PILLARS OF A FREE MARKET
SYSTEM
CHAPTER 3 SECTION 1
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 guide
Basic 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
Franz Guest/Jim Belushi/Martha’s Vineyard
PUBLIC PROPERTY IS ANY GOOD
THAT IS OWNED BY THE GOVERNMENT
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
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