Transcript Adam Smith The Father of Market Economics

How much government is too much government?
Beef – Ground beef must be no
more than 30 % fat.
Crust – Each pound
of flour must contain
2.9 mg thiamine, 24
mg niacin, and at least
13 – but not more
than 16 mg of iron.
Is This
TOO MUCH
GOVERNMENT?
Tomato Sauce –
Must be of the
“reddish” variety,
with at least 24%
“natural tomato
soluble solids”
Mozzarella Cheese – must
be at least 30% and no more
than 45% fat and from
pasteurized cow’s milk
Pepperoni – 18 to
21% protein
content required
Mushrooms - Only
vitamin C and water
allowed in canned
mushrooms
That government is
best which governs
the least, because its
people discipline
themselves.
Thomas Jefferson
The paradox of planning “is
that it (a planned economy)
cannot plan, because of the
absence of economic
calculation. (no price
system).
What is called a planned
economy is no economy at
all. It is just a system of
groping about in the dark.
Ludwig von Mises
Adam Smith
The Father of Market Economics
The Wealth of Nations 1776
The Declaration of Economic Independence
reaction to mercantilism
Smith’s Key Idea - “Invisible Hand”
Individual self-interest (incentive) and
competition work together to benefit all of
society.
Markets
Willing Buyer & Seller
Buyers & Sellers Communicate by
Negotiating a Price
• Three Functions of Prices
-Transmit information
- Provide Incentives
- Determine the Distribution of Income
Adam Smith
Duties of Government
• Provide for the common defense
• Provide a system of Justice
- Rule of law
- Protect Property Rights
• Provide Goods and Services which the market will
not provide. (public goods)
• Laissez –faire (gov’t - hands off the rest)
Economic Functions of
Government Today
1 – Establish the Legal and Social framework
of society
a) Referee economic relationships
–
–
–
–
Pure Food and Drug Act 1906
Labor-management law
Contract law
Copyrights & Patents
Legal and Social Framework
b) Provide basic
government services
– Police and Fire
Legal and Social Framework
• Provide basic
government services
– Police and Fire
– Weights and Measures
Legal and Social Framework
• Provide basic
government services
– Police and Fire
– Weights and Measures
– Monetary System
2 Maintain Competition by
Controlling Monopolies
• Regulate “natural”
monopolies
– Electric power
• Anti-trust (monopoly)
laws
– Sherman 1890
– Clayton 1914
– Regulate business
behavior and promote
competition
Fix the “failures” of the
Market System
3 - Reallocate resources
where markets produce
the “wrong” quantities.
• Externalities – third party is
affected
a) Spillover costs – ex. Pollution
- Legislation – limits on amounts
- Taxes – attempt to internalize the
cost
- Market – create a market solution
(Property Rights)
Just after noon on Monday, a corner of the sludge reservoir
broke, sending caustic goo into the surrounding countryside,
turning four prosperous, picturesque villages into red-tinged
towns out of science-fiction horror films. The mud drowned at
least four people and sent more than 100 to hospitals with
burns, caused by a highly alkaline caustic substance. Sixteen
square miles of land are covered in the muck, hundreds of
residents suffered mild burns or lung irritations, and countless
animals succumbed.
Residents here are still waiting for Hungarian officials to
release their analysis of the sludge’s exact chemical content. A
dangerous pollutant at best because of its caustic nature, red
mud from aluminum production can contain heavy metals and
low-level radioactivity, ingredients that can cause health
problems like cancer and produces long-term contamination of
the environment.
New York Times Oct 6, 2010
b) Spillover benefits
ex) vaccinations, education
- increase demand – subsidy to consumer
food stamps
- increase supply – subsidy to producer
hospitals, education(university)
- government produce
fire protection, health services,
education(primary & secondary)
C) Public Goods and Services
• Too expensive to
individual consumer
• Cannot be limited to
those who pay for them
• Free-rider Problem
– Lighthouses
– Flood Control
– National Defense
• Quasi-public goods
– Parks
– Medical Care
– Education
4 Redistribute income and wealth
(fix the problem of inequity)
Social Security
welfare
unemployment insurance
health insurance
progressive income taxes
5 Stabilize economy by controlling inflation
and unemployment
Fiscal Policy
Monetary Policy
(covered in Business Cycle Unit)