Economics Question and Answers

Topics: Economics, Information asymmetry, Capitalism Pages: 4 (1265 words) Published: April 19, 2012
Chapter 1: The Power of Markets
What are the two basic assumptions that economists make about individuals and firms? Economists have two basic assumptions which keeps the economy in check. One is that people try to make themselves as versatile as possible maximizing their overall potential. The other is that a firm would do what it needs to make the most profit possible. What is the role and significance of prices in the market economy? Prices in a market economy are very important. Price allows us to give out goods appropriately to those who are able to pay. What’s so great about a market economy anyway?

Market economies are great for many reasons. A market economy makes our lives better through competition either through lowering prices or improving products. Market Economies have very little need of government interference because they are self-correcting and essentially self governing. Chapter 2: Incentives Matter

Explain how each of the following relates to efficient outcomes in a market economy: Adverse selection, “perverse incentives”, principal agent problem, and the prisoners dilemma. Adverse selection affects the outcomes in market economies by giving workers reason to change jobs. Perverse incentives can be important in market economies because they happen essentially on the fly. Principal agent problems can drastically affect the economy when, let’s say a major company, a CEO decides to make bad decision to get a large sum of money for himself. The prisoner dilemma shows how most people come straight to the conclusion that the other is going to “rat them out”. Chapter 3: Government and the Economy

In your own words, explain what an externality is.
Externality is very easy to explain. An externality is the measurement of the difference in what something costs for you and what it costs for society in economics. Besides addressing externalities, what other important and beneficial roles does government play in our economy? Governments play highly...
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