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Unformatted text preview: 1 Walrasian Equilibria and Market E¢ ciency Reading in Textbook: Chapter 3 in Stiglitz. 1.1 Motivation When thinking about the role of government we have to consider a number of rather funda- mental questions, such as: & What should a government do? & Why are some activities undertaken in the private sector and others in the public sector, & What are the pros and cons of having the government intervene in a particular market? & Assuming that the government should intervene in a particular market, how can we determine what a &good¡intervention would be? As is pointed out in the very beginning of the textbook, one way to start thinking about these very basic questions is to look at some facts from the real world. The ¢rst two chapters in the book are intended to give you a bit of background, and I think you should read these chapters. However, for now I think that it is su£ cient that we agree on the following: 1. Government spending accounts for a big chunk of total economic activity. In sum, federal and local government spending about 30% of GDP in the US, and more than this in almost all other developed countries. 2. Certain goods (military defense, water and sewage, national parks, highway construc- tion etc.) are almost exclusively provided by governments. 3. Other goods (education, mail delivery, policing) are provided by both the public and the private sector. 4. The government also provides a legal system. 1 5. Even for sectors like steel, autos, tomato growing, sugar etc. the government inter- venes by providing explicit or implicit subsidies, tari/ protection, and other regulatory measures that in&uence the market outcomes. 6. The government also redistributes income. However, while the public sector is important, we rely mainly on the private sector for the production and distribution of most goods and services. Indeed, most economists would argue that a decentralized (=private) system has many virtues, and that one should be careful with government intervention in markets that work. This view is of course partially grounded in empirical observations (that is, comparing the Soviet Union and its satellites with the US and its European allies). However, another reason for the belief that ¡one should not mess with market¢is that there are appealing theoretical arguments for this view: the logic of the ¡invisible hand¢ pioneered by Adam Smith is the cornerstone of the most important model in economics- the competitive (or Walrasian or neoclassical l) equilibrium model. My view is that, before even thinking about why government intervention can in some cases be justi£ed, it is crucial to understand this model, which tells us that price taking behavior has certain advantages that seem hard for the public sector to replicate....
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This note was uploaded on 11/02/2008 for the course ECON 440 taught by Professor Peternorman during the Spring '08 term at UNC.
- Spring '08