1 overview of comparative economics chapter ii market capitalism
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1
Overview of Comparative Economics
Chapter II
Market Capitalism
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Market Capitalism
Form of Ownership → Most of the time land and produced means of production (capital stock) are owned by private individuals or private firms
Role of Planning → Market capitalism is usually planned by the market (with demand and supply)
Material Incentives → In market capitalism material incentives exist in forms of rewards for entrepreneurship and capital investment as economic profits
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Market Capitalism
Income Redistribution → is usually done through social safety nets in market capitalism
Role of politics and ideology → Are market capitalist countries mostly democratic? Social democrat parties exist in market capitalist
countries supporting income redistribution, extensive social safety nets, nationalization and central planning
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Why Market Capitalism Popular? End of communism → most former
communist countries are concentrating on market capitalist economic systems
Predominantly market capitalist economies are making efforts to move toward a purer version of this system
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Advantages and Disadvantages of Market Capitalist Economies Experienced enormous technological
advances and growth as they underwent the Industrial Revolution in the late 18th century “ability to revolutionize the means of production”
Experienced large macroeconomic fluctuations with serious downturns in the 19th century (unequal distribution of income and increasing concentrations of industrial monopoly power)
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Pure Version of Market Capitalist System Pure version of market capitalist system does
not exist Closest to the ideal of pure laissez-faire
market capitalism are: Hong Kong Singapore New Zealand
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Efficiency
Static efficiency → no one in society can be made better off without making someone else worse off resources are being utilized to their best potential
given the existing technology Dynamic efficiency → allocation of resources
over time to maximize long-run sustainable growth technological dynamism destabilizing process of “creative destruction”
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Theoretical Efficiency of Market Capitalism Efficiency Theorem
The general ability of markets to allocate goods and resources efficiently through the law of supply and demand A complete competitive full-information general equilibrium is efficient
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Theoretical Efficiency of Market Capitalism Complete
For any good or service that affects someone’s utility, there is a market
Competition There are many buyers and sellers with free entry
and exit There are well-defined homogenous goods and
services No individual supplier has any control over the
price in his or her market
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Theoretical Efficiency of Market Capitalism Full information
All agents in the economy know everything about consumer preferences, production technologies and prices
General equilibrium Every single market is in equilibrium in the sense that the
quantity supplied equals the quantity demanded of the good or service
If that does not happen: Surplus Shortage
Partial equilibrium with a few markets being in equilibrium
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Theoretical Efficiency of Market Capitalism Efficiency
Pareto optimality → no one in the economy can be made better off without making someone else worse off
If someone can be made better off without making someone else worse off, then the economy is not producing as much as possible of what people want
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Why is a complete, competitive, full-information, general equilibrium efficient? Adam Smith’s invocation of invisible hand of the
market working across all sectors to allocate goods in a way that maximizes the “wealth of the nations”
He founded classic laissez faire economics He argued that the government should get out of the
economy (minimal government intervention) It is at the equilibrium price that the maximum amount
will be both produced and sold and thus actually consumed by public
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Invisible Hand
In the free marketplace an “invisible hand” regulates and self-corrects the economy
The market itself will regulate the economy Efficient producers will prosper and the
inefficient producers will lose The public will get the best product for the
lowest price Supply and demand will determine prices
better than any government official can
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Limits to The Efficiency of Laissez-Faire Market Capitalism Monopoly Power Externalities Collective Consumption Goods Imperfect Information
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Source of Inefficiency:Monopoly Power Monopoly power prohibits competition Monopolist will maximize profits by setting marginal
cost equal to marginal revenueExceptions: Natural monopoly
Characterizing an industry with economies of scale (declining LRAC) even at level of output equal to total market demand
Technological dynamism More competitive industries will be more technologically
progressive
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Source of Inefficiency:Monopoly Power Intermediate market forms
Monopolistic competition Many firms, each having some price setting power as a
result of product differentiation Excess capacity theorem
Oligopoly Small number of firms in industry with reaction to any
action taken by others Perfect collusion
Joint-maximizing cartel (OPEC in oil crisis) Longest surviving cartel?
