Calculation problem

The economic calculation problem is a criticism of using economic planning as a substitute for market-based allocation of the factors of production. It was first proposed by Ludwig von Mises in his 1920 article "Economic Calculation in the Socialist Commonwealth" and later expanded upon by Friedrich Hayek. In his first article, Mises describes the nature of the price system under capitalism and describes how individual subjective values are translated into the objective information necessary for rational allocation of resources in society.

In market exchanges, prices reflect the supply and demand of resources, labor and products. In his first article, Mises focused his criticism on the inevitable deficiencies of the socialisation of capital goods, but Mises later went on to elaborate on various different forms of socialism in his book, Socialism. Mises and Hayek argued that economic calculation is only possible by information provided through market prices, and that bureaucratic or technocratic methods of allocation lack methods to rationally allocate resources. The debate raged in the 1920s and 1930s, and that specific period of the debate has come to be known by economic historians as The Socialist Calculation Debate. Mises' initial criticism received multiple reactions and led to the conception of trial-and-error market socialism, most notably the Lange–Lerner theorem.

In the 1920 paper, Mises argued that the pricing systems in socialist economies were necessarily deficient because if a public entity owned all the means of production, no rational prices could be obtained for capital goods as they were merely internal transfers of goods and not "objects of exchange", unlike final goods. Therefore, they were unpriced and hence the system would be necessarily irrational, as the central planners would not know how to allocate the available resources efficiently. He wrote that "rational economic activity is impossible in a socialist commonwealth". Mises developed his critique of socialism more completely in his 1922 book Socialism: An Economic and Sociological Analysis, arguing that the market price system is an expression of praxeology and can not be replicated by any form of bureaucracy.

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