Economics 101

How the Knowledge Problem Impacts Your Daily Decisions

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How do people make decisions about buying and selling goods and services?

Understanding how knowledge shapes people’s decision-making is one of the landmark breakthroughs of twentieth-century economics. Nobel laureate, Friedrich August von Hayek, actually won the Nobel Prize, in part, for his discernment of the “knowledge problem.”

What do we mean by the “knowledge problem” exactly?

Let’s look at this question in light of the decisions you and I make every day.

What Economic “Knowledge” Is Required for Making Dinner?

How do you know what route to take to get to work, what to cook for dinner, where to send your kids to soccer camp?  In a world of scarcity (finite resources) these decisions manifest themselves quite differently than they would in a world without scarcity. We never have full and perfect knowledge or information.

I remember when my husband and I bought our house and I had a new route to work that I had to figure out. It was 38 miles away so every minute I could save mattered and added immensely to my sanity level! The first day I just plugged in the address to my GPS and went for it. Because of traffic, it was the longest way possible I could have taken. It took me what seemed like forever to get there!

Eventually I had it figured out; if traffic was super heavy take route A, if not take route B. If I had to be in especially early, take route C or D. The point is that it took time and experience to build that storehouse of knowledge and once I had that storehouse built, I was able to be a more efficient commuter. This information is what Hayek called “knowledge of the particular circumstances of time and place.”

Knowledge Blind Spots

Hayek’s insight is that this knowledge is dispersed and scattered. No one person has all the knowledge. Hayek stresses in his 1945 essay “The Use of Knowledge in Society,” that this is the central economic problem:

The particular character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.

What Hayek points out is a “triple-whammy” knowledge problem,

  1. Scarcity implies dispersed individual knowledge.
  2. The information we do have is often contradictory.
  3. As unique individuals, we will all act upon the knowledge differently (subjective valuation), so behavior is more difficult to predict. It’s amazing that we get anything done at all!

Sharing Knowledge

Think about my commute. I am sure there are some neighbors who have a similar commute and I could have attempted to figure out who they were and ask them their secrets for minimizing their time in the car, because even my GPS doesn’t possess the precise knowledge of time and place. It doesn’t know where an accident will occur, where construction is active, or if a marathon that day will have streets shut down.

All of this knowledge is dispersed and scattered and although some is easy to get (the marathon schedule), some is difficult to get (surveying all of my neighbors) and some we will never know (when an accident will occur before it happens). The beauty is that markets help coordinate this dispersed knowledge through voluntary exchange.

In IFWE’s homeschool curriculum, Biblical Foundations for the Economic Way of Thinking, we describe the mechanism by which knowledge is dispersed this way:

Consumers can tell producers how much they value items in the market based on how much they are willing to pay. By sending signals about scarcity and subjective value, prices help us cope with the knowledge problem by giving economic actors a way to share exclusive information and make informed choices based on price signals.

Only God is all-knowing. We are finite and limited, so prices help us disperse knowledge efficiently. And, just as there are built-in interdependencies in other parts of creation—and particularly with respect to using the gifts each of us has been given (Romans 12:4-6; 1 Cor. 12:21-25)—the knowledge problem also reveals our inherent interdependence. Prices communicate information we need to streamline those interdependencies and serve each other through trade.

Ultimately, overcoming the knowledge problem to make good decisions with what we’ve been given is good stewardship and is part of God’s design and desire for his creation.


Editor’s note: Learn more about applying the economic way of thinking to our daily lives in Anne Bradley’s booklet, Be Fruitful and Multiply: Why Economics is Necessary for Making God-Pleasing Decisions in the IFWE Bookstore

Help reach more people with this critical message of freedom, fulfillment, and flourishing! Donate to IFWE today.

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