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Source of Inefficiency:Externalities These are either costs or benefits that are
born by or accrue to an agent other than the agent generating them External costs negative externalities External benefits positive externalities
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Source of Inefficiency:Externalities External costs are negative externalities,
such as environmental pollution If the firm that generates pollution damages
another industry but does not reduce that damage → the private marginal cost to the firm does not equal the social marginal cost and too much pollution is produced, resulting in inefficiency
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Source of Inefficiency:Externalities External benefits are positive externalities,
such as technological invention without patent protection for inventors If an inventor has no patent protection, then other firms can
steal her invention and she may make no money even if her invention generates great social benefits
Private marginal benefit to the inventor does not equal marginal social benefit of the invention and too little inventing will occur, resulting in inefficiency
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Source of Inefficiency:Collective Consumption Goods Consumption goods = public goods → such as
national defense Because of the nature of such goods, it is difficult for
private markets to organize themselves to provide these goods in optimal quantities
The characteristics of pure public good: Non-excludability of consumption: It is not possible to
exclude this kind of consumption Non-depletability of consumption: Everyone consumes it
simultaneously, and no individual’s consumption reduces any other individual’s consumption Free-rider problem
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Source of Inefficiency:Imperfect Information Unrealistic to have perfect information When one party in a transaction knows more
than another, special problems arise causing asymmetric information Akerlof “The market for Lemons” Principal agent problem Sub-optimizing behavior
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The Role of Labor Unions
Redistribute income to their members Deal with safety, job security, benefits, social
functions and lobbying politically for broader social outcomes
Offset the monopolistic power of big firms
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Macroeconomic Instability of Market Capitalism The General picture
The major market capitalist economies have been less than perfectly stable over time
There was a general increase in unemployment rates after the early 1970s in many countries, associated with a general stagnation of economic growth, that appears to have been reduced recently
The considerable variation in capital investment can be explained by factors Exogenous fluctuations in new technologies that can serve as
the basis for the investment Fluctuations in government monetary policies affecting
interest rates Psychological fluctuations due to the “animal spirits” of those
making investments
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Macroeconomic Instability of Market Capitalism QUESTION
Why do these variables lead to fluctuations in the unemployment rate, since in a perfectly labor market, wage rates should fall when the demand for labor falls, thereby preventing the emergence of any involuntary unemployment?
TWO DIFFERENT ANSWERS Keynesian School Classical School
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Macroeconomic Instability of Market Capitalism Keynesian School
Rigidities of various sorts exist in labor markets and that capital investment can collapse and stay down for extended periods of time, as in the Great Depression
The implication is that government intervention through fiscal or monetary policies is advisable to stimulate the economy and to stabilize and smooth out business cycles
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Macroeconomic Instability of Market Capitalism The Classical School
Deriving from 19th century classical political economists such as David Ricardo
Market capitalist economies are powerfully self-stabilizing
Conscious government intervention merely generates inflation and intensifies fluctuations
To minimize unemployment, unions should be broken up and a stable fiscal and monetary environment should be maintained within a laissez-faire environment
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Laissez-faire Economic Policies Shift toward supporting more laissez-faire
economic policies There is a tension between asserting the
efficiency of competitive equilibria and recognizing the limits of the applicability of that theorem Chicago School’s (Milton Friedman) argument
draws directly from the efficiency theorem and follows by asserting the irrelevance or unimportance of the various exceptions and limits
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Chicago School
Markets are almost always efficient, so government should keep its hands off
The most externalities will be resolved by private markets if property rights are properly defined and enforced “free market”
Many of the goods provided by the public sector are not really collective consumption goods and could be more efficiently provided privately
Information costs are inevitable and cannot be avoided The Chicago School supports the Classical School approach in
macroeconomics Friedman is the most prominent advocate of monetarism in the
US With respect to distribution of income, people should be allowed to
keep what they earn from the free market Inequalities are the necessary outcome of providing sufficient
incentives for production, investment and growth
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Public Choice Theory
“Criticism of government intervention” The government agencies designated to carry out
the market-correcting activities are self-interested agencies that became captured by special interests operating through their legislative connections
Anne Krueger “rent-seeking”
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Austrian School
They reject equilibrium analysis and emphasize dynamic market processes
Entrepreneurs are the most important agents in the economy They must be allowed to function freely, without
government restriction, so that they can lead the market to evolve in conjunction with the evolution of consumer preferences through process of innovation
Static efficiency is relatively unimportant It is the dynamic success of market capitalism that is its
most important economic feature
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