The Market System In Chapter 2 After reading this chapter, you should be able to: Differentiate between a command system and a market system. List the main characteristics of the market system. Explain how the market system decides what to produce, how to produce it, and who obtains it. Discuss how the market system adjusts to change and promotes progress. Describe the mechanics of the circular flow model (this is more a macro topic). The economic problem is scarcity! Remember this means wants are larger than can be produced with the resources we have available. An economic system is way society goes about dealing with the economic problem. There are “institutional arrangements” in an economic system. These arrangements consider 1) Who owns the factors of production (resources land, labor, capital and entrepreneurial ability), and 2) The methods used to motivate, coordinate and direct economic activity. On the next slide I have a table with two economic systems and how the arrangements are dealt with. Command system (socialism, communism) Market system (capitalism) Owner of Resources State, or government The people, or private ownership Director Of activity Central Planning board Markets and Prices What is a market? A market is a meeting of buyers and sellers! Characteristics of a market system (a compilation of markets) include: Private property freedom of enterprise and choice Self interest competition specialization technology and capital goods use of money Active, but limited, government Let’s look at self interest. This is the idea that each economic entity tries to achieve its own particular goals. People have many facets. As entrepreneur the goal is to maximize profit. As landowner the goal is to get the highest price for sale or rent of land. As labor the goal is to maximize utility by getting the best combination of wages, hours, fringe benefits, and working conditions. As consumer the goal is to maximize utility by allocating their income to the best combination of goods and services. Competition requires 1) 2 or more buyers and 2 or more sellers acting independently in a market, and 2) Freedom to enter or leave a market. THE INVISIBLE HAND Some dude (Adam Smith) a long time ago said something about an invisible hand. Not too long ago my dad said something about a visible foot hitting me from the back side. The invisible hand considers the relationship between private interest and social interest. The private interest idea was mentioned before – self interest. Self interest is the idea people have goals to achieve. What is the social interest? Remember we have an economic problem. Note that much of your general education will deal with the social interest. I am going to say the social interest includes 1) Having the goods and services you and I value made (what you might call contributing to our “well-being” or “standard of living”), 2) Making the goods and services you and I value the most (or let’s have the highest standard of living we can), 3) Making the goods and services in the most efficient manner (or let’s not “waste” resources), and 4) Allowing the free, unforced expression of personal development in these endeavors. The invisible hand idea suggests that individuals acting in their own self-interest within in free market system will automatically, or simultaneously, as if guided by an invisible hand, achieve the social interest. Why do command systems fail? The coordination and incentive problems are ideas that the central planning group can not gather the information needed nor has the incentive to see how all the resources available can be brought together to make what people want in the desired fashion.