Economic Calculation Problem Explained—Why Socialism Doesn’t Work

Economic Calculation Problem Explained—Why Socialism Doesn’t Work

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So Ludwig Von Mises made an argument on prices
in 1920 and this was on the Economic Calculation Problem and really all what it’s down to is
price information signals that have been distorted by government’s intervention, through government’s
price controls. Two of the most important pieces of information that you gather from
prices are profits and losses. Profits, no different to losses are very important, they’re
vitally important to the operation of an economy. The whole purpose of profits is not just about,
you know, companies making money in order to meet their operational costs, etc. It’s
important to understand that profits are a signal that enable the company, the producers
to know what they’re going to produce more of and what resources to use, etc, where to
allocate them. So this is the issue, because, socialists just look at prices as an obstacle
to getting the things that they want and this is a very big mistake because prices are not
an obstacle. So, whenever you see a high prices in the market, a high price in the market
is a signal, it’s telling you there is a shortage. No different to a low price in the market
which tells you there is an abundance. Price is what is determined through the laws of
supply and demand, it’s determined through consumer demand in the marketplace. After
all, you know, it’s all well in this imaginary world that businesses can just produce whatever
the hell they like, set whatever price the hell they like and people will just buy it.
The reality is, products will only sell dependent on the consumer, whether the consumer is willing
to pay for it or not. The market is driven by consumer demand that’s going to determine
what prices are and it’s going to determine simply what’s going to produced and what’s
not going to, after all, if producers are not going to produce what consumers are demanding,
consumers through choice will go elsewhere and get it or they will seek alternatives.
Let’s just say for argument sake that consumers walk into a electrical good store or whatever
store it may be, or a clothing store, whatever; the consumer walks in, they pick and choose
what products they want to buy, they go to the counter, they pay for the product and
they go home and after the end of each month, a business can see what its most bought products
are and what its least bought products are, simply just from consumers walking into their
store and buying their goods freely. That information is actually telling the company
what their profits and losses are. The most bought products is telling them here’s where
their profits are, therefore, the business, since its main incentive is to make profits,
it’s going to produce more of what the consumer is buying most of. It can see what their most
bought products are, therefore, without the consumer realising it that that is the consumer
telling the company: “here’s what we want you to produce more of,” so the company will
produce more of that, it knows what resources to use simply from the information of what
consumers are spending on, because after all, these are the products that are most bought,
so they know what resources their going to use, they know where to take the resources,
where to allocate them and they know what to invest more in. Likewise, from the least
bought products in a company, they know the information of their losses; they know what
to stop producing; they know what resources to stop using and they know where to stop
allocating, you know, they know what to stop investing in and Ludwig Von Mises argued that
in the destruction of the information of prices, of these price signals, you would not hold
the information of what to produce or where to allocate them or, you know, what to invest
more in, etc, etc. And what ends up happening is when you destroy the information of prices,
of market-driven prices that is; a market-driven price is basically prices determined by the
consumer, from consumer’s just freely walking into the stores and buying what they want,
that’s what you call market-driven prices. When you destroy that information, you end
up with what you call ‘the misallocation of valuable scarce resources.’ So what ends up
happening is, the central government ends up taking the wrong resources, it over uses
them, it ends up overproducing, it misallocates the resources into the wrong parts of the
market where there isn’t so much demand and it neglects the very parts of the market where
it is most in demand of. So, this is the issue. So, this is what the problem is with that
of the central government through central planning, fixing prices, trying to fix prices
above or below the market value. Through government’s price fixing, it destroys the information
of profits and losses, so, it doesn’t know the information of, you know; what resources
to use; where to allocate them; you know, how much to produce or even what to invest
more in, etc, etc. So, since it doesn’t know this information it’s left with guess work.
This is why when you go back to that of the Democratic Socialist politician, Jay Douglas
of the Labour Party, it’s the reason why he came out and said: “the gentlemen of Whitehall
really do know what is best for the British people than the British people do themselves.”
It’s more or less his way of saying that, you know: “Okay, we don’t know what the needs
and wants of the people are through our central planning, so, well just take the self-centred
attitude of we will just produce for what we think is best for them.” Now, there are
two different kinds of price controls, you have that of; price ceilings and the price
floors. Price ceilings will result in shortages and the price floors result in the surplus
waste problems. To explain briefly; a price floor is where the government will artificially
(the keyword there is artificially,) and it will artificially raise the cost and set a
minimum so that the cost cannot go below the minimum. A good example of that would be the
minimum wage law. Price floors will, you know, end up resulting in, you know, overproducing
and it creates that of surplus waste. When you look at that of the price ceiling’s, it’s
the opposite, it’s basically where the government would artificially lower the cost and that
it would set a maximum so that the price cannot go above the maximum, you cannot sell above
the government’s maximum fixed, you know, price ceiling. We’ve seen this, you know,
