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

new insights into markets and situations that the basic competitive model cannot fully
address. Differences between the predictions of the basic competitive model and
observed outcomes can help guide us to other models that provide a better understanding
of particular markets and circumstances. While the basic competitive
model may not provide a perfect description of some markets, most economists
believe that it gives us tremendous insights into a wide range of economic issues;
for that reason, it is the foundation on which economists build.
Wrap-Up
INGREDIENTS IN THE BASIC COMPETITIVE
MODEL
1. Rational, self-interested consumers
2. Rational, profit-maximizing firms
3. Competitive markets with price-taking behavior
Incentives and Information:
Prices, Property Rights,
and Profits
For market economies to work efficiently, firms and individuals must be informed
and have incentives to act on available information. Indeed, incentives can be viewed
as at the heart of economics. Without incentives, why would individuals go to work
in the morning? Who would undertake the risks of bringing out new products?
Who would put aside savings for a rainy day? There is an old expression about the
importance of having someone “mind the store.” But without incentives, why would
anyone bother?
Market economies provide information and incentives through prices, profits,
and property rights. Prices provide information about the relative scarcity of different
goods. The price system ensures that goods go to those individuals and firms that
are most willing and able to pay for them. Prices convey information to consumers
about scarcity, and consumers respond by adjusting their consumption. Similarly,
prices convey information to firms about how individuals value different goods.
The desire for profits motivates firms to respond to the information provided
by prices. By most efficiently producing what consumers want, in ways that least
use scarce resources, they increase their profits. Similarly, rational individuals’ pursuit
of self-interest induces them to respond to prices: they buy goods that are more
expensive—in a sense, relatively more scarce—only if those goods provide commensurately
greater benefits. If a good such as oil becomes scarcer, its price rises. In
order to make rational decisions about how much heating oil to use, consumers do
not need to know why the price of oil has risen. Perhaps a particularly cold winter
INCENTIVES AND INFORMATION: PRICES, PROPERTY RIGHTS, AND PROFITS ∂ 29