- The invisible hand works through the price system by: a) The interaction of buyers and sellers determines prices b) Each price reflects the good’s value to buyers and the cost of producing the good. c) Prices guide self-interested households and firms to make decisions that, in many cases, maximize society’s economic well being. 7. Governments can Sometimes Improve Market Outcomes- Important role for govt: Enforce property rights (with police, courts etc)- People are less inclined to work, produce, invest or purchase if large risks of their property being stolen. -Market Failure: When the market fails to allocate society’s resources efficiently. - Cause of Market Failure: a) Externalities: When the production or consumption of a good affects bystanders (e.g. pollution) b) Market Power: A single buyer or seller has substantial influence on market price (e.g. monopoly) *In such cases, public policy may promote efficiency. - Govt. may alter market outcome to promote equity. - If the market’s distribution of economic well being is not desirable, tax or welfare policies can change how the economic “pie” is divided. • ECONOMISTS AS A SCIENTIST- Economist play two roles 1. Scientists: Try to explain the world 2. Policy advisors: Try to improve it - As scientists economists employ the scientific method : the dispassionate development and testing of theories about how the world works. • ASSUMPTIONS AND MODELS- Assumptions simplify the complex world, make it easier to understand. Example: To study international trade, assume two countries and two goods. - Assumptions are unrealistic but they are simple to use and they give us useful insights about the real world. -Model: A highly simplified representation of a more complicated reality. Economists use models to study economic issues.
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