Economics I
Chapter 2: Modern Mixed Economy
Mixed Economy
- A combination of private enterprise working through the
marketplace and government regulation, taxation, and
programs
- Command + Market Economy
Market Mechanism
- Who – no single individual or organization or government
is responsible for solving the economic problems
 Everyone is.
 Invisibly coordinated by a system of prices and
markets
- The use of money exchanged by buyers and sellers with
an open and understood system of value and time trade
offs to produce the best distribution of goods and services
Market Economy
- Coordinates people, activities, and businesses through a
system of prices and markets
Marketplace
- Where farmers bring their goods to sell
Market
- A mechanism wherein buyers and sellers interact,
exchange goods and services for assets, and determine
prices
- May be centralized (stock exchange) or decentralized
(foreign exchange market)
- CENTRAL ROLE: determine the price of goods
- markets for consumer goods = markets for factors of
production (see page 27, par 2-3)
o same idea concerning increase and decrease
- TWO DIFFERENT KINDS
1. Product Markets/ Flow of Outputs
2. Markets for Inputs or Factors of Production
Price
- Value of a good in terms of money
- Represent terms on which different items can be
exchanged
- Serve as a signal to producers and consumers
o ^ demand = ^ price = ^ supply needed
- The balance wheel of the market mechanism
- IN GOODS MARKETS: set to balance consumer demand
with business supply
- IN FACTOR MARKETS: set to balance household supply
with business demand
Market Equilibrium
- Represents a balance among all the different buyers and
sellers
- Meets the desired prices for which buyers desire to buy
exactly the quantity that sellers desire to sell
- Equilibrium of supply and demand
Outline of the Market Equilibrium
- To solve the questions what, how, and for whom
1. Dollar Votes – determine goods and services to be
produced through buyers’ purchase decisions and
where the goods go
o No one buys pagers anymore, pagers went
extinct
 To maximize profit for firms
 PROFIT – net revenues
(Total Sales – Total Costs)
o WHAT to produce
2. Adopt most efficient methods of production
o Keep costs at a minimum in production
 For producers to meet price competition and
maximize profits
o HOW to produce
 Determined by completion amongst
producers
3. A buyer willing to purchase a good at the equilibrium
price for it
o Ex. Distribution of income among the population
is determined by the quantity of services and the
prices of factors
o FOR WHOM to produce
o FACTOR MARKETS – determine FACTOR PRICES
(wage rates, land rents, interest rates, and
profits)
Dual Monarchs TASTE and TECHNOLOGY
- Main forces affecting the shape of the economy
- TASTE: direct the use of society’s resources
- TECHNOLOGY and resources available
o Customer demand has to dovetail with business
supply of goods and services to determine what
should be produced
o All controlled by consumer demand
o Influence costs, prices, and what goods are
available
The Invisible Hand
- How a market economy organizes complicated forces of
supply and demand
o First recognized by Adam Smith
- That private interest can lead to public gain when it takes
place in a well-functioning market mechanism
Market Failures
- Leads to inefficient production or consumption
- Monopolies and other forms of imperfect competition
- Spillovers or externalities outside the marketplace
o occurs when an individual or firm making a
decision does not have to pay the full cost of the
decision
o Ex. Pollution/Vaccine
From Adam Smith
- Perfect competition + NO market failures = efficiency
- Imperfect competition + Market failures =/= efficiency
- “Consumption is the sole end and purpose of production.”
