Tying It Together
This chapter is about understanding what markets do. And what they do best is reallocate resources to better uses. That reallocation generates gains from trade. What’s the source of these gains from trade? We make more stuff when we use comparative advantage to reallocate tasks to their lowest-cost producer. The result is an extraordinary degree of specialization, in which prices play a central role in coordinating economic activity.
We can see all of this by following the story of a particular good through the economy, from start to finish. Here’s what happened when Nobel laureate Milton Friedman gazed with wonder upon a single pencil, musing about the extraordinary economic journey it took to your desk:
Milton Friedman with his remarkable pencil.
Look at this lead pencil. There’s not a single person in the world who could make this pencil . . .
The wood . . . comes from a tree . . . To cut down that tree, it took a saw. To make the saw, it took steel. To make steel, it took iron ore. This black center . . . comes from some mines in South America. This red top up here, this eraser, a bit of rubber, probably comes from Malaya, where the rubber tree isn’t even native! It was imported from South America by some businessmen with the help of the British government. This brass ferrule? I haven’t the slightest idea where it came from. Or the yellow paint! Or the paint that made the black lines. Or the glue that holds it together.
Literally thousands of people cooperated to make this pencil. People who don’t speak the same language, who practice different religions, who might hate one another if they ever met!
Next time you pick up a pencil, you really should marvel at the extraordinary path that it has taken to you. And marvel also at the incredibly low price: If you buy a few dozen pencils, they’ll cost you only about 10 cents each.
These two marvels are linked. The pencil follows an extraordinary path because every single part of the pencil is produced by folks who specialize in the narrow task for which they hold a comparative advantage. Markets reallocate stuff to better uses, and in this case, they reallocate the tasks that go into making a pencil to those who can do them at the lowest opportunity cost.
The extraordinary symphony of productive effort that led to the production of Milton Friedman’s pencil was conducted by the price system, which signals what is needed, provides an incentive to act, and aggregates the information needed to decide how to act.
So if you’re ever stuck in an exam trying to remember what markets do, just look at the pencil you’re writing with.