[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

12 ∂ CHAPTER 1 MODERN ECONOMICS
firms make the decisions. Individuals make decisions that reflect their own desires
as they respond to the incentives they face. Firms make decisions that maximize their
profits, and to do so they strive to produce the goods that consumers want at the
lowest possible cost. This process determines what is produced, how it is produced,
and for whom. As firms compete in the quest for profits, consumers benefit, both
from the kinds of goods produced and from the prices at which they are supplied.
On the whole, markets ensure that society’s resources are used efficiently.
In some areas, however, markets lead to outcomes that society may find inadequate.
There may be too much pollution, too much inequality, and too little concern
about education, health, and safety. When the market is not perceived to be
working well, people often turn to government. An economy such as in the United
States is often called a mixed economy—one that relies primarily but not exclusively
on the free interaction of producers and consumers to determine what is
produced, how, and for whom. In some areas, the government makes the decisions,
in others it imposes regulations that affect the incentives firms and households
face; and in many areas, both the private sector (households and businesses) and the
public sector (local, state, and federal governments) are involved (education is a
good example).
Governments play a critical role in all market economies. For example, governments
provide the legal structure within which private firms and individuals operate.
No one would open a store if others could simply steal things off the shelf with
impunity; the store owner needs to know there is a legal system that he can use to
prosecute theft. No bank would lend money to a family to buy a home if it could not
legally require the family to repay the loan. Governments also regulate businesses
in many ways. There are regulations to ensure firms do not discriminate by race or
sex, do not mislead consumers, and are careful about the safety of their workers. In
some industries, such as education and mail service, the government is a major supplier
of services. In other industries, such as the defense industry, government is
the major purchaser. The government also supplies goods and services that the private
sector does not, such as the national defense, roads, and currency. Government
programs provide for the elderly through Social Security (which pays income to
retired individuals) and Medicare (which funds the medical needs of the aged). The
government helps those who have suffered economic dislocation, through unemployment
insurance for those temporarily unemployed and disability insurance for
those who are no longer able to work. The government also provides a safety net of
support for the poor, particularly children, through various welfare programs.
One can easily imagine the government controlling the economy more directly.
In countries where decision making is centralized and concentrated in the government,
government bureaucrats might decide what and how much a factory should
produce and set the wages that should be paid. At least until recently, governments
in countries such as the former Soviet Union and China attempted to control practically
all major decisions regarding resource allocation. Even in Europe, not long ago
many governments ran oil companies, coal mines, and the telephone system.
Increasingly, however, governments have sold these enterprises to the private sector,
a process called privatization.
Market economies in which individuals and firms make the decisions about what
to produce and how much to pay have proven adept at developing new technologies