Principles of Market Economy

YD Ahn

June 2008

Revised 2012 

Market Economy and the Government

 

Modus Operandi of the Market

 

Self-interest ⇒

Desire for wealth ⇒

Competition for resources ⇒

Innovation to win in the competition ⇒

National economic growth and development ⇒

Betterment of the human life all through the world

  

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. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. (A. Smith. The Wealth of Nations, 1776; Ch. 2)

 

 

Elements in a Free-market Economy

 

1) Freedom to choose (aka voluntary exchange)

 

2) Purposeive rules of the game

     - Fair trade and competition

     - Property right

 

3) Rule of law

 

  John Locke "No liberty without law." 

  Immanuel Kant "Man is free if he needs to obey no one but the laws."

  F.A. Hayek  "Law, liberty, and property are an inseparable trinity."   (1973. p.107)

 

Participants in the Market Economy

 

     1) Context builder

     - Institutions (rules of the game)

     - Infrastructure (the playing ground)

     - Stability of the environment

 

2) Players

     - Firms

     - Households (Individuals)

     - (The government)

 

3) Manager: The resource allocator

     - ?

 

4) Umpire

 

 

⇒ Role division 

     - The private sector:  

     - The government:   

 

 

Market Failures

 

1) Public goods

 

2) Externalities

 

3) Imperfect competition

 

4) Information asymmetry

 

Roles of the Government in a Nutshell 

 

1) Context builder

 

2) Umpire (⇒ rule of law)

 

3) Prevention of market failures 

 

 

On true meaining of "free"

 

Although many remember Smith today mainly for his brilliant insight into how market forces could support a self-organizing division of labor—the invisible hand—he was anything but a laissez-faire ideologue. Smith spends much of Book V of The Wealth of Nations explaining in detail why the state has powerful responsibilities regarding defense, justice, infrastructure, and education, areas in which collective action is required to complement, or substitute for, private-market forces.  (J. Sachs. The End of Poverty, 2005, p. 348)

 

Mainly what is required for rapid economic growth is (as Smith himself put it as a young man) "peace, low taxes and a tolerable administration of justice." (D. Warsh. Knowledge and Wealth of Nations, 2006, p. 45)

 

     ⇒ Friedrich A. Hayek [Laissez-faire a misnomer.] (Road to Serfdom, 1994)

 

 

 

Economic Policies

 

 

1) Macroscopic: As the context builder

     - Three objectives: stability in employment, price and the BOP (balance of payments) 

     - Three means: monetary, fiscal and FX intervention

 

        Gregory Mankiw "Perhaps the invisible hand guides the economy in normal times, but the invisible hand is

        susceptible to  paralysis."  (New Keynesian Economoics, 1991)

 

         Milton Friedman [Beware government intervention may be a bad means for a good cause.]

         (Free to choose, 1980) 

 

2) Microscopic: as manager (or players sometimes)

     - Industrial policy

     - Trade policy

     - Financial policy

     - Regional development policy

     - Equal employment opportunity policy

     - And You name it .

 

 

Notable & Quotable
June 19, 2008; Page A15, WSJ

Arthur Laffer speaking last month to graduates of Mercer University:

"Pursuing your dream of prospering will benefit everyone . . . When I graduated from Yale University, we had a serious commencement speaker not like the one you are stuck with today. The commencement speaker was President John F. Kennedy. And the point I'm making today is the same point he made all those years ago. He said, "No American is ever made better off by pulling a fellow American down, and all of us are made better off whenever any one of us is made better off." He concluded by using the analogy that 'a rising tide raises all boats.'

"Never forget or be ashamed of the fact that pursuing your own self interest furthers everyone's interest. Without you, the poor would be poorer."