Lecture 4
MARKETS AND GOVERNMENT

A. The three coordination tasks for an economy

  1. What to produce - how much of each good?

  2. How to produce goods efficiently

  3. For whom: How to distribute the produced goods

B. Central Planning

  1. Degree of government intervention
  2. The failure of central planning

C. The market system

  1. The market prices of goods serve as signals to firms
  2. Firms maximize profits: Need to use inputs efficiently
  3. The market prices of goods serve as signal to consumers

    Adam Smith's Invisible Hand doctrine

    • The usefulness of self-interest

D. Efficiency and Equity

  • Free markets generally lead to efficient production

  • However, may not lead to equitable distribution of income

E. Role of the government

  • Income redistribution

  • Stabilization

  • Market failure

F. Comparative advantage

  • Specialization

  • Basis for international trade


ECONOMIC ORGANIZATION

SOCIALISM: You have two cows. State takes one and gives it to someone else.

COMMUNISM: You have two cows. State takes both of them and gives you milk.

FASCISM: You have two cows. State takes both of them and sells you milk.

NAZISM: You have two cows. State takes both of them and shoots you.

BUREAUCRACY: You have two cows. State takes both of them, kills one and spills the milk in system of sewage.

CAPITALISM: You have two cows. You sell one and buy a bull.

Source: Economics Jokes


The Invisible Hand

"Every individual necessarily labours to render the annual revenue of the society as great as he can. He generally neither intends to promote the public interest, nor knows how much he is promoting it...He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention."

- Adam Smith, The Wealth of Nations

Should Tiger Woods Mow His Own Lawn?

Tiger Woods spends a lot of time walking around on grass. One of the most talented golfers of all time, he can hit a drive and sink a putt in a way that most casual golfers only dream of doing. Most likely, he is talented at other activities too. For example, let's imagine that Woods can mow his lawn faster than anyone else. But just because he can mow his lawn fast, does this mean he should?

To answer that question, we can use the concepts of opportunity cost and comparative advantage. Let's say that Woods can mow his lawn in 2 hours. In that same 2 hours, he could film a television commercial for Nike and earn $10,000. By contrast, Forrest Gump, the boy next door, can mow Wood's lawn in 4 hours. In that same 4 hours, he could work at McDonald's and earn $20.

In this example, Wood's opportunity cost of mowing the lawn is $10,000 and Forrest's opportunity cost is $20. Woods has an absolute advantage in mowing lawns because he can do the work in less time. Yet Forrest has a comparative advantage in mowing lawns because he has the lower opportunity cost.

The gains from trade in this example are tremendous. Rather than mowing his own lawn, Woods should make the commercial and hire Forrest to mow the lawn. As long as Woods pays Forrest more than $20 and less than $10,000, both of them are better off.

- Gregory Mankiw, Principles of Economics

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