it is not worth the extra 25% to me. If I get a pay raise, that 25% threshold might turn into 30%. That feedback helps the restaurant know what to sell in order to please their customers.
3) The value of the quality of the products/services: Purchases also tells the restaurant if they are doing a good job. If the chef over cooks the eggs, customers may stop coming to the restaurant.
5) The best means of production: If someone invents a robot to automatically cook the eggs over easy, should the restaurant buy the robot instead of paying for the chef? It largely depends on the price of the robot. The restaurant can calculate the amount of money saved by buying a robot instead of hiring a chef, and determine the best means to produce their product. Buying the robot might allow the restaurant to lower the price of the eggs over easy, but the quality of the eggs might be worse. The price difference between scrambled eggs and eggs over easy might be 10%, and I might not care that the quality is worse, so I am willing to buy the robot cooked eggs. The lower price might also attract more customers to the restaurant.
6) Constant feedback: Each customer, each order, each change in price of the raw goods required to create the product/service is a data point. Depending on the industry, the data can be changing by the day/hour/minute/second.
7) Allocation of resources: If the demand for eggs increases suddenly because people start going on a diet high in eggs, there are ripple effects in the supply chain for those eggs. More chickens will need to be raised which might cause a need for more farmers, construction of chicken coups, more chicken feed grown, more gasoline to power the tractors, more schools in rural areas to teach the children of the farmers, and the list goes on. At the same time, other variables interact with the supply chain such as droughts in the area that grow the feed, new farming technology, advances in genetically modified organisms, the price of alternative crops (a farmer might decide it’s not worth it to grow some other crop like alfalfa and switch to growing corn). What data would be used if there was no price system?

These points illustrate the complexity of making decisions by businesses even when creating seemingly mundane products like eggs. The detailed granularity of constant feedback given by the price system tends to be easier to collect and digest by many people at a local level. Determining how much each of the supply chain components needs to change due to the change in demand and the exponentially increasing number of secondary variables becomes too difficult for a centrally located power to collect, understand, and react to in order to determine the best allocation of resources.

Other motivation:
People are more likely to find innovative ways to please other people if there is incentive to do so. That is not to say people don’t work hard to help other people for benevolent reasons. I made the point in my previous post: In a socialist society, even if you believe you are working hard towards a benevolent cause (a nurse helping a patient for example), but the final goal is not achieved (the patient is unsatisfied), you can go home and feel good about yourself for the effort you exerted believing you made the world a better place (and you might keep your job). In a capitalist society, the results matter, and customers ceasing to purchase your good/service is strong feedback because you can eventually go out of business. What would have motivated Henry Ford to perfect the assembly line if there was no financial incentive to do so? People would still build cars, but the efficiency gains would not have been realized. I believe people would still tend to invent innovative products even if there was little financial incentive to do so. There is a prestige about creating useful things, and it is more clear what needs to be invented, but I don’t believe people would look for a few percent efficiency gains here and there if their financial compensation was unaffected.

Criticisms of the free market
I also brought up in the first article, that the price system doesn’t just tell us the value of goods; it also tells us who has the money. Someone may value something more than another person, but if they are poor and cannot afford the good, that good could still go to the person that values it less, but is wealthy. We are not all born with the same balance in the bank. The ability to pass along wealth to your progeny is one of the incentives to work hard.

Secondly, there are also cases of market failure, i.e., when some of the population is not provided a product/service or the product/service is not satisfying to customers, or in the cases of monopoly and monopsony. In those situations, sometimes governments set laws, competes within the market, or may even remove the market altogether attempting to solve the market failure. You can read more about an example of this in my next article: Free Market Failures: Primary and Secondary Education