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It is a matter of commonsense that economic transactions
take place in markets. What is, however, not that commonly
known is about the economic transactions that take place
within firms and a host of other institutional arrangements,
but are mostly guided by the market prices. Some of these
markets are highly regulated by governments, while some
others are free from such governmental interventions. And,
often markets are held as efficient `allocation mechanisms',
for they stay focused on the problems relating to incentives
and private information.
However, in the early 20th century, there emerged a new
concept called `socialism' that triggered a bitter argument
among the economists as to whether socialist reform of economic
institutions was possible without loss of economic efficiency.
Von Mises and Hayek argued that "A centrally-planned
economy was doomed to collapse: because every individual
knew his own needs and capabilities best, government planners
could never hope to piece it all together and make sensible
decisions." But economists like Oskar Lange and Abba
Lerner disagreed with them arguing that a centralized planning,
if conceived and executed well, can even surpass the performance
of the competitive market.
Their arguments, however, remained inconclusive, for the
then existing framework of economic analysis was felt inadequate
to formally prove any side of argument as right. To measure
the efficiency levels of these two distinctly different
forms of economic architecture, a new and more general theoretical
framework was felt essential. Hayek also argued that any
model attempting to evaluate these two economic organizations
must first recognize that economic institutions of all kinds
essentially serve as a means to transmit the widely dispersed
information about the desires and resources of different
individuals of the society. But the economists of those
days have, in the words of Hayek, ignored the importance
of communication in market systems. It is of course a different
matter that the subsequent corpus of research findings under
the economic theory of competitive markets and the bitter
failure of socialist economies have made many to conclude
that Von Mises and Hayek were right but what then Hayek
looked for was a new mathematical model that could capture
the importance of communication in market systems and permit
a generalized comparison of the two systems.
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