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ECON 208 (113)
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ECON 208 - Notes, week of Nov 10

5 Pages
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Department
Economics (Arts)
Course Code
ECON 208
Professor
Lee Ohanian

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Adrienne Pacini ECON 208 WEEK November 10 2009 MARKET FAILURES AND GOVERNMENT INTERVENTON Chapter 16Basic Functions of Government The operative choice is between which mix of markets and government intervention best suits peoples hopes and needsWhen governments monopoly of violence is secure and functions with restrictions against its arbitrary use citizens can safely carry on their ordinary economic and social activitiesThe Case for Free MarketsThe formal case for free markets is based on the concept of allocative efficiency o Where society is using its resources to produce the optimal mix of goods and services i at PMC which ii maximizes economic surplus meaning iii all mutually beneficial trades have been undertakenThe informal case is based on three central arguments o Free markets coordinate actions automatically o The pursuit of profits leads to innovation and growtho Free markets decentralize economic power Automatic Coordination Free markets are flexible and selfcorrecting because economic power is decentralized o Economic profits or losses signal firms to enter or exit an industry to alter the allocation of the economys resources in the production of goods and serviceso Prices respond to changes in demand and supply via the market forces of excess demand and supply and both firms and consumers respond to the changes in pricesSo the price mechanism in free markets coordinates the responses of the individual economic agents the firm and the consumer seeking only their selfinterest o This coordinates markets Without any conscious planning Without any individual consumer or producer needing to understand how the system works Innovation and Growth Profit motive creates incentives for research and development creating new and better products and production methods often by trial and errorThe biggest failure of centrallyplanned economies was to hinder research and development by o Not letting the market make decisions o Not providing the incentivesPursuit of selfinterest gives individuals an incentive to work hard and improve their stock of human capitalDecentralization of PowerMarket systems have less centralized power than planned economies o Probably less scope for corruption and abuse of powerAlmost all developed command economies have moved to much more freemarket systems o Rates of economic growth were too low to maintain acceptable standards of living relative of other developed economies lacking incentives
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