PILLARS OF A FREE MARKET SYSTEM

CHAPTER 3 SECTION 1

Remember: free enterprise,

free market and capitalism are

used interchangeably in this

class!!!

PERVERSE INCENTIVES

In their book, meltdown – inside the soviet economy, authors Paul Craig Roberts and Karen Lafollette report on the seemingly mysterious propensity of soviet geologists for drilling many shallow holes rather than a smaller number of deep holes. Since most of the oil deposits lie at relatively deep levels, it is not too surprising that “…soviet geological expeditions in the republic of Kazakhstan have not discovered a valuable oil deposit for many years…. The surprising fact is that they were “…considered successful …. the geologists and ministers are paid handsomely for their efforts, everyone goes out and gets drunk, and no one cares that the whole exercise has been an extraordinary waste of time and money.” What incentive system explains their actions?

Clues

• In the process of oil-well drilling, the deeper the hole, the slower the drilling progress.

• The soviet geologists were paid if they reached their quota and received bonuses if they exceeded it.

NORTH KOREA VERSUS SOUTH KOREA

• FROM KOREAN WAR TO MID-1970S, NORTH KOREA AND SOUTH KOREA HAD A SIMILAR GDP PER CAPITA

• Umm, what’s GDP per capita? ADD UP ALL OF THE GOODS AND SERVICES PRODUCED IN ONE COUNTRY IN ONE YEAR AND DIVIDE IT BY THE NUMBER OF PEOPLE.

• TODAY • PER CAPITA GDP IN NORTH KOREA IS $1,800

• PER CAPITA GDP IN SOUTH KOREA IS $31,900

NORTH KOREA VERSUS SOUTH KOREA

FEBRUARY 2014

NORTH KOREA VERSUS SOUTH KOREA

FEBRUARY 2014

WHAT DO THESE IMAGES TELL YOU ABOUT NORTH KOREA?

FEBRUARY 2014

WHAT ACCOUNTS FOR THE DIFFERENCE BETWEEN NORTH AND SOUTH KOREA?

• INCENTIVES MATTER!

WORKING FOR THE GOOD OF SOCIETY VS WORKING FOR YOUR OWN SELF INTEREST

FEATURES OF A FREE MARKET SYSTEM

1. Private property

2. Economic incentives

3. Freedom to choose

4. Voluntary exchange

5. Competition

EOC study guideBasic Economic Concepts

#12

1. PRIVATE PROPERTY

PRIVATE PROPERTY IS ANY GOOD THAT

IS OWNED BY AN INDIVIDUAL OR A BUSINESS

• INDIVIDUALS MAY OWN AS MUCH PROPERTY AS THEY ARE WILLING AND ABLE TO BUY

• OWNERS MAY PROHIBIT OTHERS FROM USING THEIR PROPERTY

PUBLIC PROPERTY IS ANY GOOD

THAT IS OWNED BY THE GOVERNMENT

Franz Guest/Jim Belushi/Martha’s Vineyard

2. ECONOMIC INCENTIVES

• A FREE ENTERPRISE SYSTEM IS DRIVEN BY THE DESIRE FOR PROFIT

• MONEY ACTS AS AN INCENTIVE TO PRODUCE

• PRODUCE GOODS AND PRODUCE LABOR

• PROFIT IS A POWERFUL INCENTIVE THAT LEADS ENTREPRENEURS AND BUSINESSES TO ACCEPT THE RISK OF BUSINESS FAILURE

3. FREEDOM TO CHOOSE

WORKERS CAN CHOOSE WHAT WORK TO DO AND FOR WHOM THEY WILL WORK

BUSINESSES CAN CHOOSE THE PEOPLE

THEY WANT TO WORK FOR THEM

3 ½ . FREEDOM TO CHOOSE CONT.

BUSINESSES CAN CHOOSE THE PRODUCTS THEY WILL PRODUCE AND HOW MUCH THEY WANT TO SELL THEM FOR

BUYERS CAN CHOOSE THE PRODUCTS THEY BUY

4. VOLUNTARY EXCHANGE

• VOLUNTARY EXCHANGE IS THE FREE EXCHANGE OF GOODS AND SERVICES BETWEEN BUYERS AND SELLER IN SOME SORT OF MARKETPLACE.

• BUSINESSES AND INDIVIDUALS HAVE THE RIGHT TO MAKE EXCHANGES OR TRADES THEY BELIEVE WILL MAKE THEM BETTER OFF

• GUY TRADES A PAPERCLIP FOR A HOUSE

EOC study guide

Basic Economic Concepts

#9

5. COMPETITION

• INDIVIDUALS ARE FREE TO OPEN BUSINESSES THAT COMPETE WITH OTHERS

• CONSUMERS BENEFIT FROM COMPETITION

• COMPETITION IMPROVES QUALITY AND LOWERS PRICES

• COMPETITION BETWEEN EMPLOYERS FOR WORKERS RAISES WAGES