A Self-Correcting System

Feedback occurs all around us--it is everywhere in biological systems, and engineers use it extensively in control structures. It is also quite apparent in market systems, providing them with an important element of stability. For example, if a product becomes less available, its price rises. This rise in price causes a number of actions to occur which limit the rise, and may in some cases set the stage for a future reduction in price.

First, higher prices cause people to use less of a product. They may substitute or do without. Higher prices of petroleum in the 1970s, for example, encouraged people to drive less, to work closer to the places they lived, to insulate their homes, to turn down thermostats in winter and to turn up thermostats in summer, to buy smaller and more fuel-efficient cars, and to find a host of other ways to cut usage. The higher the price, the greater is the incentive for consumers to buy less.

Second, higher prices encourage producers and potential producers to find ways to produce more of the product. As a response to the oil price increases, producers found ways to extract more oil from old wells. They also found it worthwhile to greatly step up the search for new oil fields around the world, and a considerable amount of new oil was found as a result of this search.

Third, higher prices signal people to search for new ways to meet old demands. The higher prices of oil spurred attempts to increase the energy efficiency of machines. It encouraged people to switch to substitute fuels. It spurred research on alternative energy sources, including new ways to tap the energy in solar radiation, wind, and water.

The dampening feedback system in a market also works when the price falls. When a product becomes cheaper, reactions opposite to those described above are set into motion. When oil became cheaper in the mid-1980s, people were encouraged to use more, producers were encouraged to search for less, and everyone was encouraged to stop substituting away from oil.

Viewed in terms of the concept of feedback, the market system reveals important self-stabilizing features. Sometimes these features are ignored. For example, there were some highly publicized "doomsday" forecasts in the early 1970s that foresaw a rapid depletion of the earth's resources and a collapse of industrial societies. These studies often ignored price effects entirely, simply assuming that one could extrapolate present usage trends into the future. In this view, the use of the resource would continue to rise until suddenly it would be depleted and usage would collapse to zero.

The future is very hard to predict with any accuracy. Perhaps someday, industrial civilization will collapse because of resource depletion. But anyone who believes such a forecast of the future should be able to explain why this outcome is reasonable given the dampening feedback system of price incentives. If they ignore this feedback, they will inevitably foresee doom and gloom, but they do not deserve serious intellectual consideration.

Finally, be aware that feedback systems can have delays in adjusting. A system with dampening feedback may not be in equilibrium, but it does have forces that keep it close to equilibrium.

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Copyright Robert Schenk