A Price Is a Signal Wrapped Up in an Incentive
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0:00 - 0:05♪ [music] ♪
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0:15 - 0:18- [Alex] A modern economy
depends on the cooperation -
0:18 - 0:20of vast numbers of strangers,
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0:20 - 0:22but how is this cooperation
coordinated? -
0:23 - 0:25Let's revisit the economics
behind roses, -
0:25 - 0:28but this time,
let's go back to 1973. -
0:29 - 0:33In the 1970s, the price of oil
skyrocketed so it made sense -
0:33 - 0:37to economize --
but oil has many uses. -
0:37 - 0:42So which uses should we cut back
and which should we maintain? -
0:43 - 0:47In a market economy, no one person
decides these questions -
0:47 - 0:51or perhaps more accurately,
everyone does. -
0:51 - 0:55A price is a signal
wrapped up in an incentive. -
0:55 - 0:59So when the price of oil increased,
it signaled that oil -
0:59 - 1:02had become more scarce
and it gave everyone -
1:02 - 1:06an incentive to listen
to that signal. -
1:06 - 1:10It said, "Find ways
to economize on oil -
1:10 - 1:13or develop substitutes
and you will profit." -
1:13 - 1:15When the price of oil
first increased, -
1:15 - 1:18most roses bought
in the United States were grown -
1:18 - 1:21in greenhouses in New Jersey,
in Pennsylvania. -
1:21 - 1:24The increased price of oil
meant that it cost more -
1:24 - 1:28to heat those greenhouses,
which meant a shift upwards -
1:28 - 1:32in the supply curve for flowers
and an increase in the price. -
1:33 - 1:35The result was that
it encouraged people -
1:35 - 1:37to turn to substitutes.
-
1:37 - 1:40Such as chocolate and Teddy bears
to give to their loved ones -
1:40 - 1:44at Valentine's Day --
but the story doesn't end there. -
1:45 - 1:48Seeing the higher price of oil,
entrepreneurs began to think -
1:48 - 1:51about other ways
to produce flowers. -
1:51 - 1:55Instead of heating a greenhouse,
why not use the natural heat -
1:55 - 1:57of the sun and transport the roses.
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1:58 - 2:02Entrepreneurs encouraged farmers
in Kenya and Ecuador -
2:02 - 2:03to start growing roses.
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2:03 - 2:07And they began to invest
in a new global infrastructure -
2:07 - 2:09to deliver roses around the world.
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2:10 - 2:12Who could have predicted it?
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2:12 - 2:15That one way of adjusting
to a reduced supply of oil -
2:15 - 2:17was greater consumption
of chocolate? -
2:17 - 2:20And another way,
was by importing roses. -
2:20 - 2:24In fact, no one
could have predicted, -
2:24 - 2:28let alone plan all the myriad ways
in which people responded -
2:28 - 2:30to the increased price of oil.
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2:30 - 2:33That's because no one knows
all the information -
2:33 - 2:35that the market uses.
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2:35 - 2:38Everything from the cost
of growing greenhouses, -
2:38 - 2:41to the demand for roses
versus chocolate, -
2:41 - 2:43to the value
that a particular piece -
2:43 - 2:47of land in Kenya has
for growing flowers versus coffee. -
2:48 - 2:51No single individual
knows all of this information. -
2:51 - 2:53It's dispersed.
-
2:53 - 2:57So when oil becomes scarce,
we want people all over the world -
2:57 - 3:02to use this dispersed information,
their information -
3:02 - 3:07and their ingenuity to figure out
how best to economize on oil. -
3:07 - 3:11The price system does this
in a remarkably efficient way. -
3:12 - 3:15The Kenyan farmer doesn't have
to know anything about oil -
3:15 - 3:18to have an incentive
to do the right thing. -
3:18 - 3:23He just sees that the price paid
for roses has increased -
3:23 - 3:26and so following his self interest,
he starts to produce more roses. -
3:28 - 3:32Ultimately, that frees up more oil
to be used in the production -
3:32 - 3:35of jet fuel where there
are fewer substitutes. -
3:36 - 3:40Millions of decisions like this
made all over the world, -
3:40 - 3:43rearrange and reallocate
the world's production. -
3:43 - 3:47Taking oil from where
it has low value and moving it -
3:47 - 3:51to where it has high value
so that we produce the most value -
3:51 - 3:53from our limited resources.
-
3:54 - 3:57That is the invisible
hand in action. -
3:58 - 4:00If it had been invented,
the price system -
4:00 - 4:04would be one of the most amazing
creations of the human mind. -
4:04 - 4:07But like language,
it wasn't invented, -
4:07 - 4:11and it worked long before
anyone had any understanding -
4:11 - 4:13of its principles.
-
4:13 - 4:17As Nobel Prize winning economist,
Vernon Smith, has put it, -
4:17 - 4:21"The pricing system
is a scientific mystery as deep, -
4:21 - 4:26fundamental, and inspiring
as that of the expanding universe -
4:26 - 4:28or the forces that bind matter."
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4:28 - 4:31We'll be exploring more
about the mystery -
4:31 - 4:34and the marvel of the price system
in the next video. -
4:34 - 4:36- [Narrator] If you want
to test yourself, -
4:36 - 4:38click "Practice Questions."
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4:38 - 4:42Or if you're ready to move on,
just click "Next Video." -
4:42 - 4:47♪ [music] ♪
- Title:
- A Price Is a Signal Wrapped Up in an Incentive
- Description:
-
Join Professor Tabarrok in exploring the mystery and marvel of prices. We take a look at how oil prices signal the scarcity of oil and the value of its alternative uses. Following up on our previous video, “I, Rose,” we show how the price system allows for people with dispersed knowledge and information about rose production to coordinate global economic activity. This global production of roses reveals how the price system is emergent, and not the product of human design.
Microeconomics Course: http://mruniversity.com/courses/princ...
Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/price-system-spontaneous-order#QandA
Next video: http://mruniversity.com/courses/principles-economics-microeconomics/markets-link-world
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 04:47
Martel Espiritu edited English subtitles for A Price Is a Signal Wrapped Up in an Incentive | ||
Martel Espiritu edited English subtitles for A Price Is a Signal Wrapped Up in an Incentive | ||
Martel Espiritu edited English subtitles for A Price Is a Signal Wrapped Up in an Incentive | ||
Martel Espiritu edited English subtitles for A Price Is a Signal Wrapped Up in an Incentive | ||
MRU2 edited English subtitles for A Price Is a Signal Wrapped Up in an Incentive | ||
MRUniversity edited English subtitles for A Price Is a Signal Wrapped Up in an Incentive |