“Yes, we believe in democracy, with elections that are free and
fair, and independent judiciaries and opposition parties, civil
society and uncensored information so that individuals can
make their own choices. Yes, we believe in open economies
based on free markets and innovation and individual initiative
and entrepreneurship and trade and investment that creates a
broader prosperity.” – President Obama
THE FREE MARKET SYSTEM
An overall view of Capitalism
Why Markets Exist:



We are not self-sufficient.
You did not grow the fibers to
weave the cloth to make the shirt
you're wearing.
Markets allow us to exchange the
things we have for the things we
want
Specialization:



Instead of being selfsufficient, we specialize!
We (individuals and firms)
concentrate our efforts on a
limited # of activities.
Specialization leads to
efficient use of resources:
capital, land, and labor.
Private Property:
* Is the base/foundation for a The Free Market System
Individuals have the right to Land, Resources, and even Ideas.
•Examples:
•1.) Titles & Deeds – proof of ownership
•2.) Contracts – important protection for owners
•3.) Right to bequeath – can pass on property at death
•4.) Includes “intellectual property”
•All the above are important traits to encourages investment, innovation, exchanges &
economic growth
•Individuals can feel secure in their ownership because the government is
not allowed to take whatever they want.
Private Property
Positives to ownership
• Encourages investment
• Innovation
• exchange
• maintenance of property
• Economic growth
Example:
Do you own a house?
Do you care about that house?
Freedom of Enterprise & Choice








Freedom of Enterprise:
can choose to own a business
how to run it, where to work
how to spend income
Profit Motive – producers choose to produce what
makes them a profit (money)
Freedom of Choice:
Consumer have freedom to buy what they want
To use or not use resources as they wish
MARKET SYSTEM CHARACTERISTICS:


PRIVATE SECTOR – INCLUDES
HOUSEHOLDS & BUSINESSES
HOUSEHOLDS own all resources &
receive INCOME for them (Wages,
Rent, Interest & Profits = WRIP)
 Wages
= largest % of income (70%)
 Capital = rent interest & profits income
(30%)
CONSUMER SPENDING = 84% of income;
TAXES = 16%, SAVINGS = less than 1%
MARKET SYSTEM CHARACTERISTICS


BUSINESSES (Firms) receive
REVENUE for goods and services
in Product Market & buy resources
in Factor (or Resource) Market
3 Types of business =
 Sole
proprietorship – one owner
 Partnership – two or more owners
 Corporations – many owners
(stockholders)
(73% of all businesses are Sole
Proprietorships; 20% are
Corporations – BUT make 90% of
all sales!)
Circular Households pay
firms for goods
Flow
and services
Model of
a Market
Economy:
The Product Market
Firms supply
households
with goods
and services
$
Households supply firms
with land, labor, and
capital
The Factor
Market
Firms pay household
for land, labor, and
capital
Money
$
Government’s Role in a Mixed Economy
PUBLIC
SECTOR –
includes all
levels of
government:
• national
• state
• local
The Government:
Performs functions not possible by private sector:


Provides
public
goods and
services
Receives tax
revenue to
pay for
government
spending (or
borrow!)
In a Mixed Economy:
Circular Flow Diagram of a Mixed Economy
Product market
In a mixed economy,
 Purchases goods
and services in the
product market.
monetary flow
physical flow
Households

The government
purchases land,
labor, and capital
from households in
the factor market
expenditures
Government
physical flow
monetary flow
Factor market
expenditures
Firms
Comparing Mixed Economies
An economic system that permits the conduct of business with minimal
government intervention is called Free Enterprise. The degree of
government involvement in the economy varies among nations.
Continuum of Mixed Economies

Centrally planned
Free market
Iran
North Korea
Cuba
South Africa
China
Russia
France
Botswana
Greece
United Kingdom
Canada
Peru
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
Hong Kong
Singapore
United States
The Market’s Self-Regulating Nature




The interaction of buyers and sellers, motivated by
self-interest and regulated by competition, all
happens without a central plan = Free Market Forces
This phenomenon is called “the invisible hand of the
marketplace.”
In every transaction, the buyer and seller consider only
their self-interest, or their own personal gain. Selfinterest is the motivating force in the free market.
Producers in a free market struggle for the dollars of
consumers. This is known as competition, and is the
regulating force of the free market.
Self Interest:
The motivating force in the free market

"It is not from the benevolence of the butcher, the brewer, or the baker, that
we expect our dinner, but from their regard to their own self-interest. We
address ourselves, not to their humanity but to their self-love, and never talk
to them of our own necessities but of their advantages."
-- Adam Smith
• IN an Economy
(market):
• The Buyer and Seller
consider only their selfinterest (personal gain)
Competition:
The regulating force of the Free Market


Producers in a free market struggle for the dollars of consumers =
competition
One person can’t dominate…


How does this help the consumer? (Prices?)
The rivalry of businesses to gain customers = “the best product at the best price”
Incentives: Profit is
1.) a monetary incentive ($)
2.) or, nonmonetary incentive (gifts, service, and other goods)
 It allows for businesses to enter or leave a market - leads to

efficiency & adjusts for changes of tastes, technology & resources


Ex. Apple vs. Microsoft
Competition stimulates growth and innovation... “everyone wants the
competitive edge”
Invisible Hand:











Self-Interest motivates consumers to buy certain goods and service and firms
to produce them.
Competition causes more production and moderates firms’ quest for higher
prices
In a Nutshell:
The interaction of buyers and sellers is motivated by self-interest
and regulated by competition
Consumers get the products they want
At prices $ that closely reflect the cost of producing them.
All of this happens by market forces!
No central plan
No command direction
This is phenomenon “the invisible hand of the marketplace” – Adam
Smith
Advantages of a Free Market:



1.) Economic Efficiency:
Responds efficiently to
rapidly changing conditions
Producers make only what
consumers want, when they
want it, and generally at
prices they are willing to
pay
2.) Economic freedom:




Workers get to work where they want
Firms produce what they want
Individuals consume what they want
Even Mike Tyson can get what he
wants….
3.) Economic growth:



Because competition encourages innovation, free
markets encourage growth.
Entrepreneurs are always seeking profitable
opportunities
“Yes, we believe in democracy, with
elections that are free and fair, and
independent judiciaries and opposition
parties, civil society and uncensored
information so that individuals can make
their own choices. Yes, we believe in open
economies based on free markets and
innovation and individual initiative and
entrepreneurship and trade and investment
that creates a broader prosperity.” –
President Obama
4.) Additional Goals:



Free markets offer a wider variety
of goods and services than any other
economic system.
Producers have incentives to meet
consumers desires
Consumers, in essence, decide what
gets produced = Consumer
sovereignty