conference paper

Exploring Prices as an Information Technology

INTEG 420 / 421 Conference Paper

Geoffrey Evamy Hill

Supervisor: Dr. Patricia Marino

December 2014

1. Introduction

I have spent the last ten months thinking about price systems. The questions of interest were about the mechanisms that form prices, how well these prices track perceived value, and the interventions that might help to improve how these pricing mechanisms track perceived value. My main purpose has been to attempt to understand how we might deal, as a society, with impending threats of climate change. The fundamental assumption is that the low cost of hydrocarbon based fuel sources significantly contributes to this issue, and prices must be adjusted in a way that allows for human society to carry forward while taking better account of nature.

The questions I have asked need to be answered for functional purposes. I believe that our societal feedback and information systems need to take in deep consideration of the earth. My research has led me to conclude that the answers to these questions are a long way off. There is no sign of a complete objective understanding of the mechanisms of markets. We must therefore operate under of conditions of uncertainty to avoid crises that underpriced oil can lead us too.  We must still engineer a system that is effectively a black box to us.

After working with diverse readings and ideas, this project became about developing a way to look at the problem of price formation going forward. I have though of a heuristic that I hope will be useful to others and myself in understanding societal mechanisms of information and perception as manifested in the price system. I have attempted to synthesize important areas of my research in able to come to a mental framework that would help in more directed further conceptualizing. This paper is a summary of this work.

2. This Project in Relation to the Discipline of Economics

My project pulled together ideas from a milieu of areas around the discipline of economics.  From reading Robinson’s Economic Philosophy, Foster’s “Why is Economics not a Complex Systems Science?”, and Schumpeter’s “Science and Ideology”, I have come to see economics as ideological. This is in the sense that all sciences are ideological, that social perspective influences how data is collected and how theories are formed. Schumpeter states, “perception of a set of related phenomena is a pre-scientific act”(Schumpeter, 350); economics is not exempt. The positive and the normative are often intertwined.

Economics is not the definitive study of the phenomenon of economies, it is value-laden in its approach. This must be taken into account when analyzing the topic, and when reflecting on my own approach. We have a number of strong ideas about how prices are and are not formed. There are a plurality of competing ideas and theories, with no unified approach. An informational approach to thinking about them seems to be a useful paradigm. It is necessary to consider how markets are human constructions existing in the natural world. It is only by looking at the topic of economics in a broader, transdisciplinary framework that I can have the flexibility to explore this issue.

3. Informational approach to understanding prices

Information is what is conveyed or represented by a particular arrangement or sequence of things. (Beavers, 2) Signals are a form of information that carry a message. When transmitted to a receiver, signals direct material, energy and informational flows in the world. (Beinhocker, 71) They drive the actions and beliefs of people. Signals are incredibly powerful.

In his 1945 paper “The use of knowledge in society”, Friedrich Hayek claims that a free-market system is superior to a planned economy in how it determines price. Hayek argues that an individual or small committee cannot gather enough relevant knowledge about all aspects of an economy in order to understand how to set appropriate prices. He says that a market system allows agents to interactively communicate information that essentially leads to an appropriate price. This, he argues, matches supply to demand and results in fewer shortages or surpluses and highlights the fundamental flaw in the logic of a planned economy. Essentially, he sees knowledge of an economic reality highly fragmented and competition through local markets as a method of integrating it. The price system is an essential part of the functioning of markets. This perspective pulls back to a much broader conception of prices.

This view places importance on what the price system accomplishes, instead of forwarding a viewpoint of what information particular is integrated into prices. Hayek views prices as a kind of arbitrary numerical economic calculus that helps in coordination of economic activities. The price system, situated in the market, it is a way of pulling together information and knowledge from across society in order to accomplish the fulfillment of material needs. There are a number of things not explicitly considered by Hayek that must be added. The primary considerations are: the geographic and temporal situation of markets, the differential power of market participants, as well as the construction of currencies and institutions as prerequisites to markets.

Prices and markets exist within the context of exchange; this is situated in time and space. Geographer Brian J. L. Berry envisages a three-stage sequence of exchange systems in his book Geography of Market Centers and Retail Distribution. The first is socially administered exchange driven by redistribution and reciprocity. The second is barter exchange together with simple money-based exchange common in occasional markets and less economically complex areas. The third is permanent market-centre hierarchies depending on production specialization and deep interdependence between places.  In terms of the computational metaphor, this fact could be conceived as a change from the idea that a whole society is a single market information-super-processor, as it is implied in a Hayekian approach, to the idea that markets are situated computational structures.  Prices are generated from the interaction of humans with markets. Markets are more like automata, situated evolutionary “software” structures instead of background processors (Mirowski, 225). Markomata are “a specialized piece of software, which both calculates and acts upon inputs, comprised of an integrated set of algorithms.” (Mirowski, 226) The purpose of these human constructions is to facilitate allocation and coordination, just as social technologies facilitate social structures (Beinhocker, 262). These computational exchange mechanisms generate prices, a signaling system for allocation and coordination. This is a way of conceiving markets as situated information processors.

