Economic calculation problem

Definition

As a problem

The economic calculation problem refers to the problem of determining how resources are to be allocated to productive uses in an economy.

Usual meaning as a criticism of central planning

The term economic calculation problem is typically used as a critique of central planning, i.e., the planning or direction of a large economy by a central actor (such as the government of a nation-state). The critique was first made by Ludwig von Mises and then elaborated on by Friedrich von Hayek, and it is a key ingredient of the Austrian school of economics.

Mises, Hayek, and others argued that the problem of resource allocation is solved in a market economy by means of the price mechanism, where a multitude of actors make use of their local knowledge and generate a spontaneous order.

Knowledge and incentives

The economic calculation problem, viewed as a critique of central planning, focuses on the knowledge aspect: the argument is that it is impossible for a single actor to capture all the knowledge necessary to decide how to allocated resources rationally in the economy. There is a related critique based on incentives:

What the focus is on	Corresponding argument supporting a market economy	Corresponding argument against central planning
Knowledge	individual market actors use local knowledge and this is coordinated among multiple actors by means of the price mechanism	the economic calculation problem: it is impossible for a single actor to gather all the information necessary to allocate resources rationally across the economy.
Incentives	invisible hand: a market economy helps channel each individual's pursuit of self-interest to socially beneficial activities and outcomes, through the price mechanism (see market price for the interaction of supply and demand)	public choice economics (a branch of political economy): the incentives that government actors may lead them to act in self-interested ways that are not socially beneficial.