Microeconomics: Big Picture

MICROECONOMICS: THE BIG PICTURE

For the final exam, know the Big Picture. The Big Picture is that competitive markets are efficient. Competitive markets assure that goods are provided to those who are willing to pay a price which is consistent with covering all costs of production, but no higher than that. Competitive markets get the good to the people who value the good the most, at as low a cost as possible. Everyone agrees that somehow, scarce resources have to be parceled out, i.e., rationed. The price mechanism is that rationing device which involves the least coercion possible. If the price gets too high, some consumers will decide that their money is better spent elsewhere. If the price gets too low, some producers will decide that their efforts are better rewarded elsewhere. And such decisions to leave the market are not coerced by government–they are voluntary. So competitive markets are consistent with the personal freedom which we value in a democracy.

Competitive markets move toward market-clearing equilibrium through the interaction of supply and demand. This is why prices in such markets are good guides for allocating the resources of the economy. As you know, demand is based on the (marginal) benefit of the good to the consumer, while supply is based on the (marginal) cost to the producer. Equilibrium equates those benefits and costs. [Do markets ever reach "market-clearing equilibrium"? Probably not, because markets are dynamic and supply and demand factors are constantly changing. So the particular equilibrium is constantly changing. But the movement toward equilibrium is what permits markets to move resources in the direction for which they are most desired, and which gives good signals to consumers and producers.]

This Big Picture assumes that markets are competitive and unregulated. If markets are not competitive (i.e., they are monopolized or "oligopolized"), or if government–through a desire to "do good"– tries to regulate markets for some other purpose (price controls on rents, or tariffs on imported goods to protect domestic manufacturers), then markets will not be efficient and will not be able to do their job. Where should government intervene in markets? Probably in the case of externalities, probably in the case of need to provide public goods, and perhaps in the case of monopoly. But care must be exercised here, because if you listen to political debate or the arguments of political lobbyists, you will notice that there is nearly always an appeal to some externality or other, or some "public need" (i.e., public good), for which their proposed "solution" is just what the doctor ordered–except that the point of their efforts may be to get the legislative body to pass and fund a program which serves the private interests of the one who is paying the lobbyist. In other words, just how far should one go in accepting the externality and public good arguments? This is not something which can be answered easily, but of which we should all be aware.

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