We must also consider that markets do not operate in perfect competition, so there will be inequalities transmission of price information. Monopolies and oligopolies occur when there are few large suppliers in a market. Monopsony or oligopsony refers to when there are few large buyers. These market participants are able to set prices because of their supplying or buying power (Chang, 39), and would therefore show that the knowledge in markets would not be representative of the whole. Unequal market power would refute any claim that markets are perfect information processors.

The Hayekian approach presupposes currency and legal institutions. For markets to work as described, their genesis cannot be taken for granted. We must understand how governments create currency and how the value of currency is supported by human confidence (Chang, 22).  It must also be considered how contracts and property rights are enforced to allow for market functioning (Marshall, 190). We must consider these imperfections to use the informational metaphor.

I have thought of price systems as social technologies: coordinating processes that use conceptual symbolic representation to guide human action in order make change in the material world. How might we improve the performance of the price system as an information system and social technology?  I am most concerned with the impact artificially low oil prices have on climate change.

4. Improving Price Systems as Information Systems

Heuristics are “good enough” techniques that can be used to solve problems, to learn, and to discover.  They are not optimal, but are typically experienced based and meet a given set of goals. They also offer a platform for multiple disciplines to understand and work on the same problem, making collaboration easier. (Huutoniemi & Tapio, 5) Their non-optimality is incredibly useful when time is short; resources are lacking, and when the complexity is huge.

It seems we will spend another century attempting to understand exactly how price systems work, and we will lose out against the social and environmental problems they create in the mean time. We need a heuristic for looking at price systems as social technologies instead of optimizations in order to solve current problems. The conception of price systems as information systems and prices as their outputs has helped me conceive of functional ways to improve their processes with regard to the environment. Prices are information that directs action. They direct action in ways that are problematic for human society. Namely, information directs action that causes climate change, ecological degradation, and biodiversity loss (Meadows, 15).  If we are to continue using the price system, we need to find ways to mitigate these effects.

Particularly if we think of price systems as an information technology, we can think of them in a systems engineering framework. A tool for assessing communications and signaling systems in engineering is a matrix of bias and precision. We should aspire towards pricing systems that are unbiased and precise. There is no perfect price, but by taking the “via negativa” approach, we can become closer to prices that better represent the world. Heuristically, we can detect bias in pricing through an analysis of what is not included. This is via negativa, or a view through the negative (Taleb, 301). The negative can really only be detected in the extreme case of deviation. Prices are formed by many different mechanisms. These can and should be individually studied in different geographies, times and industries. The bias of these mechanisms is a function of how closely mental models of participants correspond to reality. The precision of these mechanisms is a function of the measurement and recording tools, processes and norms of the evaluator.

Various states of bias and precision are not intrinsically good or bad, but their evaluation is entirely dependent on the intended ends. A very biased price system could favour some people, and a very precise system could fine tune economic coordination. In the case of climate change and hydrocarbon pricing, pricing is currently inaccurate because it doesn’t account for future risk and current cost but very precise as it is mediated by advanced technologies of organization that permit coordination for economy to run in a highly tuned fashion.

What are features of unbiased pricing systems? Paradigmatic mental models are the broad determinants of the bias of pricing mechanisms. It matters who participates in pricing systems and how much power they might have. The cognition and representations of individual participants within an economy pricing systems is fundamental to pricing. If individuals are ignorant or are simply incapable of conceiving a value, risk, cost or uncertainty then the pricing system will not account for it.

Unbiased prices are a function of the worldview and relative power of those participating in markets, the institutions that uphold them and the associated pricing methods. Unbiased prices are those that reflect the valuation of the thing to the best of human’s societal knowledge. These are prices generated by mechanisms that accurately take into account the supply or demand and capture what would otherwise be significant externalities. Unbiased prices are the product of market mechanisms that take into account the different standpoints of the participants in the market. We would suspect prices to be unbiased when they are set in competitive markets with multiple players. Unbiased prices are flexible; they respond to changes in the physical world and the knowledge space. They should account for both local and global conditions – the stock of a good in one region as well as the global impact of the good on the climate. Bias in prices is the result of systemic misrepresentation of the environmental conditions by the price signals.

What are the features of precise pricing systems? Measurement and record keeping are ways to capture value and differentiates prices, and lead ways to more complex ways of differentiating prices – they provide other ways of creating a sort of language. The technologies for measurement and quantification, physical and social, are the broad determinants of the precision of pricing mechanisms. Precision is the reproducibility and consistent internal logic of a pricing system allowing for increased complexity and coordination. Prices are a form of measurement that presupposes common mental paradigms of what it is to be measured. Measurement is mediated social and physical tools such as formal weights and measures, property rights, double entry bookkeeping and corporate processes.

