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Economics I Outline of the Market Equilibrium

Chapter 2: Modern Mixed Economy - To solve the questions what, how, and for whom
1. Dollar Votes – determine goods and services to be
Mixed Economy produced through buyers’ purchase decisions and
- A combination of private enterprise working through the where the goods go
marketplace and government regulation, taxation, and o No one buys pagers anymore, pagers went
programs extinct
- Command + Market Economy  To maximize profit for firms
 PROFIT – net revenues
Market Mechanism (Total Sales – Total Costs)
- Who – no single individual or organization or government o WHAT to produce
is responsible for solving the economic problems 2. Adopt most efficient methods of production
 Everyone is. o Keep costs at a minimum in production
 Invisibly coordinated by a system of prices and  For producers to meet price competition and
markets maximize profits
- The use of money exchanged by buyers and sellers with o HOW to produce
an open and understood system of value and time trade  Determined by completion amongst
offs to produce the best distribution of goods and services producers
3. A buyer willing to purchase a good at the equilibrium
Market Economy price for it
- Coordinates people, activities, and businesses through a o Ex. Distribution of income among the population
system of prices and markets is determined by the quantity of services and the
prices of factors
Marketplace o FOR WHOM to produce
- Where farmers bring their goods to sell o FACTOR MARKETS – determine FACTOR PRICES
(wage rates, land rents, interest rates, and
Market profits)
- A mechanism wherein buyers and sellers interact,
exchange goods and services for assets, and determine Dual Monarchs TASTE and TECHNOLOGY
prices - Main forces affecting the shape of the economy
- May be centralized (stock exchange) or decentralized - TASTE: direct the use of society’s resources
(foreign exchange market) - TECHNOLOGY and resources available
- CENTRAL ROLE: determine the price of goods o Customer demand has to dovetail with business
- markets for consumer goods = markets for factors of supply of goods and services to determine what
production (see page 27, par 2-3) should be produced
o same idea concerning increase and decrease o All controlled by consumer demand
- TWO DIFFERENT KINDS o Influence costs, prices, and what goods are
1. Product Markets/ Flow of Outputs available
2. Markets for Inputs or Factors of Production
The Invisible Hand
Price - How a market economy organizes complicated forces of
- Value of a good in terms of money supply and demand
- Represent terms on which different items can be o First recognized by Adam Smith
exchanged - That private interest can lead to public gain when it takes
- Serve as a signal to producers and consumers place in a well-functioning market mechanism
o ^ demand = ^ price = ^ supply needed
- The balance wheel of the market mechanism Market Failures
- IN GOODS MARKETS: set to balance consumer demand - Leads to inefficient production or consumption
with business supply - Monopolies and other forms of imperfect competition
- IN FACTOR MARKETS: set to balance household supply - Spillovers or externalities outside the marketplace
with business demand o occurs when an individual or firm making a
decision does not have to pay the full cost of the
Market Equilibrium decision
- Represents a balance among all the different buyers and o Ex. Pollution/Vaccine
- Meets the desired prices for which buyers desire to buy From Adam Smith
exactly the quantity that sellers desire to sell - Perfect competition + NO market failures = efficiency
- Equilibrium of supply and demand - Imperfect competition + Market failures =/= efficiency
- “Consumption is the sole end and purpose of production.”
