Chapter 2
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Economic System
◦ A particular set of institutional arrangements and a
coordinating mechanism to respond to the
economizing problem
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Differ in 2 Ways
1. Who owns the Factors of Production
2. The method used to Motivate, coordinate, and
direct economic activity
Types of Systems
1. Market System

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Otherwise known as Capitalism
Command System
2.
◦
Otherwise known as socialism or communism

Command system
◦ Government owns most of the property resources
◦ Decision-making occurs through a Central
Economic Plan
◦ A Central Committee specifies allocation of
resources and production goals
◦ http://youtu.be/J02RdkvI6zo
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Market System
◦ Private Ownership of most of the property
resources
◦ Decision-making occurs through markets and
prices
◦ Participants act in their own self-interest
◦ Competition between buyers and sellers
◦ Increased monetary awards (Motivation)

Market Systems
◦ Laissez-faire
 Hand off or Let it Be
 Government stays out of the decision making process
completely
 http://youtu.be/8fmEJ7yrnlA

Market Systems –United States
◦ Government does play a role
 Promotes economic stability
 Provides rules for economic activity
 Provides certain goods and services that would
otherwise be under produced or not produced at all

Market Systems
◦ Characteristics
 Private Property
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Individuals and firms own land and capital
Freedom to negotiate contracts, use, and sell property
Right to inherit property
Encourage investment and innovation (incentives)
Legitimizes ownership and facilitates exchange
Extends to intellectual property

Market Systems
◦ THINK About it this way:
 Would you go out of your way do something that you
were not guaranteed credit for in some way?

Freedom of Enterprise
◦ Entrepreneurs and private businesses are free to
obtain and use economic resources to produce
what they want and sell them when they want

Freedom of Choice
◦ Owners are able to employ and dispose of their
property and their money any way they would like
◦ Workers can enter any profession
◦ Consumers can buy whatever they want

Self Interest
◦ Motivating force of the various economic units as
they express their free choice
◦ Get what you want

Competition
◦ Two or more buyers or sellers acting independently
in a particular resource market
◦ Freedom of sellers or buyers to leave a market
based on their own self-interest

Market
◦ Brings buyers and sellers into contact
◦ Those who listen to what the market wants and
needs are rewarded
◦ Those who don’t fail
◦ Example AOL

Advanced Technology
◦ The Market System encourages the develop and
advancement of technology
◦ More efficient production means much more
abundant output

Specialization
◦ The use of resources of an individual of firm to
produce one or a few goods or services rather than
an entire range
◦ Producers usually do not consume what they
produce
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Division of Labor (human
specialization)Contributes by:
◦ Making use of different talents and abilities
◦ Fosters learning by doing
 Develop improved techniques
◦ Saves time
 No back and forth
 Focus and move to the next one
 Less down time

Geographic Specialization
◦ Some items are better suited to be produced in a
certain area (oranges =Florida)
◦ Surpluses are sold for other items

Both Human & Geographic Specialization
◦ Are needed to achieve efficiency in the use of
limited resources

Characteristics of Money
◦ Medium of Exchange
 Makes trade easier
 It must be generally acceptable to sellers in exchange
for their goods and services
 Money is socially defined as:
 Whatever society accepts as a medium of exchange
 i.e. Flintstones use clam shells

Barter
◦ Swapping Goods for other goods
 Main Problem you have to have a coincidence of wants
 i.e. You have to want what the other person wants and
vice versa

Active, but limited Government is needed
◦ Due to market failures
 Shortcomings in the market

THINK ABOUT IT:
◦ Why does government help the market system?
What goods and services will be produced?
1.
Those that make Profit
Profits or Losses = TR-TC (Total Revenue – Total
Cost)
Economic Costs include:
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Wages for labor
Interest and Rental payments for land and capital
Payments to the entrepreneur for organizing and
combining the resources to produce a good

TR>TC
◦ Industry Expands
◦ Resources are put into
the industry
◦ Existing firms grow
◦ New firms enter
Expansion & Growth

TC>TR
◦ Reduced production
◦ Exit of resources from
industry
◦ Firms contract
◦ Firms go out of business
◦ Industry contracts
Contraction & Death
What goods and services will be produced?
1.
Consumer Sovereignty
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Consumers are in control
Dollar Votes
Crucial in determining the types and quantities to
produce
Customers spend their money on what they want to
buy
If people want it, it will be made
Influences producers and resource suppliers
2. How will goods and services be produced?
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In combinations and ways that minimize the cost
per unit of output
Competition will eliminate high-cost producers
Profitability will require that firms produce output
at a minimum cost per unit
2. What goods and services will be produced?
Least-cost production
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Firms must employ the most economically efficient
technique of production in producing their output
Depends on the available technology (combination of
resources needed)
Depends on prices of the needed resources
(See page 36 and worked problem 2.1)
3. Who will get the goods and services?
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Distributed based on the willingness and ability to
pay (if you can buy it at the price offered you get
it!!)
And your preference (if you want it)
4. How will the system accommodate change?
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Market systems are dynamic and change
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Consumer preferences
Technology
Allocation of resources
Directed and guided by consumer
preferences
5. How will the system promote progress?

Technological Advance
Create technologies that will reduce cost and
therefore increase market share and profit
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Competitors will have to keep up or fail
Creative Destruction
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New technology that totally makes other technology
or processes obsolete (Cell Phones pay phones)
5. How will the system promote progress?

Capital Accumulation
◦
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Entrepreneur and business owners uses dollar
votes for capital goods
Will result in greater future profit
Can get money for these investments from selling
shares

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Individuals will promote the public good of
society by doing what is best for them as an
individual
This invisible hand will guide resources to
areas where they are needed
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Efficiency
◦ Encourages and guides resources to the most
efficient way of production
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Incentives
◦ Risk can equal great reward
◦ Working harder and acquiring more skills will result
in higher individual gains

Freedom
◦ Personal freedom to make choices that benefit the
individual
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Coordination Problem
◦ Central Planning committee had to coordinate the
decisions of numerous people and industries
◦ Failure of one decision would set off a domino
effect
◦ Managers would get bonuses based on qty not
quality so they would sacrifice quality
◦ Also many things were not spelled out
◦ i.e. needed 1 lb of nails, company made 1, 1 lb nail
◦ i.e. needed 1,000 nails, company made 1,000 tiny
nails
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Incentive Problem
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No profit incentive
No one then cared
Could not gain unless you were political
Got paid no matter what

Resource Market
◦ The place where resources or the services of
resource suppliers are sold

Product Market
◦ The place where goods and services are bought and
sold

Now create your own Circular Flow Model
using the desks in the room