the market system aka the free market aka free enterprise aka capitalism


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The market system

The market systemAKA The Free Market AKA Free Enterprise AKA CapitalismAdam SmithFather of Modern EconomicsPublished The Wealth of Nations in 1776, which became the founding work of Classical EconomicsAdvocated laissez faire economics, with minimal government interference

Smiths Prescriptions for a Recession***If a recession occurs, the market will self-correctThe invisible hand of the market will cause the recession to (eventually) fix itselfThis might require waiting for the long run, but the costs of government interference are not worth the government trying to actively fix the recession. In fact, government intervention might make a recession worse.John Maynard KeynesPublished The General Theory of Employment, Interest, and Money in 1936 (during the Great Depression)Challenged the tenets of Classical Economics; founded Keynesian Economics (the approach used by most modern governments, including the US), in which the government fine-tunes the economy in the short run.

Keynes Prescriptions for a Recession***If a recession occurs, government intervention might be appropriate/necessaryThe economy might fall into an equilibrium below full employmentEven if the recession might self-correct in the long run, it might not be worth waiting for the self-correction: In the long run, were all dead (Keynes)For example, while a society waits for the economy to fix itself, many people might have to stay unemployed.It might be worth the costs of government interference to address a recession in the short run with government policy.

Keynesians vs. Neo-Classical EconomistsToday, there is an ongoing debate between Keynesian economists and New Classical economists that call for waiting for the long run and self-correction (for different reasons than the old Classicals).

Economic Profit vs. Normal ProfitNormal Profit is useful for taxing profits, but Economic Profit tells an entrepreneur whether to enter, stay in, or leave an industry.(Well need to illustrate on the board how this works.)Some Final Economics VocabCreative destruction: a new technology/product destroys the market for an old technology/product (and markets for the inputs for that product)Ex: Computers replaced typewriters, and at the same time destroyed demand for typewriter manufacturing laborers, typewriter repair, etc.Derived demand: demand for a good/service creates derived demand for the inputs necessary to make that good or serviceEx: Increase in Demand for haircuts leads to an increase in Demand for scissors, barber labor.Ex: Increase in Demand for baseball bats leads to an increase in Demand for wood, baseball-bat cutting machines (capital), etc.


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