Modern Principles: Microeconomics 3rd Edition

Book Preface

That is the opening from Chapter 1 of Modern Principles: Microeconomics, and only an economist could write such a sentence. Only an economist could see that incentives are operating just about everywhere, shaping every aspect of our lives, whether it be how good a job you get, how much wealth an economy produces, and, yes, how a jail is run and how well the prisoners end up being treated. We are excited about this universal and powerful applicability of economics, and we have written this book to get you excited too.

In the first two editions, we wanted to accomplish several things. We wanted to show the power of economics for understanding our world. We wanted to create a book full of vivid writing and powerful stories. We wanted to present modern economics, not the musty doctrines or repetitive examples of a generation ago. We wanted to show—again and again—that incentives matter, whether discussing the tragedy of the commons, political economy, or what economics has to say about wise investing. Most generally, we wanted to make the invisible hand visible, namely to show there is a hidden order behind the world and that order can be illuminated by economics.

Make the Invisible Hand Visible

One of the most remarkable discoveries of economic science is that under the right conditions the pursuit of self-interest can promote the social good. Nobel laureate Vernon Smith put it this way:

At the heart of economics is a scientific mystery . . . a scientific mystery as deep, fundamental and inspiring as that of the expanding universe or the forces that bind matter. . . . How is order produced from freedom of choice? We want students to be inspired by this mystery and by how economists have begun to solve it. Thus, we will explain how markets generate cooperation from people across the world, how prices act as signals and coordinate appropriate responses to changes in economic conditions, and how profit maximization leads to the minimization of industry costs (even though no one intends such an end).

We strive to make the invisible hand visible, and we do so with the core idea of supply and demand as the organizing principle of economics. Thus, we start with supply and demand, including producer and consumer surplus and the two ways of reading the curves, and then we build equilibrium in its own chapter, then elasticity, then taxes and subsidies, then the price system, then price ceilings and floors, then international trade, and then externalities. All of this material is based on supply and demand so that students are continually gaining experience using the same tools to solve more and deeper problems as they proceed. The interaction of supply and demand generates market prices and quantities, which in turn lies behind the spread of information from one part of a market economy to another. Thus, we show how the invisible hand works through the price system.

In Chapter 7 we show how the invisible hand links romantic American teenagers with Kenyan flower growers, Dutch clocks, British airplanes, Colombian coffee, and Finnish cell phones. We also show how prices signal information and how markets help to solve the great economic problem of arranging our limited resources to satisfy as many of our wants as possible.

The focus on the invisible hand, or the price system, continues in Chapter 8. As in other texts, we show how a price ceiling causes a shortage. But a shortage in one market can spill over into other markets (e.g., shortages of oil in the 1970s meant that oil rigs off the coast of California could not get enough oil to operate). In addition, a price ceiling reduces the incentive to move resources from low-value uses to high-value uses, so in the 1970s we saw long lines for gasoline in some states yet at the same time gas was plentiful in other states just a few hours away. Price ceilings, therefore, cause a misallocation of resources across markets as well as a shortage within a particular market. We think of Chapters 7 and 8 as a package: Chapter 7 illustrates the price system when it is working and Chapter 8 illustrates what happens when the price system is impeded.

Students who catch even a glimpse of the invisible hand learn something of great importance. Civilization is possible only because under some conditions the pursuit of self-interest promotes the public good. In discussing the invisible hand, we bring more Hayekian economics into the classroom without proselytizing for Hayekian politics. That is, we want to show how prices communicate information and coordinate action while still recognizing that markets do not always communicate the right information. Thus, our chapters on the price system are rounded out with what we think is an equally interesting and compelling chapter on externalities. The subtitle of Chapter 10, “When the Price Is Not Right,” harkens directly back to Chapter 7. By giving examples where the price signal is right and examples where the price signal is wrong, we convey a sophisticated understanding of the role of prices.