As we learned in the Introduction, an economy is a system for coordinating the productive activities of many people. In a market economy like we live in, coordination takes place without any coordinator: each individual makes his or her own choices.
Interaction of choices—
Yet those choices are by no means independent of one another: each individual’s opportunities, and hence choices, depend to a large extent on the choices made by other people. So to understand how a market economy behaves, we have to examine this interaction in which my choices affect your choices, and vice versa.
When studying economic interaction, we quickly learn that the end result of individual choices may be quite different from what any one individual intends. For example, over the past century farmers in the United States have eagerly adopted new farming techniques and crop strains that have reduced their costs and increased their yields. Clearly, it’s in the interest of each farmer to keep up with the latest farming techniques.
But the end result of each farmer trying to increase his or her own income has actually been to drive many farmers out of business. Because American farmers have been so successful at producing larger yields, agricultural prices have steadily fallen. These falling prices have reduced the incomes of many farmers, and as a result fewer people find farming worth doing. That is, an individual farmer who plants a better variety of corn is better off; but when many farmers plant a better variety of corn, the result may be to make farmers as a group worse off.
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5. There are gains from trade. |
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6. Because people respond to incentives, markets move toward equilibrium. |
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7. Resources should be used as efficiently as possible to achieve society’s goals. |
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8. Because people usually exploit gains from trade, markets usually lead to efficiency. |
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9. When markets don’t achieve efficiency, government intervention can improve society’s welfare. |
TABLE 1-
A farmer who plants a new, more productive corn variety doesn’t just grow more corn. Such a farmer also affects the market for corn through the increased yields attained, with consequences that will be felt by other farmers, consumers, and beyond.
Just as there are four economic principles that underlie individual choice, there are five principles underlying the economics of interaction. These principles are summarized in Table 1-2 and we will now examine each of them more closely.