Chapter 2: The Market System and the Circular Flow

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Chapter 2: The Market
System and the
Circular Flow
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
What, How, and Who?

In order to determine what goods are
produced, how they are produced and who
gets them, each society develops an
economic system to respond to the
economic problem.

An economic system is a particular set of
institutional arrangements and a coordinating
mechanism.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Economic Systems
There are two general types of economic
systems:


the command system
the market system
They differ in terms of (1) who owns the
factors of production and (2) the method
used to motivate, coordinate, and direct
economic activity.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
The Command System
The command system is also known as
socialism or communism.


Government owns most property resources
and economic decisions are made by a central
government body.
The government owns most of the business
firms and a central planning board determines
production goals and how resources will be
allocated.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
The Market System
The market system, or capitalism, is one in
which property resources are privately
owned and 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.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Characteristics of
the Market System
Some of the key
features of the
market system
include:

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
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Characteristics 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.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Characteristics of
the Market System
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.
Self-interest is the most advantageous
outcome as viewed by each firm,
property owner, worker, or consumer.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Characteristics of
the Market System
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.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Characteristics of
the Market System
Technology and capital goods promote
efficiency and the ability to produce more
goods and services.
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.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Characteristics of
the Market System
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.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Four Fundamental Questions
The key features of the market system
help explain how market economies
respond to four fundamental questions:
1)
2)
3)
4)
What products will be produced?
How will the products be produced?
Who will get the goods and services?
How will the system promote progress?
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
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.



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.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
How Will They Be Produced?
The combination of resources and
technologies that minimizes the cost per
unit of output will be used to produce
goods and services.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Who Will Get the Output?



The distribution of goods and services is
determined by:
Consumers’ ability and willingness to pay
its existing price
Amount of income that consumers have,
in addition to the prices, and preferences
for, various goods.
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.
How Will the System
Promote Progress?
To achieve a higher standard of living
and economic growth, or progress, the
market system must promote:



technological improvements
capital accumulation
Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

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