The Theory of the Yearn

Written by Ryan Watkins & Jonathan Otto

There’s a theoretical equilibrium in economies where scarce resources are allocated perfectly allowing everyone to get what they want for the lowest possible price. In practice this is difficult or impossible to achieve because it requires participants to have "perfect information" - i.e. the actual price of all goods and services in an economy no matter how trivial.

But society has a mechanism for approaching "perfect information" called markets, which aggregate information from independent and diverse individuals into prices by exploiting the human desire to attain wealth.

If a farmer sees the price of corn increase, they’ll know it’s a great time to produce more corn. The same works vice versa. These “price signals,” often referred to as the “invisible hand,” guide market participants to produce (or not produce) what society needs, such as more masks during a global pandemic.

But if markets are so good at allocating resources, then why don't we use them for all economic activity?

The Theory of the Firm

In 1937, Ronald Coase attempted to explain why we don’t use markets for all economic activity in his now famous paper "The Nature of the Firm". He concluded that there are three types of "transaction costs" (costs associated with buying/selling a good or service) that discourage the use of markets, and encourage the use of firms: