Principle 7: Governments (Can Sometimes
Here are we start from principle 7 to 10 but other other are described in previous post.
Improve Market Outcomes If the invisible hand of the market is so great, why do we need government? One purpose of studying economics is to refine your 'view about the proper role and scope of government policy.
One reason we need government is that the invisible hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy. Most important, market economies. need institutions to enforce property rights so individuals can own and control scarce resources.
A farmer won't grow food if she expects her crop to be stolen a restaurant won't serve meals unless it is assured that customers will pay before they leave and film company won't produce movies if too many potential customers avoid paying
by making illegal copies. We all rely on government-provided police and courts to enforce our rights over the things we produce-and the invisible hand counts on our ability to enforce those rights.
Another reason we need government is that, although the invisible hand is
powerful, it is not omnipotent. There are two broad rationales for a government to intervene in the economy and change the allocation of resources that people would choose on their own to promote efficiency or to promote equality That is, most policies aim either to enlarge the economic pie or to change how the pie is divided.
Consider first the goal of efficiency. Although the invisible hand usually
leads markets to allocate resources to maximize the size of the economic pie, this is not always the case. Economists use the term market failure to refer to a situation in which the market on its own fails to produce an efficient allocation of resources. As we will see, one possible cause of market failure is an externality, which is the impact of one person's actions on the well-being of a by stander. The classic example of an externality, is pollution. When the production of a good pollutes the air and creates health problems for those who-live near the factories, the market left to its own devices may fail to take this cost into account. Another possible cause of market failure is market power, which refers to
the ability of a single person or firm (or a small group) to unduly influence market prices. For example, if everyone in town needs water but there is only one well, the owner of the well is not subject to the rigorous competition with which the invisible. And normally keeps self-interest in check; she may take advantage of this opportunity by restricting the output of water so she can charge a higher price. In the presence of externalities or market power, well-designed public
policy can enhance economic efficiency. Now consider the goal of equality. Even when the invisible hand yields efficient outcomes, it can nonetheless leave sizable disparities in economic well-being A market economy rewards people according to their ability to produce things that other people are willing to pay for. The world's best basketball player earns more than the world's best chess player simply because people are
willing to pay more to watch basketball than chess. The invisible hand does not ensure that everyone has sufficient food, decent clothing, and adequate health-care. This inequality may, depending on one's political philosophy, call for government intervention. In practice, many public policies, such as the income tax
and the welfare system, aim to achieve a more equal distribution of economic
well-being. To say that the government can improve on market outcomes does not mean that it always will. Public policy is made not by angels but by a political process that is far from perfect. Sometimes policies are designed simply to reward then politically powerful. Sometimes they are made by well-intentioned leaders who are not fully informed. As you study economics, you will become a better judge o when a government policy is justifiable because it promotes efficiency or equally
and when it is not. Why is a country better off not isolating itself from all other countries.
Quick Quiz
Why do we have markets, and according to economists, what roll
should government play in them?
How the Economy as a Whole Works
We started by discussing how individuals make decisions and then looked at how people interact with one another. All these decisions and interactions together make up "the economy. The last three principles concern the workings of the
economy as a whole.
1-3a Principle 8: A Country's Standard of Living Depends on
Its Ability to Produce Goods and Services The differences in living standards around the world are staggering. In 2014, the average American had an income of about $55,000. In the same year, the average
Mexican earned about $17,000, the average Chinese about $13,000, and the aver-age Nigerian only S6,000. Not surprisingly, this large variation in average income is reflected in various measures of quality of life. Citizens of high-income countries have more TV sets, more cars, better nutrition, better healthcare, and a longer life expectancy than citizens of low income countries. Changes in living standards over time are also large. In the United States, incomes have historically grown about 2 percent per year (after adjusting for changes in the cost of living). At this rate, average income doubles every 35 years. Over the past century, average U.S. income has risen about eightfold.
What explains these large differences in living standards among countries and over time? The answer is surprisingly simple. Almost all variation in living standards is attributable to differences in countries productivity-that is, the amount of goods and services produced by each unit of labor input. In nations where workers can produce a large quantity of goods and services per hour, most people enjoy a high standard of living; in nations where workers are less productive, most people endure a more' meager existence. Similarly, the growth rate of a nation's productivity determines the growth rate of its average income. The fundamental relationship between productivity and living standards is simple, but its implications are far-reaching. If productivity is the primary determinant of living standards, other explanations must be of secondary importance. For example, it might be tempting to credit labor unions or minimum-wage laws for the rise in living standards of American workers over the past century. Yet the real hero of American
workers is their rising productivity. As another example, some commentators have claimed that increased competition from Japan and other countries explained the slow growth in U.S. incomes during the 1970s and 1980s. Yet the real villain was not
Competition from abroad but flagging productivity growth in the United States.
