As we learned earlier, in a market economy decisions about production and consumption are made via markets. In fact, the economy as a whole is made up of many interrelated markets. Up until now, to learn how markets work, we’ve been examining a single market—the market for used textbooks. But in reality, consumers and producers do not make decisions in isolated markets. For example, a student’s decision in the market for used textbooks might be affected by how much interest must be paid on a student loan; thus, the decision in the used textbook market would be influenced by what is going on in the market for money.

We know that an efficient market equilibrium maximizes total surplus—the gains to buyers and sellers in that market. Is there a comparable result for an economy as a whole, an economy composed of a vast number of individual markets? The answer is yes, but with qualifications.

When each and every market in the economy maximizes total surplus, then the economy as a whole is efficient. This is a very important result: just as it is impossible to make someone better off without making other people worse off in a single market when it is efficient, the same is true when each and every market in that economy is efficient. However, it is important to realize that this is a theoretical result: it is virtually impossible to find an economy in which every market is efficient.

For now, let’s examine why markets and market economies typically work so well. Once we understand why, we can then briefly address why markets sometimes get it wrong.