WEBVTT

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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this dispersed information, their
information and their ingenuity to figure

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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marvel of the price system in
the next video.

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

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ready to move on, just click Next Video.

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