The Market System

The Market System
1. Private individuals and organizations
own and control their property resources
by means of private property.
PP, coupled with the freedom to negotiate
contracts, enables individuals/firms to obtain,
control, use and dispose of property
PP rights encourage investment, innovation,
exchange of assets, maintenance of property and
economic growth
PR extend to intellectual property through patents,
copyrights, and trademarks.
2. Freedom of Enterprise and
choice exists.
Freedom of enterprise
• Entrepreneurs and
businesses have the
freedom to obtain and
use resources, to
produce products of their
choice, and to sell these
products in the markets of
their choice
Freedom of choice
• Owners of property and money
resources can use resources
as they choose.
• Workers (labor), can choose
the training, occupations, and
job of their choice.
• Consumers free to spend their
income in such a way as to
best satisfy their wants
(consumer sovereignty)
3. Self-Interest
• One of the driving
forces in a market
Entrepreneurs try to
losses; resource
suppliers try to
maximize income;
consumers maximize
• As each tries to
maximize profits,
income, satisfaction
the economy will
benefit if competition
is present.
4. Competition among buyers/sellers is
a controlling mechanism
• Large #s of sellers
mean that no single
producer/seller can
control the price or
market supply
• Same for buyers
• Ease of entry/exit for
5. Markets and Prices
A market system conveys the decisions
of the many buyers and sellers of the
product and resource market.
A change in the market price signals
that a change in the market has
Those who respond to the market signals
will be rewarded with profits and income.
6. Active but limited
• Although the market
system promotes
efficiency, it has
certain shortcomings.
• Later referred to as
market failures.
• Looked at closer in
chp 5
In common with the other
advanced economies of the
world, the U.S. has three major
7. Reliance on technology and
capital goods
• Competition, freedom of choice, selfinterest, and the potential of profits provide
the incentive for capital accumulation
• Advanced technology and capital goods
uses the more efficient roundabout
method of technology.
8. Specialization
• Division of labor allows workers to
– Makes use of differences in abilities and skills
– identical skill sets can still benefit from
– saves time (set up costs)
• Geographic specialization
• regional/international specialization take
advantage of localized resources
9. Use of money as a medium
of exchange.
• Money substitutes for barter
– coincidence of wants
Market System at Work
• Self-Interest
• Brings consumers and producers together
in an efficient manner
• 4 questions that must be addressed by
every economic system (Key)
1. What goods and services to be
2. How will these goods and services be
3. Who will get these goods and services?
4. How will the system accommodate
The price system, including markets and
households’ and business firms
choices furnish the economy with answers
to theses questions.
1. In order to be profitable, businesses must
respond to consumers’ wants/desires.
2. When businesses allocate resources in a
way that is responsive, they will be
profitable leading to allocative efficiency.
Must know!
• Economic Profit = total revenue (TR) –
total cost (TC)
• TR = Product price x quantity of product
• TC = The sum of the (price of each
resource used by the amount employed)
• Economic costs include the return to the
entrepreneur. This return must be received
if the entrepreneur is to continue.
The payment for the entrepreneur’s
contribution is called normal profit.
If the TR exceeds of these economic costs
the gravy goes to the entrepreneur and is
called economic profit.
2. Self-regulating nature of the market place
Expanding industries
Declining industries
• Remind me to diagram
• Least cost method
• Lc production techniques include: locating
firms in the optimum location considering
resource prices, resource productivity, and
transportation costs, available technology
and resource prices in general
• production of a given amount of output
with the smallest input of scarce
resources, measured in $s and ¢s.
• Directly related to distribution of income of
households and individuals,
• products go to those who are willing and
able to pay for them
• productivity of the resources,, relative
supply of and ownership of will determine
the income of individuals and households
• The resource (factor) markets, which
determine income, are closely linked to
this decision
• An ↑ in D for some products will lead to
higher prices in those markets
• A↓ in D for other products will lead to lower
prices in those markets
• ↑ D leads to higher prices that induce > Qs
of output. The opposite is true for a ↓ in D.
• Higher prices lead to more profits & new
firms entering the market
• Lower prices lead to losses & firms leaving
the industry
The market system promotes technological
improvements & capital accumulation
• An entrepreneur/firm that introduces a
popular new product will be rewarded with
↑ revenue and profits. (Topline.bottomline)
• New technologies that reduce production
costs and thus price will spread throughout
the industry as a result of competition
• Creative destruction occurs when new
products/production methods destroy the
market positions of firms that can’t or won’t
Competition & the “Invisible
• Competition is the mechanism of control
for the market system. Consumer gets
what they want, firms must adopt the most
efficient production techniques.
• “Invisible Hand” promotes public interest
through a market system where the
primary motivation is self-interest. by
attempting to maximize profits, firms will
also be producing the g/s most wanted by