Prices and knowledge: A market-process perspective

Equilibrium prices and information 51own valuation of units of a commodity, and each seller knows onlyhis/her own cost of the units that might be sold’ (ibid.).In addition to the ‘extreme case of “little” knowledge’ Smithdescribes two ‘contrary hypotheses [that] have formed the core ofmain stream economic thought concerning the conditions forcompetitive equilibrium’: the ‘price taking hypothesis’, which statesthat large numbers of buyers and sellers, producing price-takingbehaviour on their part, are an essential feature of a competitivemarket, and the ‘complete knowledge hypothesis’, which asserts that‘competitive allocations require perfectly “foreseen” conditions ofsupply and demand’ (ibid.).Smith is interested in testing the ‘Hayek hypothesis’, among otherreasons, because ‘the vast majority of economists in the main streamof British and American economic thought have not accepted, indeedhave been openly sceptical of Hayek’s claim that decentralizedmarkets are able to function with such an extreme economy ofinformation’ (ibid.). In fact, ‘Hayek’s claims concerning the pricesystem as an economizer of information, must be classified as an“outrageous” hypothesis contrary to what the common sense of mostscholars had led them to expect’ (1982a: 177).Interestingly enough, Smith reports that his tests are favourable tothe ‘Hayek hypothesis’ (176). However, in his experiments, unlike inthe previous interpretations of Hayek,each agent is not in a price taking environment. The environment isone of multilateral negotiation in which each agent is as much aprice maker (who actively announces bids or offers) as a price taker(who accepts bids or offers).(169)This separates Smith’s version of Hayek from others. It is significantlydifferent, because what he tests is whether agents with ‘strict privacy’and knowledge of the trades taking place in the experimental marketcan achieve fairly quickly the theoretically determined equilibriumprice. Smith is testing whether equilibration occurs, while the‘sufficient statistic’ argument is concerned about whether or not ‘strictprivacy’ and knowledge of the equilibrium price lead traders toproduce a Pareto-optimal outcome.How should Smith’s results be interpreted? The conditionsestablished in his experimental markets make it possible that somekind of entrepreneurial process was taking place. Though it may be