- Revoked the Government for the limitations/restrictions
they start
o Limits the proper workings of the market system
Distinguishing Features of a Modern Economy Growth from the sacrifice of current consumption
1. Elaborate network of trade - Society can devote resources to new capital goods
o Depended on specialization and division of labor o Giving up present for future consumption
2. Use of money – yardstick for measuring economic values o Saving and investments
3. Use of stocks of capital – allows efficiency and - Poverty Trap
productivity o In contrast to savings and investments of highly
industrialized countries
Specialization o Low incomes
- When people/countries concentrate their efforts on a o Few productive outlets for savings
particular set of tasks o Slow process of saving and investments
- Tasks, Capital, and Lands  Lags behind economic standings of other nations
- Economic activity
Division of Labor o Involves foregoing current consumption to
- Dividing production into a number of small specialized increase capital
steps or tasks o Investments enhances the future productivity of
the economy and its future consumption
Globalization
- Denotes to an increase in economic integration among Capital and Private Property
nations - PROPERTY RIGHTS
- Major component: steady increase in the share of o Bestows to the owner the ability to use,
national output devoted to imports and exports exchange, paint, dig, drill, or exploit their capital
- Reflects an extension of specialization and division of goods
labor to the entire world - CAPITALISM
- Practices the process of “slicing up the value added” in o The ability of individuals to own and profit from
manufacturing activities capital
- Occurs in financial markets - LABOR
o FINANCIAL INTEGRATION o Cannot be turned into a commodity that is
 Lending and borrowing among nations bought and sold as private property
 Convergence of interest rates among o MOST valuable economic resource
countries
 Increases productivity Property rights for Capital and Pollution
o ECONOMIC INTEGRATION Legal Framework for a Market Economy
 Consequences - Definition of clear property rights
1. Unemployment and Lost Profits - Laws of contract
2. When Financial Integration Triggers - System for adjudicating disputes
International Financial Crises
Key Features of a Modern Economy
Money - Specialization and the Division of Labor
- The LUBRICANT that facilitates exchange o Increases efficiencies
- The means of payment in the form of currency and checks - Increased production
used to buy things o Makes trade possible
- CENTRAL BANK - Money
o Wherein the government controls a country’s o Allows trade to take place efficiently
money supply - Financial system
- Can go out of control, causing HYPERINFLATION o Allows people’s savings to flow smoothly into
o Rapid increase of prices other people’s capital
- Medium of exchange
The Visible Hand of the Government
Capital - Three Main Economic Functions
- A produced and durable input which is itself an output of o Increase efficiency
the economy o Promote equity
- Has to be produced before used o Foster macroeconomic stability and growth
- Uses involves time-consuming, roundabout methods of
production Efficiency as Government Intervention
o More efficient than direct means - PERFECT COMPETITION
o Refers to a market in which no firm or consumer
is large enough to affect the market price
o Implies to the INVISIBLE HAND doctrine
- Three contrasting occurrences to efficiency
o Imperfect Competition
o Externalities
o Public Goods
INEFFICIENCIES or MARKET FAILURES
1. Imperfect Competition
- Or MONOPOLY
- Occurs when a buyer or seller can affect a good’s price
- Leads to prices that rise above cost and to consumer
purchases that are reduced below efficient levels
o Too high price
o Too low output
- Extreme case:
o Monopolist
 A single supplier who alone determines
the price of a particular good or service
- GOVERNMENT INTERVENTION:
o Regulate the price and profits of monopolies
o Antitrust laws
 Prohibits price fixing
 Constitutes agreements to divide up
markets
 Opening markets to competitors
2. Externalities (or spillover effects)
- Occurs when firms or people impose costs or benefits on
others outside the marketplace
- Negative EEx – air and water pollution; toxic wastes
- Government regulations
o Designed to control negative externalities
*Finding the BALANCE between FREE MARKETS and GOVERNMENT
REGULATION requires careful analysis of the costs and benefits
3. Public Goods
- Commodities which can be enjoyed by everyone and from
which no one can be excluded
- Positive EEx – weather reports, national defense
- Everyone must pay (taxes) to avail of the good even if
they don’t want it
- Two Key Attributes:
o The cost of extending the service to an additional
person is ZERO
o It is impossible to exclude individuals from
enjoying it
- Not necessarily publicly provided
Taxes
- Revenues to pay for public goods and income-
redistribution programs
- NOT voluntary
Equity
- A market economy may produce inequalities in both
income and consumption
o Education, birth rights, luck, inheritance
- G.INTERVENTION
o Engage in progressive taxation
 Taking large incomes at a higher rate
o Transfer payments
 Money payments to people
 Aid for the elderly, disabled, etc.
 Provides a SAFETY NET
o Subsidize consumption of low-income groups
 Providing food stamps, medical care,
housing, etc.
Macroeconomic Growth and Stability
Business Cycles
- Fluctuations such as recessions and inflations
Fiscal and Monetary Policies
- Affects output, employment, and inflation
- For stabilization and economic growth
- Fiscal
o Power to tax and the power to spend
o Of taxing and spending
- Monetary
o Determining the supply of money and interest
rates
o Affects interest rates and credit conditions
Government
- Uses fiscal and monetary policies
- Influences level of total spending
- Rate of growth and level of output
- Levels of employment and unemployment
- The price level and rate of inflation
- Designs macroeconomic policies to promote long-term
objectives
o Economic growth – growth in a nation’s total
output
o Productivity – the output per unit input or the
efficiency with which resources are used
*Public Saving – increases national saving and investment
Mixed Economy
- Markets determine outputs and prices
- Government steers overall economy by taxation,
spending, and monetary regulations
Rise of the Welfare State
- Aristocracies and town guilds led economic activity
- Market Mechanism followed
- 19th century – LAISSEZ-FAIRE “leave us alone”
- Government roles expanded
Welfare State
- Markets direct the detailed activities of day-to-day
economic life
- Government regulates social conditions
*Governments are over intrusive
- may lead to GOVERNMENT FAILURES
GOLDEN MEAN – line wherein the gov’t and market meet perfectly