The relationship between productivity and living standards also has profound implications implications for public policy. When thinking about how any policy will affect living standards, the key question is how it will affect our ability to produce goods services. To boost living standards, policymakers need to raise productivity ensuring that workers are well educated, have the tools they need to produce goods and services, and have access to the best available technology.
Principle 9: Prices Rise When the Government
In 1921, a daily newspaper in Germany cost 0.30 marks. Less than two
Prints Too Much Money Later, in November 1922, the same newspaper cost 70,000,000 marks. All cases in the economy rose by similar amounts. This episode is one of how-to spectacular examples of inflation, an increase in the overall level prices in the economy.
Although the United States has never experienced inflation even close to that of Germany in the 1920s, inflation has at times been an economic problem. During the 1970s, for instance, when the overall level of prices more than doubled, President Gerald Ford called inflation "public enemy number one." By contrast, inflation in the first decade of the 21st century ran about 24 percent per year; at this rate, it would take almost 30 years for prices to double. Because high inflation imposes various costs on society, keeping inflation at a low level is a goal of economic policymakers around the world.
What causes inflation? In almost all cases of large or persistent inflation, the culprit is growth in the quantity of money. When a government creates large quantities of the nation's money, the value of the money falls, In Germany in the early 1920s, when prices were on average tripling every month, the quantity of money was also tripling every month. Although less dramatic, the economic history of
the United States points to a similar conclusion: The high inflation of the 1970s was associated with rapid growth in the quantity of money, and the return of low inflation in the 1980s was associated with slower growth in the quantity of money.
Principle 10: Society Faces a Short-Run Trade-off
between Inflation and Unemployment
Although a higher level of prices is, in the long run, the primary effect of increasing the quantity of money, the short-run story is more complex and controversial. Most economists describe the short-run effects of monetary injections as follows:
Increasing the amount of money in the economy stimulates the overall level
of spending and thus the demand for goods and services. Higher demand may over time cause firms to raise their prices, but in the mean time, it also encourages them to hire more workers and produce a larger quantity of goods and services. More hiring means lower unemployment.
This line of reasoning leads to one final economy-wide trade-off: a short-run trade-off between inflation and unemployment. Although some economists still question these ideas, most accept that society faces a short-run trade-off between inflation and unemployment. This simply means that, over a period of a year or two, many economic policies push inflation and un-employment in opposite directions. Policymakers face this trade-off regardless of whether inflation and unemployment both start out at high levels (as they did in the
early 1980s), at low levels (as they did in the late 1990s), or someplace in between. This short-run trade-off plays a key role in the analysis of the business cycle the irregular and largely unpredictable. fluctuations in economic activity, as measured by the production of goods and services or the number of people employed.
Policymakers can exploit the short-run trade-off between inflation and un-
employment using various policy instruments. By changing the amount that the government spends, the amount it taxes, and the amount of money it prints, policy makers can influence the overall demand tor goods and services. Changes in demand in turn influence the combination of inflation and unemployment that the economy experiences in the short run. Because these instruments of economic policy are potentially so powerful, how policymakers should use them to control the economy, if at all, 1s a subject of continuing debate.
This debate heated up in the early years of Barack Obama's presidency. In 2008 and 2009, the U.S. economy, as well as many other economies around the world, experienced a deep economic downturn. Problems in the financial system.
TEN PRINCIPES OF ECONOMIC:
bets on the housing market, spilled over into the rest of the economy, causing incomes to fall and unemployment to soar. Policymakers responded in various ways to increase
at the overall demand for goods and services. President Obama's first major initiative was a stimulus package of reduced taxes and increased government spending, At
the same time, the nation's central bank, the Federal Reserve, increased the supply money. The goal ot these policies was to reduce 'unemployment. Some feared, how is ever, that these policies might over time lead to an excessive level of infixation.
List and briefly explain the three principles that describe how the economy as a whole work.
Conclusion:
You now have a taste of what economics is all about. In the coming chapters, we envelop many specific insights about people, markets, and economies. Mastering these insights will take some effort, but it is not an overwhelming task. The field of economics is based on a few big ideas that can be applied in many different
situations. Throughout this book, we will refer back to the Ten Principles of Economics high-lighted in this chapter and summarized in Table 1, Keep these building blocks in mind Even the most sophisticated economic analysis is founded on the ten principles introduced here.
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