This chapter closes our discussion of the simple framework and how prices direct resources to their highest valued use. No doubt at some point, probably at many points, you've asked, "Can it really be this simple?" After all, if it really were like we said it was, why do economists disagree on so many issues? Surely, there must be a catch somewhere. And there is. But before we get to it, let's review the assumptions we've made so far in our analysis.

First, we've assumed that there are a large number of consumers in the market for any particular good. And second, we've assumed that the prices that buyers and sellers transact at are "market prices." By this we mean that sellers are free to increase or decrease their prices in accordance with supply and demand; and that there are plenty of goods and services available to buyers at the prices sellers set. We haven't required that consumers have perfect information. We haven't required that there be an infinite number of sellers in the market. We haven't required that all firms sell identical (homogeneous) products. In short, we haven't required a lot of things that economics textbooks associate with "perfect competition," that ethereal world that exists in the minds of economists but nowhere else. As generations of economics students have no doubt wondered, if the advantages of a free-market/capitalistic economy require the conditions of perfect competition, and if perfect competition doesn't exist, then what's so great about free-market/capitalism?

Now comes the catch. The last assumption we need for our conclusions to hold is that there are no "market imperfections" (usually called "market failures"). What's a "market imperfection?" The cute answer is that it is anything that invalidates our previous analysis. Economists usually attempt to define market imperfections by example. In particular, there are three types of market imperfections which have dominated the debate about the proper role of government. These three are (i) monopoly, (ii) externalities, and (iii) public goods.

When one finds two economists who disagree about a particular public policy, the great majority of the time their disagreement can be traced to how significant each one thinks these market imperfections are. If one believes that neither monopoly, externalities, or public goods are significantly present in a particular instance, then one is led to the conclusions of our previous analysis. Namely, government interventions will distort the allocation of resources and lower society's happiness. On the other hand, if one believes that one or more of these imperfections exists in a significant way, and if one believes that government intervention is likely to successfully address the market imperfection, then government intervention can serve to increase society's happiness.

As we discussed above, most government interventions can be grouped into one of five categories: (i) price controls, (ii) subsidies, (iii) taxes, (iv) quotas, and (v) mandates. The art of government intervention consists of applying the right "dose" of the right intervention. Just because government intervention can improve society's happiness, doesn't mean that it will. Indeed, as we shall show, public sector allocation decisions are also plagued by "imperfections." So there is no guarantee that a particular intervention will ever improve the imperfect allocation of resources made by the private sector. Government intervention always carries with it the risk of making things worse. Once we leave the world of no market imperfections, we return to the world of the economic planner--a world of darkness and uncertainty--where we are never quite sure of what we can do to improve society's happiness. These are the issues of our next, and final, section.