The fundamental task of every economic system is to determine which goods are produced, how they are produced, and who gets them. Economists believe that a system of competitive markets tends to perform this task both cheaply and reasonably well. They recognize, however, that there are some situations in which competition generates unsatisfactory outcomes. In these situations (collectively known as market failures), government intervention can lead to better outcomes. The greater portion of this book is devoted to describing the various kinds of market failure and, where possible, the government policies that correct them.

This part of the book, however, deals with a more basic issue. What are the grounds for the economist's belief that competitive markets perform a vital function in our economy? Why are economists unwilling to accept government intervention in the market system unless some cogent justification can be given?

The next three chapters answer these questions through the study of two simple economies. The first economy is the exchange economy, in which existing goods are exchanged but no goods are produced. The second is the production economy, in which goods are both produced and exchanged. In each of these economies, two issues are examined:

• Which ways of allocating goods to people and (in the production economy) factors of production to firms are desirable?

• Which allocations occur when people and (in the production economy) firms trade in competitive markets?