Sean McDermott has been giving me a hard time on my Facebook page for my blog. The advantages of commenting there include being able to fix typos and knowing who you are discussing issues with.

I don't agree with many of his views but I cannot accuse him of not being well-read. This guest blog entry is on bounded rationality. If you would like to write a guest blog entry send me an email.

Bounded Rationality By Sean McDermott

Bounded rationality is the economic theory, first posited by F. A. Hayek that society is made up of individuals, each with incomplete knowledge about everything. Specifically he is talking about an economic context of a market. These individuals with incomplete knowledge form a coherent price system that functions to transmit information quite efficiently, more so than any central planner or central planning body with "endless" amounts of information.

I'll discuss how this plays with respect to three actors; a producer, a retailer and a consumer. If a commodity is suddenly scarce, like a tomato during a drought, it's price will rise. The price of an individual tomato rises due to its scarcity relative to the all of the other tomatoes. If a producer is able to produce tomatoes during a drought, he will charge more. His tomatoes are now more valuable due to their scarcity. Also, when the retailer has less tomatoes to sell due to the diminished supply, but the same amount of demand he will increase the price of the tomato so as not to run out of his inventory too soon. The consumer of tomatoes who sees the increase in price will make one of two decisions; she'll either buy the pricier tomato or substitute it for another commodity that didn't go up in price.

In Ventura County example; Casey Houweling owns a multi-million dollar hothouse that hydroponically grows tomatoes in Oxnard. His hothouse gobbles up as much sun as possible, is immune to wind, captures rainwater, hosts its own bees for the dissemination of pollen and is very resistant to pests without using much (if any) pesticide. I'm barely scratching the surface, if you want to read all about just how cool the Houweling's hothouse is, you can check out the original articles I read here and here.

The Houweling hothouse is able to churn out regular, predictable amounts of tomatoes. The hothouse tomatoes are almost completely immune to droughts and recalls. The capitalist should be encouraged to make frugal investments in his agribusiness. Bounded rationality, as explained by F.A. Hayek allows for the shrewd entrepreneur to make a profit by serving his fellow man. The Houweling hothouse should be allowed to charge more for tomatoes in droughts, recalls (remember the recent salmonella recall?) and any other shortages. The Houweling's took the risks, they made the investments and they ought to benefit from their hard work, insight, agricultural talent and smarts.

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