- Revoked the Government for the limitations/restrictions
they start
o Limits the proper workings of the market system
Distinguishing Features of a Modern Economy Growth from the sacrifice of current consumption
1. Elaborate network of trade - Society can devote resources to new capital goods
o Depended on specialization and division of labor o Giving up present for future consumption
2. Use of money – yardstick for measuring economic values o Saving and investments
3. Use of stocks of capital – allows efficiency and - Poverty Trap
productivity o In contrast to savings and investments of highly
industrialized countries
Specialization o Low incomes
- When people/countries concentrate their efforts on a o Few productive outlets for savings
particular set of tasks o Slow process of saving and investments
- Tasks, Capital, and Lands  Lags behind economic standings of other nations
- Economic activity
Division of Labor o Involves foregoing current consumption to
- Dividing production into a number of small specialized increase capital
steps or tasks o Investments enhances the future productivity of
the economy and its future consumption
- Denotes to an increase in economic integration among Capital and Private Property
- Major component: steady increase in the share of o Bestows to the owner the ability to use,
national output devoted to imports and exports exchange, paint, dig, drill, or exploit their capital
- Reflects an extension of specialization and division of goods
labor to the entire world - CAPITALISM
- Practices the process of “slicing up the value added” in o The ability of individuals to own and profit from
manufacturing activities capital
- Occurs in financial markets - LABOR
o FINANCIAL INTEGRATION o Cannot be turned into a commodity that is
 Lending and borrowing among nations bought and sold as private property
 Convergence of interest rates among o MOST valuable economic resource
 Increases productivity Property rights for Capital and Pollution
o ECONOMIC INTEGRATION Legal Framework for a Market Economy
 Consequences - Definition of clear property rights
1. Unemployment and Lost Profits - Laws of contract
2. When Financial Integration Triggers - System for adjudicating disputes
International Financial Crises
Key Features of a Modern Economy
Money - Specialization and the Division of Labor
- The LUBRICANT that facilitates exchange o Increases efficiencies
- The means of payment in the form of currency and checks - Increased production
used to buy things o Makes trade possible
o Wherein the government controls a country’s o Allows trade to take place efficiently
money supply - Financial system
- Can go out of control, causing HYPERINFLATION o Allows people’s savings to flow smoothly into
o Rapid increase of prices other people’s capital
- Medium of exchange
The Visible Hand of the Government
Capital - Three Main Economic Functions
- A produced and durable input which is itself an output of o Increase efficiency
the economy o Promote equity
- Has to be produced before used o Foster macroeconomic stability and growth
- Uses involves time-consuming, roundabout methods of
production Efficiency as Government Intervention
o More efficient than direct means - PERFECT COMPETITION
o Refers to a market in which no firm or consumer
is large enough to affect the market price
o Implies to the INVISIBLE HAND doctrine
- Three contrasting occurrences to efficiency
o Imperfect Competition
o Externalities
o Public Goods
1. Imperfect Competition Macroeconomic Growth and Stability
- Or MONOPOLY Business Cycles
- Occurs when a buyer or seller can affect a good’s price - Fluctuations such as recessions and inflations
- Leads to prices that rise above cost and to consumer Fiscal and Monetary Policies
purchases that are reduced below efficient levels - Affects output, employment, and inflation
o Too high price - For stabilization and economic growth
o Too low output - Fiscal
- Extreme case: o Power to tax and the power to spend
o Monopolist o Of taxing and spending
 A single supplier who alone determines - Monetary
the price of a particular good or service o Determining the supply of money and interest
o Regulate the price and profits of monopolies o Affects interest rates and credit conditions
o Antitrust laws Government
 Prohibits price fixing - Uses fiscal and monetary policies
 Constitutes agreements to divide up - Influences level of total spending
markets - Rate of growth and level of output
 Opening markets to competitors - Levels of employment and unemployment
- The price level and rate of inflation
2. Externalities (or spillover effects) - Designs macroeconomic policies to promote long-term
- Occurs when firms or people impose costs or benefits on objectives
others outside the marketplace o Economic growth – growth in a nation’s total
- Negative EEx – air and water pollution; toxic wastes output
- Government regulations o Productivity – the output per unit input or the
o Designed to control negative externalities efficiency with which resources are used

*Finding the BALANCE between FREE MARKETS and GOVERNMENT *Public Saving – increases national saving and investment
REGULATION requires careful analysis of the costs and benefits
Mixed Economy
3. Public Goods - Markets determine outputs and prices
- Commodities which can be enjoyed by everyone and from - Government steers overall economy by taxation,
which no one can be excluded spending, and monetary regulations
- Positive EEx – weather reports, national defense
- Everyone must pay (taxes) to avail of the good even if Rise of the Welfare State
they don’t want it - Aristocracies and town guilds led economic activity
- Two Key Attributes: - Market Mechanism followed
o The cost of extending the service to an additional - 19th century – LAISSEZ-FAIRE “leave us alone”
person is ZERO - Government roles expanded
o It is impossible to exclude individuals from
enjoying it Welfare State
- Not necessarily publicly provided - Markets direct the detailed activities of day-to-day
economic life
Taxes - Government regulates social conditions
- Revenues to pay for public goods and income- *Governments are over intrusive
redistribution programs - may lead to GOVERNMENT FAILURES
- NOT voluntary
GOLDEN MEAN – line wherein the gov’t and market meet perfectly
- A market economy may produce inequalities in both
income and consumption
o Education, birth rights, luck, inheritance
o Engage in progressive taxation
 Taking large incomes at a higher rate
o Transfer payments
 Money payments to people
 Aid for the elderly, disabled, etc.
 Provides a SAFETY NET
o Subsidize consumption of low-income groups
 Providing food stamps, medical care,
housing, etc.