Ask any economist about how to make a market work and sooner or later she'll tell you that you have to have information. Markets are most effective only when all parties have full, free and timely information. At the most basic level, you can't engage in your guilty pleasure of Chef Boyardee ravioli if the vendor won't tell you how much the can costs. However, the basic explanation works like this: if ten vendors offer the same product, you buy from the one who selling it the cheapest. Knowing which vendor sells your guilty pleasure is simply a matter of "information". Seems pretty simple, eh?
How do you know which vendor offers the best deals? Unless you're Pat Robertson getting election news from God, information isn't magically beamed into your head. You have to search for this information. Searching takes time and, in fact, most don't want to do it. Despite advertising, the average customer shops at the supermarket closest to his or her home. For them, comparison shopping involves glancing at the bottom shelf prices.
The costs of searching for information aren't simply in knowing where to look. It can also involve knowing what you're looking at. I used to sell cars. In car dealerships where the salesmen fight for customers, you'll notice that the car salesmen frequently congregate by the used cars, not the new ones. Well, that's information, if you can figure out what it means. The salesmen obviously want to make the largest amount of money possible and, in fact, it turns out that we make a hell of a lot more money selling used cars than new ones (that's partly due to availability of information, but I'll never finish this post if I keep digressing).
Sometimes you can't have the information. I've got you in my office and you've agreed to buy the car. You probably want to know how much the dealership paid for it. I won't tell you that information because I can't. The dealership won't tell me unless they're really stuck trying to make a deal. If every customer knew the invoice prices, we'd make less money so we won't tell them.
So you're sitting in my office, wanting to buy that new car, but I don't give you the information you want. That's OK. You have a loan through your bank and they've given you the information you want. You know that the invoice is $15,000. I happen to know that we have a $500 dollar factory incentive on that car, so the invoice is effectively $14,500. I could theoretically sell the car for the "invoice" price and still make money. It turns out that you know about the factory incentive, too. You have too much information and I don't know how I can make any money.
I ask about your bank loan and you tell me that it's at 7.5%. Great! What if I can get you a 7% loan? I do and you agree to take it.
What you didn't know, because I didn't want you to, is that we arranged to get you financed at 6% and we tacked an extra 1% onto the financing (we get to keep that 1%. It's standard practice in the auto industry). If you had known about that, you might have negotiated a better deal. However, it's been a long negotiating session, you're tired and cranky and just want your damn car. We pretend that you've cut us to the bone, but we've just made a handsome profit off of you.
That wasn't an example of how the auto industry rips you off. That's business as usual in any business. Everyone has an interest in hoarding their information and getting the information of others. Enron employees would have planned their retirement differently if they had accurate information. The American public might have been less supportive of the war if they had more information. Buyers and sellers are in a constant battle to keep their information from each other. And that's the fundamental paradox of the market. For it to work effectively, everyone has to have accurate information with which to make effective decisions, but the individual actors in the market are all fighting to hoard the information that everyone else needs. Even when they're not trying to hoard information, it can still be expensive to search for information, or we might misunderstand the information we have.
There is no "platonic ideal" of the market. Unlike a dog or that Chef Boyardee that you're guiltily smearing all over your body (I never said you'd eat the damned stuff), you can't point to the market. The market is nothing more than human observations of human behavior in a limited context. At its heart is the central paradox that it needs information to work, but those who participate do their best to hide the information. That's not to say the market doesn't work. We know that it's a great way to decide how to allocate resources, but we often refuse to acknowledge that it's not a Utopia. That's a damned shame because the sooner we pull our heads out (of the ravioli, I presume), the sooner we can start figuring out what we really need rather than let some silly bureaucrat yell "free markets" and think it solves everything.