2 Invisible Hand Price Mechanism Competition They all go together You cannot have one without the others
3 Invisible Hand Adam Smith coined this term The invisible hand is a kind of economic guidance system that makes everything work outThe invisible hand is made possible by people pursuing their own self-interestThe bottom line is the “profit motive”
4 Price MechanismThe price mechanism is based on the law of supply and demandPrices send signals to both consumers and producers
5 CompetitionTo have real competition, you need many firms in a particular industryYou need so many that no one firm is large enough to have any influence over priceWhen sectors of American industry are not very competitive the price system doesn’t work wellThe invisible hand becomes less active and more ineffectiveThe forces of supply and demand are distorted
6 Equity & EfficiencyDoes this system allocate limited resources efficiently?Most economists agree that this system leads to a very efficient allocation of resources
7 Equity ≠ EfficiencyDoes this system lead to a fair distribution of income?NoThe case for equityTax away money from the rich and middle class and redistribute it to the needyThis raises the questionsHow much do we tax and who do we tax?Will “handouts” lessen incentives to work?
8 Economic Role of Government Federal governmentFifty state governmentsTens of thousands of local governmentsEachCollects taxesProvides servicesMake laws and regulationsThis somewhat alters the outcome of the three questionsWhat? How? and For Whom?
9 Economic Role of Government The Government ShouldProvide the infrastructure for a market to function efficientlyEnsure that competition flourishesSee that information flows freelyProtect property rightsMinimize unpleasant side effects such as pollutionThe size of government depends largely on how well private enterprise does the job of efficiently allocating resources
10 Market FailureWhen our resources are not allocated efficiently, we have market failureThree basic classes of market failure areExternalitiesEnvironmental pollution/ExternalitiesPublic goodsAll provide an opportunity for government to improve on Adam Smith’s “invisible hand”Another cause of market failure is “monopolies”
11 Externalities External cost This is where the production or consumption of some good or service inflict cost on a third party without compensationWhen you drive your car you cause a certain amount of pollution and congestionMillions of drivers wear out the highwaysAir and water pollution caused by industrial and business activitiesThe government can discourage these activities by taxing you or by imposing stringent regulations
12 Curbing Air and Water Pollution Air and water pollution are perhaps the two greatest external costs of industrial economiesGovernment attempts to control this by:Command-and-control regulationsIncentive-based regulations
13 Externalities External Benefits An external benefit occurs when some of the benefits derived from the production or consumption of some good or service are enjoyed by a third party. Government can try to encourage these activitiesIt is not uncommon for these additional socially beneficial things to be an unintended consequenceIf you paint your house (government can give you a grant)Operating a family farm (government can provide you with a subsidy to encourage you to continue to farm)
14 Public Goods and Services The private marketIs governed solely by the forces of supply and demandIt does not take into account external costs and external benefitsMarket failure occurs when resources are not used efficientlyWhen a market failure imposes a high cost on societyWe demand that the government do something about it
15 Public Goods and Services Public goods and services are:Nonexcludable: once it exists, everyone can freely benefit from itNon-rivalrous: one person’s benefiting does not reduce the amount of it available for othersSome examples are national defense, a court system, police and fire protection, the construction and maintenance of streets and highways, bridges, water and sewer mains, environmental protection, public parks, public schools, and public libraries
16 Capital Capital is the CRUCIAL element in every economic system Capital consist of plant & equipmentCapital is the key to every country’s standard of livingCapital comes from:Cutting consumption (by saving)Americans are now consuming too much and saving too littleIncreasing production
17 The “Isms” Socialism Communism Fascism Capitalism You have two cows. State takes one and gives it to someone elseCommunismYou have two cows. State takes both of them and gives you milkFascismYou have two cows. State takes both of them and sells you milkCapitalismYou have two cows. You sell one and buy a bull
18 Last Word: The Mixed Economy Communism Socialism CapitalismFascismThe United States is a mixed economyEvery nation in the world has a mixed economy
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