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Overview of Comparative Economics


Overview of Comparative Economics Chapter II Market Capitalism – PowerPoint PPT presentation

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Title: Overview of Comparative Economics

Overview of Comparative Economics
  • Chapter II
  • Market Capitalism

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

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

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

Advantages and Disadvantages of Market Capitalist
  • Experienced enormous technological advances and
    growth as they underwent the Industrial
    Revolution in the late 18th century
  • ability to revolutionize the means of
  • Experienced large macroeconomic fluctuations with
    serious downturns in the 19th century (unequal
    distribution of income and increasing
    concentrations of industrial monopoly power)

Pure Version of Market Capitalist System
  • Pure version of market capitalist system does not
  • Closest to the ideal of pure laissez-faire market
    capitalism are
  • Hong Kong
  • Singapore
  • New Zealand

  • 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

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

Theoretical Efficiency of Market Capitalism
  • Complete
  • For any good or service that affects someones
    utility, there is a market
  • Competition
  • There are many buyers and sellers with free entry
    and exit
  • There are well-defined homogenous goods and
  • No individual supplier has any control over the
    price in his or her market

Theoretical Efficiency of Market Capitalism
  • Full information
  • All agents in the economy know everything about
    consumer preferences, production technologies and
  • 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

Theoretical Efficiency of Market Capitalism
  • Efficiency
  • Pareto optimality ? no one in the economy can be
    made better off without making someone else worse
  • 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

Why is a complete, competitive, full-information,
general equilibrium efficient?
  • Adam Smiths invocation of invisible hand of the
    market working across all sectors to allocate
    goods in a way that maximizes the wealth of the
  • 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

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

Limits to The Efficiency of Laissez-Faire Market
  • Monopoly Power
  • Externalities
  • Collective Consumption Goods
  • Imperfect Information

Source of Inefficiency Monopoly Power
  • Monopoly power prohibits competition
  • Monopolist will maximize profits by setting
    marginal cost equal to marginal revenue
  • Exceptions
  • 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

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?

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

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

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

Source of Inefficiency Collective Consumption
  • 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
  • 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 individuals
    consumption reduces any other individuals
  • Free-rider problem

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

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

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
  • 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

Macroeconomic Instability of Market Capitalism
  • 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?
  • Keynesian School
  • Classical School

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

Macroeconomic Instability of Market Capitalism
  • The Classical School
  • Deriving from 19th century classical political
    economists such as David Ricardo
  • Market capitalist economies are powerfully
  • 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

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 Schools (Milton Friedman) argument draws
    directly from the efficiency theorem and follows
    by asserting the irrelevance or unimportance of
    the various exceptions and limits

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
  • 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

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

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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