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ECON 208 Chapter 16.docx

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Economics (Arts)
ECON 208
Sebastien Forte

1  The operative choice is between which mix of markets and government intervention best suits people’s hopes and needs  When government’s monopoly of violence is secure and functions with restrictions against its arbitrary use, citizens can safely carry on their ordinary economic and social activities  “The first duty of the sovereign is that of protecting the society for the violence and invasion of other independent…” – Adam Smith  The formal case for free markets is based on the concept of Allocative efficiency (Allocative efficiency is the reason why capitalist/free market is best market, but this is based on assumptions that the market has no flaws/failures)  The informal case for free markets is based on three central arguments: 1. Free markets coordinate automatically 2. The pursuit of profits leads to innovation and growth 3. Free markets decentralize economic power (which results in no one being able to abuse power and appropriate rents benefitting them)  A centralized market system adjusts quickly to changes. As market conditions change, prices in a market economy also change. Decision makes can react continually  Not everyone having the same privileges and consequences = bad policy (ex. Lehman brothers was allowed to fail, other banks were bailed out)  A market system coordinates without anyone needing to understand how the whole system works  Firms in free market innovate because they get to keep the rewards  Similar motives give individuals an incentive to invest in human capital (wanting to be a doctor, not a sociologist, because wages are higher)  Market systems have less centralized power than planned economies o Probably less scope for corruption  Market failure: a situation in which the free market fails to achieve Allocative efficiency  Market power: firms with market power will typically reduce output below competitive levels and lead to allocatively efficiency – this is the motivation for competition policy  We must also recognize the benefits of innovation that come from imperfectly competitive firms (monopoly, oligopoly, etc.)  ^with a monopoly, a competitive bureau tries to reduce individual firm’s market power, patents go the opposite way (more incentive to innovate)  Externalities: when actions taken by firms or consumers impose costs or confer benefits on third parties  Individual agents care about private costs. But what matters for Allocative efficiency is social cost 2  Even if all markets we
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