Overview: The World of Perfect Competition

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Economics divides its study of exchange into two parts, each concerned with a different set of questions. Macroeconomics is concerned with questions of inflation and recession. Microeconomics is concerned with questions of allocation and rationing.

Allocation involves questions about ways a society can decide what goods to produce and how to produce them. Should it produce a lot of bread or a lot of clothes? Should it produce more for use now and ignore the future, or should it sacrifice consumption now and invest so that more will be available in the future? Where should it use its workers and where should it use its machinery? Rationing is concerned with the for-whom question: for whom are the goods and services produced? Notice that these questions of allocation and rationing assume that scarcity exists--that the society cannot do everything it would like to do, but must choose some options at the expense of others.

This section of readings begins with an overview of how societies can ration and allocate. Relying heavily on the model of supply and demand, it shows that rationing can be done with prices, but that there are also other ways to ration, including those of queuing and coupon rationing. It also shows that prices can perform as an allocation system, transmitting both the information and incentives needed to make decisions about what to produce and how to produce it. This system is sometimes called a system of "dollar voting." The readings also describe an alternative way to make allocation decisions--the way of central planning.

After you complete this unit, you should be able to:

  • Explain why prices can be a way of rationing.
  • Explain the effects of price ceilings and price floors.
  • Distinguish between scarcity and a shortage.
  • Give examples of queuing by line and list, and coupon rationing.
  • Interpret a Lorenz curve.
  • Explain what the term "dollar voting" means.
  • Distinguish between positive and negative feedback.
Copyright Robert Schenk