How People Interact
oPrinciple 5: Trade
Trade between different parties allow for a greater category of
goods and services.
oPrinciple 6: Markets Organize Economic Activity
Communist economies relied on a government or central
planner organizing economic activity.
Previous communist economies have abandoned the
decisions of the central planner and instead allocate their
resources through the decentralized decisions of many
independent firms and households interacting in a market for
good and services, a system known as a market economy.
According to Adam Smith, market economies are guided by an
“invisible hand” that leads markets to desirable outcomes.
When governments prevent prices from adjusting naturally to
supply and demand, the invisible hand is unable to coordinate
the decisions of the independent households and firms that
make up a market economy.
oPrinciple 7: Governments Can Improve Market Outcomes
Market economies require institutions, such as the
government that maintain and protect property rights.
Property rights are the ability for an individual to own
and control their own scarce resources.
Governments typically interfere in markets through policies
that either promote efficiency or equality.
When a market economy left on its own fails to allocate
resources efficiently, it is called a market failure.
An externality is when the decisions of an individual
impact the well-being of an uninvolved bystander.
oExternalities can cause market failures.
The ability of an individual or a small group of
individuals to substantially impact the market is called
oIndividuals with market power can cause market
Market economies rewards those with an ability to produce
things that others are willing to pay for.
The invisible hand does not achieve or assist equality.
How the Economy as a Whole Works