principles 5-7

Question 1

what do the next 3 principles (5-7) deal with

Answer 1

how people interact with one another

Question 2

what is principle 5

Answer 2

trade off can make everyone better off

Question 3

why is trade with two countries a good thing

Answer 3

it can make countries better off

• each country can specialize in what they are good at
• we can buy greater variety of goods and services at lower costs

Question 4

how is trade for individuals a good ting

Answer 4

allows each person to specialize in the activities they are best at (farming, sewing, selling, management)

Question 5

what is principle 6

Answer 5

markets are usually a good way to organize economic activity

Question 6

what is market economy : definition

Answer 6

an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services

Question 7

how is a market economy different than communism

Answer 7

decisions of a central planner are replaced by the decisions of millions of firms and households

Firms - decide who to hire and what to make

Households - decide which firms to work for and what to spend their money on

• these firms and households interact with the market place, where prices and self-interest guide their decisions

Question 8

what are free markets

Answer 8

• have many buyers an sellers
• numerous goods and services
• all interested primarily in their own well-being

Question 9

who is Adam Smith

Answer 9

made the most famous decision in all of economics

Question 10

what was the decision Adam Smith made

Answer 10

households and firms interacting in markets act as if they are guided by an invisible hand that leads them to desirable market outcomes

Question 11

what are prices

Answer 11

• are the instruments with which the invisible hand directs economic activity
• buyers look at the price when determining how much to demand
• sellers look a the price when determining how much to supply

Question 12

decisions that buyers and sellers make (how much to buy based on price as well as how much to sell based on price) market prices reflect what

Answer 12

both the value of a food to society and the cost to society of making the good

Question 13

what was Smith’s great insight with regards to prices

Answer 13

prices adjust to guide individual buyers and sellers to reach outcomes that, in many cases, maximize the welfare of society as a whole

Question 14

what happens when governments prevent prices form adjusting naturally to supply and demand

Answer 14

• it impedes the invisible hand’s ability to coordinate the millions of households and firms that make up the economy

Question 15

explain the failure of communism

Answer 15

prices were not determined in the market place but were dictated by central planners
- central planners failed because they tried to run the economy with one hand tied behind their backs - the invisible hand of the market place

Question 16

what is principle 7

Answer 16

governments can sometimes improve market outcomes

Question 17

definition: property rights

Answer 17

the ability of an individual to own and exercise control over scarce resources

Question 18

definition: market failure

Answer 18

a situation in which a market is left on its own fails to allocate resources efficiently

Question 19

definition; externality

Answer 19

the impact of one person’s actions on the well-being of a bystander

Question 20

definition: market power

Answer 20

the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices

Question 21

if the invisible hand is so great why do we need the government/

Answer 21

1. invisible hand needs gov. to enforce rules and maintain the institution that are key to a market economy

Most important:
- market economies need institutions to enforce property rights so individuals can own and control scarce resources

Question 22

what are the two broad reasons for a gov. to intervene in the economy and change the allocation of resources that people would choose on their own

Answer 22

1. to promote efficiency

2. to promote equity

Question 23

what do most policies aim either to do

Answer 23

to enlarge the economic pie or

to change how the pie is divided

Question 24

what is the goal of efficiency

Answer 24

invisible hand usually leads markets to maximize the size of the economic pie it is not always the case though
when this happens we have market failure

Question 25

what are the possible cause of market failure

Answer 25

1. exernality - classic example is pollution
2. market power
   - if everyone in town needs water and there is only one well
   - the owner of the well is not subject to the rigorous competition with which the invisible hand normally keeps self- interest in check

Question 26

what is the goal of equity

Answer 26

• even when the invisible hand is yielding efficient outcomes, it can nonetheless leave sizable disparities in economic well-being
• a market economy rewards people according to their ability to produce things that other people are wiling to pay for
  (basket ball players vs chess players)

Question 27

just because the gov. can improve market outcomes does not mean it always will why is that

Answer 27

• system is not perfect
• reward political power
• well intention leaders might not be fully informed