Generally, the types of interventions to the price system by taking an informational approach are to decrease bias and to temporarily decrease precision. The problem is that highly efficient system with precision pricing (and therefore coordination) is most susceptible to outside shocks because of the potential for bias. It seems like precision must be temporarily be given up until the bias fundamentals are reformed. Decreasing bias is by changing mental models of participants or changing the influence that specific players have in a price system. While precision of price systems is helpful for economic coordination, temporarily decreasing the precision by reducing price flexibility would make it easier for bias fundamentals to be adjusted.

The idea of bias and precision as an evaluation of pricing systems must by applied metaphorically and subjectively. We cannot have the same technical definitions. They are only useful heuristics if we see economics as a value-laden discipline. Bias refers to a drift of prices away from competitive market functioning and valuation based on common knowledge. Precision refers to the internal consistency of prices. Biased prices are not necessarily bad, and precise prices are not necessarily good. It requires a case-by-case exploration. We might want prices to be biased in order to serve the poorest in our society, and we might frown upon prices set by monopolists. Precise prices can lead to highly tuned market and corporate functioning; while they might give use a sense of false precision when we attempt to value a human life or a tonne of carbon.

5. Future Studies

The bias and precision metaphor already implies some empirical validating studies that I have recognized. For example, if participants in a market pricing system matter, or their perceptions of the world around them matter, then changes in these would change prices. These would include periods of paradigmatic mental shifts and periods of entrance of new people into economies will cause large pricing change. Theoretically, this could be a statistical study that uses conventional time series analysis of prices. A similar study could be done on the precision of pricing systems. The precision of prices would change as technologies, such as weigh scales, the internet, or double entry bookkeeping, evolve in economies. These technologies would allow for more intricately differentiated pricing schemes. This is also compared to inflation or moving from a shillings, pence system to a decimal pricing system. It allows for greater distinction of prices. The nature of the symbolic pricing system would have significant effect on increasing precision and decreasing bias prices.

6. Conclusions

In reflecting on the whole of this project, it is clear to me that my personal purpose is to generate a broader intellectual narrative about how we might tinker with or reform price systems to serve society. Robert Heilbroner was an American economist and historian of economic thought. He saw economics as “at its core… an explanation system whose purpose is to enlighten us as to the working, and therefore to the problems and prospects, of that complex social entity we call the economy.” (Heilbroner, 311) Reading broadly on differing perspectives on how price systems worked has allow my to glimpse the extent of possibilities for understanding the topic. There are compelling arguments and counter arguments to what prices are and what they are not. Exploring the topic is about attempting to make sense of something that doesn’t make a lot of sense. We should be creative in the way we conceive of these complex systems in order to make their understanding more accessible to all people and to broaden the solution space of interventions to create broader outcomes society.

7. Selected Works Cited

Beinhocker, E. (2007). The Origin of Wealth: The Radical Remaking of Economics and What It Means for Business and Society. Boston, Mass.: Harvard Business School Press.

Berry, B. J. L. (1967). Geography of market centers and retail distribution. Englewood Cliffs, NJ [u.a.: Prentice-Hall.]

Chang, H. J. (2014). Economics: The User’s Guide. London, UK: Pelican.

Heilbroner, R. L. (1972). The worldly philosophers: The lives, times, and ideas of the great economic thinkers. New York: Simon and Schuster.

Hayek, F. (n.d.). The Use of Knowledge in Society. The American Economic Review., 35(4), 519–530.

Huutoniemi, K., & Tapio, P. (2014). Transdisciplinary Sustainability Studies: A Heuristic Approach. New York: Routledge.

Kahneman, D. (2011). Thinking Fast and Slow (First.). New York, NY: Farrar, Straus and Giroux.

Marshall, A. (2014). The Surprising Design of Market Economies. USA: University of Texas Press.

Meadows, D. (2008). Thinking in Systems: A primer. White River Junction, Vermont: Chelsea Green Publishing.

Mirowski, P. (2007). Markets come to bits: Evolution, computation and markomata in economic science. Journal of Economic Behaviour and Organization, Elsevier, 63, 209–242.

Rabinovich, S. (2014). General Concepts in the Theory of Measurements. In Evaluating Measurment Accuracy: A Practical Approach (pp. 1–30). New York: Springer.

Schumpeter, Joseph A. “Science and Ideology.” The American Economic Review 39.2 (1949): 346-59. JSTOR. Web. 11 Apr. 2014. <http://www.jstor.org/stable/10.2307/1812737?ref=search-gateway:f473af2e210a47477e5be301ab0e4112&gt;.

Taleb, N. (2012). AntiFragile: How things gain from Disorder. New York: Random House Trade Paperback.

William, J. (2012). Doing Capitalism in the Innovation Economy: Markets, Speculation and the State. Cambridge, UK: Cambridge University Press.