This parable is inspired by one of the most important contributions to the Austrian school of economic thought-the reintroduction in economic theory of a focus on the actual mechanism of price formation. Ludwig von Mises, Friedrich Hayek, and their followers have built upon the writings of Richard Cantillon in order to draw our attention to the way subjective consumer perceptions of value determine relative prices and methods of production (as opposed to the classical focus on costs as determinants of prices in an imaginary long-run equilibrium). In cooperation with Milton Friedman and his colleagues in the Chicago school, the Austrians also revealed the disruptive consequences of monetary manipulations. Their arguments are illustrated in the following story about cocoa and peanuts.
Charlie is the proud heir of Willy Wonka Inc., the world's leading chocolate manufacturer. He is importing cocoa from the land of Calormen. Unfortunately, a fire-breathing dragon has flown in from the Great Dessert and made his nest in the middle of the cocoa plantations. Something needs to incentivize the Calormenes to take the additional risks in harvesting their crops. Charlie is forced to pay more for his inputs. Higher production costs lower the supply (and increase the price) of chocolate in the short run.
The result is that people like me will either spend a larger portion of their paycheck on Willy Wonka products, thus decreasing the demand for (and the prices of) other goods, or switch to consuming peanut butter cookies instead of chocolate chip muffins. Our sovereign decisions as consumers will inform Charlie, the Calormenes, those who grow peanuts in Narnia, and everyone else how to adjust to the dragon-infested cocoa plantations. Most of us need not even know about the dragon-we shall learn everything we need to know through the price mechanism. The real trouble will begin if the market mechanism is corrupted by inflation, the consequences of which will become obvious in next week's column.