Macroeconomics Wa1
ECO 111
Answer Key – WA#1
1. The "invisible hand" of the marketplace represents the idea that even though individuals and firms all act in their own self-interest, prices and the marketplace guide them to do what is good for society as a whole. Note: the “invisible hand” does not guarantee equilibrium. At the same time, it does not imply wealth redistribution – which is the worst thing for any economy. The easiest way to understand wealth redistribution is with the following example: suppose your final average in this class is 90%. Other students don’t work as hard as you and earn much lower grades. Those who advocate income redistribution would say it ’s “fair” to “tax” your grade at a rate of say 30% and distribute the 27 points (90 X .30 = 27) among the other students who performance was not as good as yours. Your final grade in this class is now a “D” (90 – 27 =63) instead of an “A.” Your success is penalized. Food for thought: if I did this, would you have an incentive to work hard?
In the past, some students have said that the concept of the invisible hand is misleading. But, this is not the case. The concept of the invisible hand applies to a free market. Recall Adam Smith was, above all, a believer in the free market. He felt that government was extremely unproductive. Why did Smith make this claim? Ask yourself the following question: what product(s) does the government produce for sale to the market so that permanent jobs are created? Answer – none. This is why Smith claimed that government is unproductive!
2. The two main causes of market failure are externalities and market power. An externality is the impact of one person’s actions on the well-being of a bystander, such as the impact from pollution. Market power refers to the ability of a single person/firm (or small group of people/firms) to unduly influence market prices. The best example of this is the cable companies. They carve up an area and each company is effectively a
Answer Key – WA#1
1. The "invisible hand" of the marketplace represents the idea that even though individuals and firms all act in their own self-interest, prices and the marketplace guide them to do what is good for society as a whole. Note: the “invisible hand” does not guarantee equilibrium. At the same time, it does not imply wealth redistribution – which is the worst thing for any economy. The easiest way to understand wealth redistribution is with the following example: suppose your final average in this class is 90%. Other students don’t work as hard as you and earn much lower grades. Those who advocate income redistribution would say it ’s “fair” to “tax” your grade at a rate of say 30% and distribute the 27 points (90 X .30 = 27) among the other students who performance was not as good as yours. Your final grade in this class is now a “D” (90 – 27 =63) instead of an “A.” Your success is penalized. Food for thought: if I did this, would you have an incentive to work hard?
In the past, some students have said that the concept of the invisible hand is misleading. But, this is not the case. The concept of the invisible hand applies to a free market. Recall Adam Smith was, above all, a believer in the free market. He felt that government was extremely unproductive. Why did Smith make this claim? Ask yourself the following question: what product(s) does the government produce for sale to the market so that permanent jobs are created? Answer – none. This is why Smith claimed that government is unproductive!
2. The two main causes of market failure are externalities and market power. An externality is the impact of one person’s actions on the well-being of a bystander, such as the impact from pollution. Market power refers to the ability of a single person/firm (or small group of people/firms) to unduly influence market prices. The best example of this is the cable companies. They carve up an area and each company is effectively a