In economic thought, mathematical models are created to reflect, and perhaps eventually to predict, the psychology of individual decision-makers, the actions of consumers and producers, and the flow of information.
The actions of buyers and sellers are shaped by what they know: information. Those actions are also shaped by what they think: psychology. So economists ask about what the buyers and sellers know, as well as about what they think they know.
Markets will be affected, therefore, not only by changes in supply and demand, but also by changes in how much information is available to buyers and sellers.
The precise, predictable abstract economy found in equations is, obviously, never found in the real world because of inefficiencies and illiquidities in the marketplace. In addition, and equally significant, are inefficiencies and illiquidities in flow of information.
Friedrich Hayek states the basic rationale for economic reckoning:
What is the problem we wish to solve when we try to construct a rational economic order? On certain familiar assumptions the answer is simple enough. If we possess all the relevant information, if we can start out from a given system of preferences, and if we command complete knowledge of available means, the problem which remains is purely one of logic. That is, the answer to the question of what is the best use of the available means is implicit in our assumptions. The conditions which the solution of this optimum problem must satisfy have been fully worked out and can be stated best in mathematical form: put at their briefest, they are that the marginal rates of substitution between any two commodities or factors must be the same in all their different uses.
In addition to the illiquidities and inefficiencies in the flow of information is the additional complicating factor of which conclusions each individual decision-maker might draw from whatever information is at hand. The admittedly crystalline beauty of algebraic economics is quickly muddied and blurred such factors, as Hayek writes:
This, however, is emphatically not the economic problem which society faces. And the economic calculus which we have developed to solve this logical problem, though an important step toward the solution of the economic problem of society, does not yet provide an answer to it. The reason for this is that the “data” from which the economic calculus starts are never for the whole society “given” to a single mind which could work out the implications and can never be so given.
Information, then, is as important as supply and demand. A buyer or seller will act in the marketplace not only according to what is offered, but also according to what is known. This can be seen in large quantity of magazines and newspapers related to finance and investing. So it is that David Crook, editor at the Wall Street Journal, wrote in 2015 that journalists in the business press operate in the
fundamentally democratic belief that you — a regular person of modest means and no professional financial background — can take control of your money and build a comfortable future. I hope that we have helped you make your life better, more secure, more free.
Beliefs and opinions, desires and fears, ultimately play a larger role in the market than the quantities of good produced by factories. Objective information is processed into subjective perceptions by sellers and buyers. Information will have an effect on the market, but it is not always calculable.
