Microeconomics

MICROECONOMICS CHAPTER 1 The Market Economy What is to be done? —Lenin When future historians look back on the close of the 20th century, one of the most sweeping changes they will note is the collapse of centrally planned economies in Eastern Europe. It is not far off to say that the Cold War between the United States and the Soviet Union was won not by the armies of the United States and its allies, but by the productive power of Western market economies. Mikhail Gorbachev, then leader of the Soviet Union, concluded that his country’s economy could not afford to continue its global military competition with the United States. The Soviet economy was simply too inefficient. He set his country on a new, more market-oriented course, in the process touching off political and economic upheavals. Why did centrally planned economies fail while market systems survived? Gorbachev’s own words provide some insight. In a 1987 speech, four years before the Soviet Union’s abandonment of communism, he noted that “One can see children using a loaf of bread as a ball in football.” Presumably, Gorbachev was irked by the wastefulness of using bread for child’s play. But even if Gorbachev was irritated by seeing the bread squandered, one still wonders why he bothered to bring it up in a major speech. To think about this issue, one must ask why the Soviet youngsters were playing with the bread in the first place. The answer is that Soviet consumers did not put much value on bread because the price they paid for it was very low. Provided that they could buy all the bread they wanted at this low price, why would consumers bother to economise on its use? If a 1.1

loaf of bread cost only the equivalent of a few pennies, why not let the children have a little fun by playing football with it! We think that Gorbachev may have related this anecdote because he viewed it as symptomatic of the problems facing the Soviet economy. In 1987, the prices of all goods were set by central planners