PART 1: AN INTRODUCTION TO
ECONOMICS AND THE
ECONOMY
CHAPTER 2
The Market System
and the Circular
Flow
Slides prepared by Bruno Fullone,
George Brown College
© 2010 McGraw-Hill Ryerson Limited
1
In This Chapter You Will Learn:
•
•
•
•
•
Learning objective 2.1: The difference
between a command system and a market
system
Learning objective 2.2: The main
characteristics of the market system
Learning objective 2.3: The five fundamental
questions any economy faces
Learning objective 2.4: About the demise of
the command economy
Learning objective 2.5: The mechanics of the
circular flow model
2
2.1 Economic Systems
Economic Systems
A particular set of institutional arrangements and a
coordinating mechanism
- The command system
- The market system
LO2.1
3
2.2 Characteristics of the Market
System
• Private property
• Freedom of enterprise & choice
– freedom of enterprise: businesses can buy & sell as
they choose
– freedom of choice:
• owners can use or sell property as they choose
• workers can work where they like
• consumers can buy what they want
LO2.2
4
2.2 Characteristics of the Market
System
• Private property
• Freedom of enterprise & choice
• Self-interest
– businesses seek profits
– consumers seek value
LO2.2
5
2.2 Characteristics of the Market
System
•
•
•
•
Private property
Freedom of enterprise & choice
Self-interest
Competition
– independently acting sellers & buyers
– easy entry & exit
• Markets and Prices
– prices signal scarcity & guide resource allocation
LO2.2
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2.2 Characteristics of the Market
System
Other Characteristics
• Technology & Capital Goods
• Specialization
– division of labour
– ability differences
– learning by doing
– saving time switching tasks
– geographic specialization
LO2.2
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2.2 Characteristics of the Market
System
Other Characteristics
• Technology & capital goods
• Specialization
• Use of money
– Medium of exchange
• Active, but limited government
LO2.2
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2.3 Five Fundamental Questions
1. What will be produced?
-those goods & services that can be produced at a profit
-what consumers vote for with their dollars
-market restraints on freedom
Consumer Sovereignty
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
-with the most efficient, least-costly methods
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
3. Who will get the goods & services?
-those with the greatest willingness & ability to pay
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
3. Who will get the goods & services?
4. How will the system accommodate change?
-by responding to price & profit signals
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
3. Who will get the goods & services?
4. How will the system accommodate change?
5. How will the system promote progress?
-Technological advance
-Capital accumulation
LO2.3
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The “Invisible” Hand
• Prices communicate information about scarcity
& value
• Competition forces producers & resource
suppliers to respond
• Firms, acting in their own best interest, also
promote society’s interests in terms of efficiency
LO2.3
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The “Invisible” Hand
Three special merits of the market system:
• Efficiency
• Incentives
• Freedom
LO2.3
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2.4 The Demise of the
Command System
• The Coordination Problem
• The Incentive Problem
LO2.4
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The Circular Flow Diagram
Figure 2-2
Factor
MARKET
FACTORS
OF PRODUCTION
INPUTS
BUSINESSES
HOUSEHOLDS
LO2.5
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The Circular Flow Diagram
Figure 2-2
FACTOR
MARKET
FACTORS
OF PRODUCTION
BUSINESSES
INPUTS
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
LO 2.5
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The Last Word: Shuffling the Deck
• If one thoroughly shuffles a deck of cards, there
is a virtual 100% chance that the resulting
arrangement of cards will be unlike any previous
arrangement.
• Yet, even though there are tens of billions of
resources in the world, these resources are
arranged in such a way as to produce the
products and services that serve human needs.
LO2.3
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The Last Word: Shuffling the Deck
• Private property eliminates the possibility that
resource arrangements will be random because
each resource owner will choose a particular
course of action if it promises rewards to the
owner that exceed the rewards promised by all
other available actions.
• The result is a complex and productive
arrangement of countless resources.
LO2.3
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Chapter 2 Summary
2.1
2.2
2.3
2.4
2.5
The difference between a command system
and a market system
The main characteristics of the market
system
The five fundamental questions any
economy faces
The demise of the command system
The mechanism of the Circular Flow model
Chapter 2
21