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♪ [music] ♪

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- [Alex] A modern economy
depends on the cooperation

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of vast numbers of strangers,

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but how is this cooperation
coordinated?

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Let's revisit the economics
behind roses,

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but this time,
let's go back to 1973.

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In the 1970s, the price of oil
skyrocketed so it made sense

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to economize --
but oil has many uses.

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So which uses should we cut back
and which should we maintain?

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In a market economy, no one person
decides these questions

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or perhaps more accurately,
everyone does.

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A price is a signal
wrapped up in an incentive.

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So when the price of oil increased,
it signaled that oil

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had become more scarce
and it gave everyone

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an incentive to listen
to that signal.

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It said, "Find ways
to economize on oil

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or develop substitutes
and you will profit."

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When the price of oil
first increased,

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most roses bought
in the United States were grown

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in greenhouses in New Jersey,
in Pennsylvania.

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The increased price of oil
meant that it cost more

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to heat those greenhouses,
which meant a shift upwards

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in the supply curve for flowers
and an increase in the price.

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The result was that
it encouraged people

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to turn to substitutes.

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Such as chocolate and Teddy bears
to give to their loved ones

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at Valentine's Day --
but the story doesn't end there.

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Seeing the higher price of oil,
entrepreneurs began to think

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about other ways
to produce flowers.

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Instead of heating a greenhouse,
why not use the natural heat

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of the sun and transport the roses.

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Entrepreneurs encouraged farmers
in Kenya and Ecuador

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to start growing roses.

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And they began to invest
in a new global infrastructure

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to deliver roses around the world.

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Who could have predicted it?

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That one way of adjusting
to a reduced supply of oil

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was greater consumption
of chocolate?

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And another way,
was by importing roses.

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In fact, no one
could have predicted,

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let alone plan all the myriad ways
in which people responded

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to the increased price of oil.

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That's because no one knows
all the information

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that the market uses.

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Everything from the cost
of growing greenhouses,

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to the demand for roses
versus chocolate,

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to the value
that a particular piece

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of land in Kenya has
for growing flowers versus coffee.

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No single individual
knows all of this information.

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It's dispersed.

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So when oil becomes scarce,
we want people all over the world

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to use this dispersed information,
their information

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and their ingenuity to figure out
how best to economize on oil.

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The price system does this
in a remarkably efficient way.

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The Kenyan farmer doesn't have
to know anything about oil

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to have an incentive
to do the right thing.

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He just sees that the price paid
for roses has increased

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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

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of jet fuel where there
are fewer substitutes.

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Millions of decisions like this
made all over the world,

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rearrange and reallocate
the world's production.

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Taking oil from where
it has low value and moving it

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

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from our limited resources.

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That is the invisible
hand in action.

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If it had been invented,
the price system

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would be one of the most amazing
creations of the human mind.

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But like language,
it wasn't invented,

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and it worked long before
anyone had any understanding

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of its principles.

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As Nobel Prize winning economist,
Vernon Smith, has put it,

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"The pricing system
is a scientific mystery as deep,

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fundamental, and inspiring
as that of the expanding universe

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or the forces that bind matter."

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We'll be exploring more
about the mystery

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and the marvel of the price system
in the next video.

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- [Narrator] If you want
to test yourself,

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click "Practice Questions."

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Or if you're ready to move on,
just click "Next Video."

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♪ [music] ♪