Economics

First Pages
CHAPTER

The Modern Mixed Economy

2

Every individual endeavors to employ his capital so that its produce may be of greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end which was no part of hisintention. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it.
Adam Smith, The Wealth of Nations (1776)

Think for a moment about some of the goods and services that you consumed over the last few days. Perhaps you took an airline flight to school or bought some gasoline for the family car. You surely had some home cooked foodbought in a grocery store or a meal purchased at a restaurant. You might have bought a book (such as this textbook) or some pharmaceutical drugs. Now consider some of the many steps that preceded your purchases. The airplane flight will illustrate the point very well. You may have purchased an airline ticket on the Internet. This simple-sounding purchase involves much tangible capital such as yourcomputer, intellectual property (in software and designs), and sophisticated fiber-optic transmission lines, as well as complicated airline reservation systems and pricing models. The airlines do all this to make profits (although profits have been very modest in that sector).

At the same time, government plays an important role in air travel. It regulates airline safety, owns many airports,manages the traffic-control system, produces the public good of weather data and forecasting, and provides information on flight delays. And this list could go on into the public and private support of aircraft manufacturing, international agreements on airline competition, energy policy on fuels, and other areas. The same point would apply—in different degrees depending upon the sector—to yourpurchases of drugs or gasoline or pharmaceuticals or just about any item. The economy of every country in the world is a mixed economy—a combination of private enterprise working through the marketplace and government regulation, taxation, and programs. What exactly is a market economy, and what makes it such a powerful engine of growth? What is the “capital” in “capitalism”? What government controlsare needed

25

sam11290_ch_02.indd 25

12/12/08 8:55:39 PM

First Pages
26
to make markets function effectively? The time has come to understand the principles that lie behind the market economy and to review government’s role in economic life.
CHAPTER 2 • THE MODERN MIXED ECONOMY

A. THE MARKET MECHANISM
Most economic activity in most high-income countries takes place in privatemarkets—through the market mechanism—so we begin our systematic study there. Who is responsible for making the decisions in a market economy? You may be surprised to learn that no single individual or organization or government is responsible for solving the economic problems in a market economy. Instead, millions of businesses and consumers engage in voluntary trade, intending to improve theirown economic situations, and their actions are invisibly coordinated by a system of prices and markets. To see how remarkable this is, consider the city of New York. Without a constant flow of goods into and out of the city, New Yorkers would be on the verge of starvation within a week. But New Yorkers actually do very well economically. The reason is that goods travel for days and weeks from thesurrounding counties, from 50 states, and from the far corners of the world, with New York as their destination. How is it that 10 million people can sleep easily at night, without living in mortal terror of a breakdown in the elaborate economic processes upon which they rely? The surprising answer is that, without coercion or centralized direction by anyone, these economic activities are...