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- [Alex] A modern economy
depends on the cooperation
of vast numbers of strangers,
but how is this cooperation
coordinated?
Let's revisit the economics
behind roses,
but this time,
let's go back to 1973.
In the 1970s, the price of oil
skyrocketed so it made sense
to economize --
but oil has many uses.
So which uses should we cut back
and which should we maintain?
In a market economy, no one person
decides these questions
or perhaps more accurately,
everyone does.
A price is a signal
wrapped up in an incentive.
So when the price of oil increased,
it signaled that oil
had become more scarce
and it gave everyone
an incentive to listen
to that signal.
It said, "Find ways
to economize on oil
or develop substitutes
and you will profit."
When the price of oil
first increased,
most roses bought
in the United States were grown
in greenhouses in New Jersey,
in Pennsylvania.
The increased price of oil
meant that it cost more
to heat those greenhouses,
which meant a shift upwards
in the supply curve for flowers
and an increase in the price.
The result was that
it encouraged people
to turn to substitutes.
Such as chocolate and Teddy bears
to give to their loved ones
at Valentine's Day,
but the story doesn't end there.
Seeing the higher price of oil,
entrepreneurs began to think
about other ways
to produce flowers.
Instead of heating a greenhouse,
why not use the natural heat
of the sun and transport the roses.
Entrepreneurs encouraged farmers
in Kenya and Ecuador
to start growing roses.
And they began to invest
in a new global infrastructure
to deliver roses around the world.
Who could have predicted it?
That one way of adjusting
to a reduced supply of oil
was greater consumption
of chocolate?
And another way,
was by importing roses.
In fact, no one
could have predicted,
let alone plan all the myriad ways
in which people responded
to the increased price of oil.
That's because no one knows
all the information
that the market uses.
Everything from the cost
of growing greenhouses,
to the demand for roses
versus chocolate,
to the value
that a particular piece
of land in Kenya has
for growing flowers versus coffee.
No single individual
knows all of this information.
It's dispersed.
So when oil becomes scarce,
we want people all over the world
to use this dispersed information,
their information
and their ingenuity to figure out
how best to economize on oil.
The price system does this
in a remarkably efficient way.
The Kenyan farmer doesn't have
to know anything about oil
to have an incentive
to do the right thing.
He just sees that the price paid
for roses has increased
and so following his self interest,
he starts to produce more roses.
Ultimately, that frees up more oil
to be used in the production
of jet fuel where there
are fewer substitutes.
Millions of decisions like this
made all over the world,
rearrange and reallocate
the world's production.
Taking oil from where
it has low value and moving it
to where it has high value
so that we produce the most value
from our limited resources.
That is the invisible
hand in action.
If it had been invented,
the price system
would be one of the most amazing
creations of the human mind.
But like language,
it wasn't invented,
and it worked long before
anyone had any understanding
of its principles.
As Nobel Prize winning economist,
Vernon Smith, has put it,
"The pricing system
is a scientific mystery as deep,
fundamental, and inspiring
as that of the expanding universe
or the forces that bind matter."
We'll be exploring more
about the mystery
and the marvel of the price system
in the next video.
- [Narrator] If you want
to test yourself,
click "Practice Questions."
Or if you're ready to move on,
just click "Next Video."
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