The Market System

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
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.
system (socialism,
Owner of
State, or
The people, or
private ownership
Of activity
Central Planning
Markets and
What is a market? A market is a meeting of buyers and
Characteristics of a market system (a compilation of markets)
Private property
freedom of enterprise and choice
Self interest
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
As entrepreneur the goal is to maximize profit.
As landowner the goal is to get the highest price for sale or rent of
As labor the goal is to maximize utility by getting the best
combination of wages, hours, fringe benefits, and working
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.
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
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

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