Naked Economics Essays

Naked Economics Essays Naked Economics Paper Naked Economics Paper Essay Topic: Economics Chapter 1: The Power of Markets 1. What are the two basic assumptions that economists make about individuals and firms? The two basic assumptions that economists make about individuals and firms are that they attempt to maximize their utility using the available resources and that they want to make the most amount of profit possible. 2. What is the role and significance of prices in the market economy? Prices in the market economy are extremely useful because they help gauge what consumers want and how badly they want it. High prices indicate strong consumer desire for that product while low ones indicate little interest. 3. What’s so great about a market economy anyway? A market economy is so good because it corresponds with normal human behavior and allows for optimum allocation of resources. It may not be completely fair, but it is the most stable and best option compared to a communist system. Chapter 2: Incentives Matter 4. Explain how each of the following relates to efficient outcomes in a market economy: adverse selection, â€Å"perverse incentives†, principal-agent problem, and the prisoner’s dilemma. Adverse selection hinders efficient outcomes in a market economy because it involves one party in an economic action having less information than the other, therefore it might agree to buy a certain product or service and pay for more than what it gets (or vice versa if seen from the ignorant seller’s perspective). The avoidance of negative perverse incentives leads governments into better policy making and achieving the desired economic effect and increase in efficiency. If the principal-agent problem is addressed correctly, business managers and employees will strive to improve the product or service and achieve economic growth in the long run because it is beneficial to them, not only the owners. The prisoner’s dilemma will probably lead to an inefficient outcome in which both parties involved will not achieve maximum profit. The only time this isn’t the case is when agreements and communication exist between the parties and they both agree on an action and thanks to that, achieve higher profits. This though is normally prohibited by government in order to prevent monopoly power. Chapter 3: Government and the Economy 5. In your own words, explain what an externality is. An externality is the cost or benefit that the production, selling, use, or even existence of a product or service has positive or negative effects on people that were not involved in the transaction. 6. Besides addressing externalities, what other important and beneficial roles does government play in our market economy? Government tries its best to reach a more equitable income distribution through the use of taxes, provides for public services that would otherwise be produced inefficiently if produced privately, and provides a law system which also prevents monopolization of industries and coalitions between powerful firms to protect consumers from monopoly prices. Chapter 4: Government and the Economy II 7. What are the main reasons why government should only take a limited role in a market economy? Government should only take a limited role in a market economy because if let to function freely, a market economy will achieve considerably efficient outcomes and only need few regulations and assistance with public goods in order to maintain competition and fairness. These functions should be executed with moderation because excessive control and regulation of the market will lead to inefficiency and maybe even market failure.