Transcript Part and/or Chapter Number and Title

Chapter 2:
The Market System and
the Circular Flow
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved
Economic System
 Societies develop economic systems to
solve their economic problem.
 There are two general types of economic
systems
 Command system
 Market system
Economic system is a particular set of
institutional arrangements and a coordinating
mechanism for producing goods and services.
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The Command System
 Economic systems differ in two main aspects:
 Who owns the factors of production
 The method used to motivate, direct, coordinate
economic activity
 In a command system (a.k.a. socialism or
communism):
 Government owns most factors of production
 Economic decisions are made by a central governing
body
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The Market System
 In a market system (a.k.a. capitalism):
 Factors of production are privately owned;
 Markets and prices are used to direct and coordinate
economic activities.
 Participants act in their own self-interest, resulting
in competition among independent buyers and
sellers of each product and resource.
In the capitalism practiced in the United States and most
other countries, government plays a substantial role in the
economy, but it is not the dominant economic force.
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Key Features of the
Market System
Private property
Freedom of enterprise and choice
Self-interest
Competition
Markets and prices
Technology and capital goods
Specialization
Use of money
Active but limited government
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Key Features of the
Market System
 Private Property is the right of persons and firms to
obtain, own, control, employ, dispose of, and
bequeath land, capital, and other property.
 Freedom of enterprise is the freedom of firms to
obtain economic resources, to use those resources
to produce products of the firms’ own choosing, and
to sell their products in markets of their choice.
 Freedom of choice is the freedom of owners of
resources to employ or dispose of them as they see
fit, and the freedom of consumers to spend their
incomes in a manner they think is appropriate.
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Key Features of the
Market System
 Self-interest is the most advantageous outcome as
viewed by each firm, property owner, worker, or
consumer.
 Competition is the presence in a market or
independent buyers and sellers vying with one
another, and the freedom of buyers and sellers to
have a market.
 A market is an institution or mechanism that brings
buyers and sellers together.
 Technology and capital goods promote efficiency
and the ability to produce more goods and services.
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Key Features of the
Market System
 Specialization is the use of resources of an
individual, region, or nation to produce one or a few
goods and services rather than the entire range of
products.
 The use of money where money is any item that is
generally acceptable to sellers in exchange for
goods and services.
 Active, but Limited, Government where
government can sometimes increase the overall
effectiveness of the economic system.
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Four Fundamental Questions
 The key features of the market system
allow market economies to answer four
fundamental questions:
 What goods and services will be produced?
 How will the goods and services be
produced?
 Who will get the goods and services?
 How will the system promote progress?
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What Will be Produced?
 The goods and services produced at a continuing
profit will be produced. Those producing at a
continuing loss will not.
 In a market system, consumers are sovereign (in
command) – they “vote” with their dollars.
Consumer sovereignty is the determination by
consumers of the types and quantities of goods
and services that will be produced with the
economy’s scarce resources.
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How Will Goods and
Services Be Produced?
 The combination of resources and
technologies that minimizes the cost per unit
of output will be used to produce goods and
services.
 In a competitive market economy, high-cost
producers lose business to low-cost producers
of equal-quality products.
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Who Will Get the Output?
 Distribution of goods and services is determined by:
 Prices of these goods and services
 Consumers’ preferences for these goods and
services
 Consumers’ ability and willingness to pay for these
good and services. This in turn depends on
income which is determined by:
 Quantity of property and human resources that they
supply
 Prices that those resources command on the resource
market
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How Will the System
Promote Progress?
 Technological advance is encouraged by the market
system
 Market rewards invention of new products
 New production technologies may help lower cost of
production
 Capital accumulation
 Entrepreneurs and business owners “vote” with their
dollars for capital goods.
 By paying interest or selling shares firms attract
households’ income to pay for capital goods.
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The Circular Flow Model
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The Circular Flow Model
 Resource Market
 Households sell resources
 Firms buy resources
 Product Market
 Households buy products
 Firms sell products
 Real flow of resources and products
corresponds to the money flow in the opposite
direction.
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