put into practice throughout socialist countries, whether it’s been the Soviet Union, Cuba,
Chile in the early 1970s or that of Venezuela and time and time again, price ceiling’s have
always resulted in the very shortage problems. We’ve got many examples we could go through;
you could look at the surplus waste problems in California where, you know, the overproduction
of orange’s and they ended up going to waste; we saw the shortage problems with the big
blackout in New York City on August 24th, 2003; you could look at the power shortages
within Venezuela; the blackout problem in Britain in the 1970s; as well of course, the
shortage at the pump. All of these are examples of that of the price ceiling that’s been set.
Another one would be that of the food shortage problem in Venezuela or even what you saw
within that of Chile. So I’ve briefly explained the Economic Calculation Problem. It’s essentially
a problem where the government’s price fixing through trying to artificially raise or lower
costs above or below market value ends up distorting the information of profits and
losses and once you’ve destroyed the information of profits and losses, you don’t hold the
information to rationally calculate; what your profits and losses are, what the information
is going to be for your profits, which is going to be; what to produce more of; what
to stop producing, which is your losses; you know, where to allocate, you know, the scarce
natural resources; what resources to use, again, profits and your losses; where to stop
allocating scarce natural resources, and of course; what resources to stop using, again,
what resources, what you need to invest more in and what to stop investing in. All of this
information from profits and losses. And even if socialists try to use the argument and
say: “well, I don’t believe in central planning, I believe in, you know, Anarchism, I believe
in Libertarian Socialism.” They’re going to argue either for a moneyless based system
or trying to control prices, they’re not going to argue for a price system that basically
leaves it down to the marketplace driven by consumer demand to determine what prices are
because that would defy everything of what socialism stands for, that is capitalism,
that is the free market economy. So, you’ve got an option between the two; fixing prices
or a moneyless based system. Without the information of, you know, profits and losses, without
a price system, you’re not going to know what resources to use more of or how much to produce
or where to allocate them; where the resources are best put, where to best allocate them.
The argument that you will get is this idea that because of technology improving and the
artificial intelligence that somehow robots will finally work out, what I want you to
do, is to sit and listen to this short explanation by Kevin D. Williamson himself that explains
in his book ‘The Politically Incorrect Guide to Socialism’ that explains that not even
the superhuman computers would be able to calculate 1-years worth of milk production:
“Milk, imagine what it would take in terms of sheer information to run a socialist distribution
network for milk in the United States. Some people, such as vegans or the lactose intolerant
consume no milk, but some households consume large quantities of the drink; those with
many kids, those who use lots of milk products in their cooking, etc. Others may consume
varying amounts; in July when it’s hot and humid, a family might prefer lemonade but
it might consume a lot of milk in August if it’s whipping up a bunch of homemade ice
cream for a big family reunion.In addition to quantity calculations, there are various
questions to answer to; whole milk or skimmed; 1 percent or 2 percent; do you prefer more
expensive organic milk or cheaper factory farmed milk and if you prefer the pricier
organic stuff, how much more are you willing to pay for it? What about soy milk, chocolate
milk, the delicious Pennsylvania Dutch treat known as Vanilla milk? There are 115 million
households in the United States, if we imagine a weekly milk consumption budget for each
of them, that’s 5.98 billion household weeks to plan for, adding in a fairly restrictive
list of variables, call it 0 to 20 quartz a week, 4 levels of fat content; organic,
non-organic; soy, dairy and 3 flavour options, you end up with around 6 trillion options
to choose from. These are the choices facing our committee of central planners and let’s
just assume that our planners are the best and brightest the world has to offer with
the temperaments of angels totally unswayed by the quotidian concerns of politics or the
influence of the various competing dairy lobbies, for instance; let’s assume they are not
human beings as we know them to exist and that they have at their exposal a vast array
of top flight supercomputers, if they took just one second to consider each of these
options, it would take them 190,128 years just to run through the possibilities of 1-years
milk consumption in the United States. That’s a lot of calculation.” Anyway folk, thank
you for watching, if you’ve got anything that you would like to ask me that, of course,
you might not understand, I could of course explain a bit more below, maybe give you examples
or that, but all-in-all, I hope that’s been informative for you, as I say, if you don’t
understand anything, you know, comment in the comments section below. You know, it’s
just, it’s one of these things that it’s part and parcel of socialism, it’s unavoidable,
not even with that of Marxism, it’s just, it’s something even within the mixed economy,
you know, socialism, in general, cannot avoid that problem. So, thank you for watching my
video, hope you’ve taken something from it and I shall talk to you’s later, cheers!


  1. Yes, this is also the reason why nationalized roads are filled with cracks. It’s simply because the government has no idea when to fix the roads, where to build them and how to price them accurately. The reason why private roads are nice and smooth is because they don’t suffer from the economic calculation problem.

  2. Hi Scotty great video as always. I was gonna ask that have you read the book called Basic economics from Thomas Sowell.

  3. This is all so silly. All that is ever asserted by these posts is that economic science cannot compute the efficient prices needed to guide the economy into its optimal state. This simply refuses to acknowledge the innumerable available counter-examples to your premise, e.g.:

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