CHAPTER 1 TEN PRINCIPLES OF ECONOMICS forces Central planners failed because they tried to run the economy with one hand tied behind their backs-the invisible hand of the marketplace PRINCIPLE #7: GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES Although markets are usually a good way to organize economic activity, this rule has some important exceptions. There are two broad reasons for a government to intervene in the economy: to promote efficiency and to promote equity. That is, most policies aim either to enlarge the economic pie or to change how the pie is divided The invisible hand usually leads markets to allocate resources efficientl Nonetheless, for various reasons the invisible hand sometimes does not work Economists use the term market failure to refer to a situation in which the market market failure on its own fails to allocate resources efficiently. a situation in which a market left One possible cause of market failure is an externality. An externality is the im- its own fails to allocate resources pact of one persons actions on the well-being of a bystander. The classic example efficiently of an external cost is pollution. If a chemical factory does not bear the entire cost of the smoke it emits, it will likely emit too much. Here, the government can raise externality economic well-being through environmental regulation. The classic example of an the woell-being of a bystander ons on the impact of one person's ac external benefit is the creation of knowledge. When a scientist makes an important discovery, he produces a valuable resource that other people can use. In this case, the government can raise economic well-being by subsidizing basic research, as fact it does Another possible cause of market failure is market power Market power market power refers to the ability of a single person(or small group of people) to unduly influ- the ability of a single economic actor competition with which the invisible hand normally keeps self-interest in check. pr( group of actors)to have a ence market prices. For example, suppose that everyone in town needs water but there is only one well. The owner of the well has market power-in this case a substa tial influence on market is not subject to the You will learn that, in this case, regulating the price that the monopolist charges can potentially enhance economic efficiency The invisible hand is even less able to ensure that economic prosperity is dis- tributed fairly. a market economy rewards people according to their ability to pro- duce things that other people are willing to pay for. The worlds best basketball player earns more than the world's best chess player simply because people are willing to pay more to watch basketball than chess. The invisible hand does not en sure that everyone has sufficient food, decent clothing, and adequate health care a goal of many public policies, such as the income tax and the welfare system, to achieve a more equitable distribution of economic well-being To say that the government can improve on markets outcomes at times does not mean that it always will. Public policy is made not by angels but by a political process that is far from perfect. Sometimes policies are designed simply to reward the politically powerful. Sometimes they are made by well-intentioned lead who are not fully informed. One goal of the study of economics is to help you judge when a government policy is justifiable to promote efficiency or equity and when it is not QUICK QUIZ: List and briefly explain the three principles concerning economic interactionsCHAPTER 1 TEN PRINCIPLES OF ECONOMICS 11 forces. Central planners failed because they tried to run the economy with one hand tied behind their backs—the invisible hand of the marketplace. PRINCIPLE #7: GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES Although markets are usually a good way to organize economic activity, this rule has some important exceptions. There are two broad reasons for a government to intervene in the economy: to promote efficiency and to promote equity. That is, most policies aim either to enlarge the economic pie or to change how the pie is divided. The invisible hand usually leads markets to allocate resources efficiently. Nonetheless, for various reasons, the invisible hand sometimes does not work. Economists use the term market failure to refer to a situation in which the market on its own fails to allocate resources efficiently. One possible cause of market failure is an externality. An externality is the im￾pact of one person’s actions on the well-being of a bystander. The classic example of an external cost is pollution. If a chemical factory does not bear the entire cost of the smoke it emits, it will likely emit too much. Here, the government can raise economic well-being through environmental regulation. The classic example of an external benefit is the creation of knowledge. When a scientist makes an important discovery, he produces a valuable resource that other people can use. In this case, the government can raise economic well-being by subsidizing basic research, as in fact it does. Another possible cause of market failure is market power. Market power refers to the ability of a single person (or small group of people) to unduly influ￾ence market prices. For example, suppose that everyone in town needs water but there is only one well. The owner of the well has market power—in this case a monopoly—over the sale of water. The well owner is not subject to the rigorous competition with which the invisible hand normally keeps self-interest in check. You will learn that, in this case, regulating the price that the monopolist charges can potentially enhance economic efficiency. The invisible hand is even less able to ensure that economic prosperity is dis￾tributed fairly. A market economy rewards people according to their ability to pro￾duce things that other people are willing to pay for. The world’s best basketball player earns more than the world’s best chess player simply because people are willing to pay more to watch basketball than chess. The invisible hand does not en￾sure that everyone has sufficient food, decent clothing, and adequate health care. A goal of many public policies, such as the income tax and the welfare system, is to achieve a more equitable distribution of economic well-being. To say that the government can improve on markets outcomes at times does not mean that it always will. Public policy is made not by angels but by a political process that is far from perfect. Sometimes policies are designed simply to reward the politically powerful. Sometimes they are made by well-intentioned leaders who are not fully informed. One goal of the study of economics is to help you judge when a government policy is justifiable to promote efficiency or equity and when it is not. QUICK QUIZ: List and briefly explain the three principles concerning economic interactions. market failure a situation in which a market left on its own fails to allocate resources efficiently externality the impact of one person’s actions on the well-being of a bystander market power the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices