Chapter 2 The basics of demand and supply(2) Government and market 1 The road to waste is often pasted with government’s good intention. 2 No modern economy can exist without government playing an important role

Main content of today’s classes 2.3 market mechanism and its superiority---anti-government interference 2.4 market failure and government’s task in economy---supporting government interference 2.5 the analysis about the effect of price control---government usually pays with no gains but usually we still have to depend on it. 2.6 two discussion questions

2.3.1 Market and market mechanism Market: Original the real place the buyer and seller bargain face to face. Now the mechanism by which buyers and sellers interact to determine the equilibrium price and quantity of goods or services. Market mechanism: the tendency in a free market for the price to change until the market clears. Price coordinates the decisions of producers and consumers in a market .Higher price tends to reduce purchases and encourage production. Lower price will stimulate consumption and discourage production. So prices are the balance wheel of the market mechanism.

2.3.2 the superiority of market mechanism--- Invisible hand theory “It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest.”--- Adam Smith, The wealth of Nation(1776) Smith pointed out the harmony between private interest and public interest. Invisible hand theory holds that in the pursuit of individual benefit, every person is led as if by an invisible hand to achieve the best benefit for all. An individual frequently promotes the interest of society more than he really intends to promote it---a spontaneous social order will come into being.

2.3.3 the history background of Smith’s anti-government intervention In 18th century, the strength of feudalism in England was rather strong and the noble tried their best to exploit the newborn capitalist. Many interventions from government constrained the development of industry and impeded people making fortune. Smith held that government interference to economy should be as little as possible and leave economic decisions to the market. In this view the role of government should be limited to the maintenance of law and order, national defense, and provision of certain public goods that private sector would not undertake. This theory is called “laissez-faire” in economics, or “leave us alone”.

2.4.1 Is the government really useless in economy? Two centuries after The wealth of nation published, economists realized that free market isn’t perfect. In economist’s logic free market is imperfect only because it can’t achieve the highest economic efficiency.( It is not because free market will cause inequity and in-humanism) This viewpoint might be shallow but it is right the contribution of economics analysis. Reasons like monopoly, externality, common goods and information imperfect result in market failure. (the situation under which the market fails to provide an efficient allocation for resources or the market can’t get cleared through the fluctuation of prices.) People hope that government can shoulder its task when there is market failure.

2.4.2 The reason of market failure Monopoly: firms produce a low level of output at high price for lack of competition. Just as the telecom industry in China, the communication fees are much more expensive than abroad and few people can afford the fees of mobile phone. Externalities: costs or benefits of people’s actions that don’t show up as a part of the market price. (cost spill out—negative externality, air pollution, students stay up before examination) benefit spill out—positive externality, beekeepers and gardeners, diligent student do homework for her friends to copy) Imperfect information: lack of information about the quality or nature of a transaction and so people cannot make correct purchase decisions.( the second-hand cars market) Public goods: goods that is both noncompetitive and nonexclusive like National defense and street lamp. The supply of common goods through free market is usually insufficient for people always want a free ride.( the bulb in public corridor) Is the book of a public library a kind of common goods?

2.4.3 Government’s role in economy Government’s three main economic functions: improve efficiency(by anti-monopoly,anti-pollution,etc);promote equity(by income taxes and subsidies);foster macroeconomic stability and growth.(fiscal and monetary policy)

2.5 Effects of government intervention----price control Positive analysis: Price regulation results in surplus (minimum price which is too high) or shortage (maximum price which is too low). As we know the government’s intervention to economy usually has elegant reasons. But who really benefits from the price regulation? And who suffers? The answer is small people gain at the cost of more people’s loss. Maximum price: producers lose and some consumers gain. ( the price of pork in 1970s) Minimum price---present producers and their political captive gain but consumers lose. (the price of crops in European Union)

Our conclusion about price control Normative analysis: We shouldn’t adopt price control. (It implies that we think efficiency is more important than equity as an economics student) It’s difficult for the regulator to ensure the controlling price is always set rationally. Relative price should be permitted to fluctuate freely for it signals to producer and consumer how to behave. If relative price is unchanged while the situation of market has changed, there will be long-run shortage or surplus. What’s more the regulator lack of the capability to change relative price in time, so the road to waste is paved with the governments good intention.

Discussion: price regulation in railway transportation The price regulation of train tickets in the Spring Festival. Did it protect the passengers’ welfare? Did it hurt the suppliers’ welfare? Why don’t we remove the price control and depend on the free market? We should pay attention to the special character (corruption) of Chinese market.

Summary What is a market The invisible hand theory The reason of market failure. The result of price regulation.