Chapter 2

Markets and Government in a

Modern Economy
 What is a Market
• A mechanism through which buyers and
sellers interact to set prices and exchange
goods and services
 Market Equilibrium
• Represents a balance among all the different
buyers and sellers
 How Market Solve Three Economic
Problems
• What goods and services will be produced
• How things are produced
• For whom things are produced
Factor Markets
 Three Distinguishing Features of Modern
Economy
• Trade: Contains specialization and division of
labor
• Money: The lubricants of exchange
• Capital: factors of production, a durable input
which is itself an output of the economy.
(Land and labor are the primary factors of
production and the rest are secondary factors
of production)
The Economic Role of Government
• Efficiency (Imperfect
competition,
externalities, public
goods)
• Equity like tax
imposition
• Macroeconomic
stability like inflation
 Govt. Can Remedy of Short-coming of Markets
Failure of Market Economy
Inefficiency
Monopoly
Externalities
Public goods
Inequality:
Unacceptable inequalities of
income and wealth
Macroeconomic problems:
Business cycles (high inflation
and unemployment)
Slow economic growth
Government Intervention
Encourage competition
Intervene in markets
Encourage beneficial activities
Redistribute income
Stabilize through macroeconomic
policies
Stimulate growth
Current Examples of Government
Policy
Antitrust laws, deregulation
Antipollution laws, antismoking
ordinances
Build lighthouses, provide public
education
Progressive taxation of income and
wealth
Income-support or transfer programs
(e.g., food stamps)
Monetary policies (e.g., changes in
money supply and interest rates)
Fiscal policies (e.g., taxes and spending
programs)
Invest in education
Raise national savings rate by reducing
budget deficit or increasing budget
surplus