The Market System and the Circular Flow

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The Market System and the Circular Flow
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
The Market System
• Known as capitalism
• Characteristics of market systems:
Private property
Freedom of enterprise and choice
Self-Interest
Competition
Markets and prices
• Australia, Switzerland, and the U.K.
LO1
2-2
Global Perspective
Index of Economic
Freedom,
Selected Nations
LO2
2-3
Technology and Capital Goods
• Advanced technology and capital
•
LO2
goods are encouraged
Specialization
• Division of labor
• Geographic specialization
2-4
Active, but Limited Government
• Government may be needed to
•
LO2
alleviate market failures
Government can increase
effectiveness of a market system
2-5
The Five Fundamental Questions
• What goods and services will be
•
•
•
•
LO3
produced?
How will the goods and services be
produced?
Who will get the goods and services?
How will the system accommodate
change?
How will the system promote
progress?
2-6
What Will Be Produced?
• Goods and services that create a
•
LO3
profit
“Dollar Votes”
• Method for consumers to determine
which goods will be produced
• Determines which products and
industries survive or fail
2-7
How Will the Goods Be Produced?
• Minimize the cost per unit by using
the most efficient techniques
• Technology
• Prices of the necessary resources
LO3
2-8
Who Will Get the Output?
• Consumers with the ability and
•
LO3
willingness to pay will get the product
Ability to pay depends on income
2-9
How Will the System Change?
• Changes in consumer tastes
• Changes in technology
• Changes in resource prices
LO4
2-10
How Will the System Promote Progress?
• Technological advance
• Creative destruction
• Capital accumulation
LO4
2-11
The “Invisible Hand”
• 1776 Wealth of Nations by Adam
•
LO4
Smith
• Unity of private and social interest
Virtues of the market system
• Efficiency
• Incentives
• Freedom
2-12
Demise of Command Systems
• Soviet Union, Eastern Europe, and
•
•
•
LO4
China
System was a failure
The coordination problem
• Set output targets for all goods
The incentive problem
• No adjustments for surplus or
shortage
2-13
The Circular Flow System
RESOURCE
MARKET
•Households sell
•Businesses buy
BUSINESSES
• buy resources
• sell products
HOUSEHOLDS
• sell resources
• buy products
PRODUCT
MARKET
•Businesses sell
•Households buy
LO5
2-14
Businesses
• Three main categories of businesses
• Sole proprietorship
• Partnership
• Corporation
LO5
2-15
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