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- A modern economy depends on the[br]cooperation of vast numbers of strangers

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but how is this cooperation coordinated?[br]Let's revisit the economics behind roses

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but this time let's go back to 1973. In[br]the 1970s, the price of oil skyrocketed

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so it made sense to economize that oil has[br]many uses. So which uses should we cut

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back and which should we maintain? In a[br]market economy, no one person decides

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these questions or perhaps more accurately[br]everyone does. A price is a signal wrapped

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up in an incentive. So when the price of[br]oil increased it signaled that oil had

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become more scarce and it gave everyone an[br]incentive to listen to that signal. It

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said find ways to economize on oil or[br]develop substitutes and you will profit.

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When the price of oil first increased,[br]most roses bought in the United States

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were grown in greenhouses in New Jersey,[br]in Pennsylvania. The increased price of

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oil meant that it cost more to heat those[br]greenhouses which meant a shift upwards in

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the supply curve for flowers and an[br]increase in the price. The result was that

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it encourage people to turn to[br]substitutes. So just chocolate and Teddy

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bears to give to their loved ones at[br]Valentine's Day but the story doesn't end

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there. Seeing the higher price of oil,[br]entrepreneurs began to think about other

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ways to produce flowers. Instead of[br]heating a greenhouse, why not use the

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natural heat of the sun and transport the[br]roses. Entrepreneurs encourage farmers in

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Kenya and Ecuador to start growing roses.[br]And they began to invest in a new global

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infrastructure to deliver roses around the[br]world. Who could have predict it? Did one

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way of adjusting to a reduced supply of[br]oil was greater consumption of chocolate?

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And another way by importing roses. In[br]fact, no one could have predicted, let

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alone plan all the myriad ways in which[br]people responded to the increased price of

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oil. That's because no one knows all the[br]information that the market uses.

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Everything from the cost of growing[br]greenhouses, to the demand for roses

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versus chocolate, to the value that a[br]particular piece of land in Kenya has for

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growing flowers versus coffee. No single[br]individual knows all of these information.

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It's dispersed. So when oil becomes scarce[br]we want people all over the world to use

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this dispersed information, their[br]information and their ingenuity to figure

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out how best to economize on oil. The[br]price system does this in a remarkably

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efficient way. The Kenyan farmer doesn't[br]have to know anything about oil to have an

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incentive to do the right thing. He just[br]sees that the price paid for roses has

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increased and so following his self[br]interest he starts to produce more roses.

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Ultimately, that frees up more oil to be[br]used in the production of jet fuel where

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there are fewer substitutes. Millions of[br]decisions like this made all over the

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world, rearrange and reallocate the[br]world's production. Taking oil from where

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it has low value and moving it to where it[br]has high value so that we produce the most

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value from our limited resources. That is[br]the invisible hand in action. If it had

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been invented the price system would be[br]one of the most amazing creations of the

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human mind. But like language it[br]wasn't invented and

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it worked long before anyone had any[br]understanding of its principles. There's

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Nobel price economist Vernon Smith has put[br]it, the pricing system is a scientific

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mystery as deep, fundamental and inspiring[br]as out of the expanding universe or the

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forces that bind matter. We'll be[br]exploring more about the mystery and the

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marvel of the price system in[br]the next video.

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- If you want to test yourself,[br]click Practice Questions or if you're

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ready to move on, just click Next Video.