, 10 PART!

INIROOUCI ION
CHAPTER I l[N PRINCIPl[S or [CO/fOMICS 11
Despite this competition, your family would not be better off isolating itself from
up an economy. This corollary explains why taxes adversely affect the allocation
"
all other families. If it did, your family would need to grow its own food, make its'.
of resources• They d1slort prices and thus the deos1ons of households and firms. It
own clothes, and build its own home. Clearly, your family gains much from its abil- 1
also explains the great harm caused by policies that directly control prices, such as
ity to trade with others. Trade allows each person to specialize in the activities she"
rent control. And it explains the failure of communism. In communist countries,
does best, whether it is farming, sewing, or home building. By trading with others,
prices were not determined in the marketplace but were dictated by central plan-
people can buy a greater variety of goods and services at lower cost. )I
ners. These planners lacked the necessary information about consumers' tastes
Countries as well as families benefit from the ability to trade with one another.
and producers' costs, which in a market economy is reflected in prices. Central
Trade allows countries to specialize in what they do best and to enjoy a greater va-
planners failed because they tried to run the economy with one hand tied behind
riety of goods and services. The Chinese, as well as the French and the Egyptians ,
their backs-the invisible hand of the marketplace.
and the Brazilians, are as much our partners in the world economy as they are ourt
1
competitors. ·'•
1-2c Principle 7: Governments Can Sometimes
1-2b Principle 6 : Markets Are Usually a Good Improve Market Outcomes
Way to Organize Economic Activity If the invisible hand of the market is so great, why do we need government' One
The collapse of communism in the Soviet Union and Eastern Europe in the 1980s' purpose of studying economics is to refine your view about the proper role and
was one of the last century's most impor1ant changes. Communist countries op: scope of government policy.
erated on the premise that government officials were in the best position to allo-l ' ,, One reason we need government is that the invisible hand can work its magic
cate the economy's scarce resources. These central planners decided what goods .: only ii the government enforces the rules and maintains the institutions that are
and services were produced, how much was produced, and who produced and
consumed these goods and services. The theory behind central planning was tha!
only the government could organize economic activity in a way that promoted
economic well-being for the country as a whole. ·
Most countries that once had centrally planned economies have abandoned the · Adam Smith and the
market economy system and are instead developing market economies. In a market economy, the , Invisible Hand
an economy that decisions of a central planner are replac,d by the decisions of millions of firms and··1
allocates resources households. Firms decide whom to hireard whatto make. Households decide which am Smith's great book The Wealth . II is not from the
through the decentralized firms to work for and what to buy with their incomes. These firms and households exact year in which American benevolence of the
decisions of many firms interact in the marketplace, where prices and self-interest guide their decisions. dependence. But the two docu; butcher. the brewer. or
and households as they At first glance, the success of market economies is puzzling. In a market econ- : ntatthetime, lndividuals the baker that we expect our din-
interact in markets for omy, no one is looking out for the economic well-being of society as a whole. Free·> ner, but from their reg;;d to their own in-
goods and services markets contain many buyers and sellers of numerous goods and services, and., terest. We address ourselves, not lo their humanity but to their
all of them are interested primarily in their own well-being. Yet despite decentral, self-love, anineve; talk to them of our own necessities bui
ized decision making and self-interested decision makers, market economies have economiesworksqwe_ll?lsit'becau·se of their adva~/ages. Nobody but a beggar chooses ta depend
proven remarkably successful in organizing economic activity to promote overalJ.' ·ea(one another with.love and kindness? •chief& ~panthe bei;.,.lence of his le/low-citizens. ...
economic well-being. • 's d§ cription of how·p.e~ple interact fn:~ ~-'"rveiyindividuaf':,' ,neither intends to promote the public
In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations1·_· I·., .+,' interest, nor knows how much he is promoting it.... He intends
economist Adam Smith made the most famous observation in all of economics}! pn/y/is 'own gain,' 14d pe is (n this, as ir. many othercases, led
Households and firms interacting in madets act as if they are guided by an "in.:j :/ant occasion.for the help of his biethren,
tii,i, lo expect it from their benevolence only by an iirvisible hand-,opromote an end which was no part of his ..,
visible hand" that leads them to desirable market outcomes. One of our goals iii;,., -He-will be morelikely to prevail if , inlentio:.'i1oifs it ~/i1;j, the "'1rse for the society that it was no ,,
this book is to understand how this invisible hand works its magic. ;, ,
he can interest lkeir self-love in his '· ,•. pad of ";i: By fl;~~;;g his own'Jnterest he frequently promotes
As you study economics, you will learn that prices are the instrument with / favour, and show them that 11 ,s for . that oi/he socie/J,,moie el'.~tua/ly than when he really intends /1
which the invisible hand directs economic activity. In any market, buyers look aj·1
the price when determining how much to demand, and sellers look at the price
' . ,. •· •
the,rown a_
- . loprol1}oleJf •. ·.:;• ... ,. .• .
¢vantagj./odo1or~(m,v . · ,. 7 ,. -~;~ ~--:J}, , .. ,;·:,'-~ -.~'o- ~.:~ ,
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when deciding how much to supply. As a result of the decisions that buyers an.d :· what he requires,ot /~em.. 7, Give ... Smith is sa~ng'that ~artiiipanjs.in the economy am motivated by self- P;
·"· me that which Iwant, andyau shall , . · interest and that-the '.invisible hand" of the marketplace guides this
sellers make, market prices reflect both the value of a good to society and t~e ;\I
cost to society of making the good. Smilh's great insight was that prices adjust t~ ,ltl -'.,, have this ~hich f<lU want, 'is (he , '-s~lf-interestinto pJO~ing generateconomic well-being. · '
guide these.individual buyers and selle,s to reach outcomes that, in many casesA~ ml!Ening of every such'ofler; and ,. ·' , Many gl Smrrh's insights nimainat the center of mO<iem economics.
it is in this mann.er that we obtain ' Our analysis in thecoining,cha~feis will allow us to express Smith"s
maximize the well-being of society as a whole. :•. :·}
_Smith's insight_ has an important corollary: When a government prevents.. ,J from one another the.far greater conclusions mo,e precisefy and to analyze mOJe fully the strengths and
pnces from adJustmg naturally to supply and demand, 11 impedes the mvIS1b!_~,,;: I part of th'.se goii ollicps which .; ·· w;aknesj s!! the mi~'! iniisib)e hand.
hand's ability to coordinate the decisions of the households and firms tliat make,,
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standinn~of...,,·. 11 ·. 1,.-: .l~ $.~:1~;..:. •:·