Markets and Economic Efficiency

Abstract

In Chapters 1 and 2 we built up a picture of how markets can be used to answer the basic economic questions of what to produce, how to produce, and for whom to produce. In Chapter 1 we introduced the ideas of Adam Smith on the division of labour. Smith supposed that markets allowed individuals the freedom to develop and make the best use of their skills. Recall that this was good not just for the individual but for everyone. An extended division of labour allows all members of society to engage in a mutually supportive constellation of production and consumption activities. In Chapter 2 we saw that markets can also serve to harmonize the interests of individuals in their guises as producers and consumers. Left to freely adjust, markets reach equilibrium positions at which supply and demand are perfectly matched. However, we also noted that the state may choose to intervene in markets where the outcomes that result are not to its liking or are in some other way undesirable. We elaborate upon the reasons for state intervention in markets in Chapters 5 and 6, but for the moment we continue with our discussion of the operation of the free market.