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CHAPTER 2 THE MARKET SYSTEM AND THE CIRCULAR FLOW

Part One: An Introduction to Economics and the Economy. CHAPTER 2 THE MARKET SYSTEM AND THE CIRCULAR FLOW. In this chapter you will learn:. 2.1 The difference between a command system and a market system 2.2 The main characteristics of the market system

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CHAPTER 2 THE MARKET SYSTEM AND THE CIRCULAR FLOW

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  1. Part One: An Introduction to Economics and the Economy CHAPTER 2THE MARKET SYSTEM AND THE CIRCULAR FLOW

  2. In this chapter you will learn: 2.1The difference between a command system and a market system 2.2The main characteristics of the market system 2.3The Five Fundamental Questions any economy faces 2.4About the demise of the command economy 2.5About market failure and how government can rectify it 2.6The mechanics of the circular flow model Chapter 2

  3. Economic Systems Economic System: A particular set of institutional arrangements and a coordinating mechanism • The command system • The market system Chapter 2.1

  4. Characteristics of the Market System • Private Property • Freedom of Enterprise and Choice • Freedom of enterprise: businesses can buy and 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 Chapter 2.2

  5. Characteristics of the Market System • Private Property • Freedom of Enterprise and Choice • Self-Interest • businesses seek profits • consumers seek value Chapter 2.2

  6. Characteristics of the Market System • Private Property • Freedom of Enterprise and Choice • Self-Interest • Competition • independently acting sellers and buyers • easy entry and exit of markets • Markets and Prices • prices signal scarcity and guide resource allocation Chapter 2.2

  7. Characteristics of the Market System Other Characteristics: • Technology and Capital Goods • Specialization • Division of Labour • ability differences • learning by doing • saving time switching tasks • Geographic Specialization Chapter 2.2

  8. Characteristics of the Market System Other Characteristics: • Technology and Capital Goods • Specialization • Use of money • Medium of exchange • Active, but Limited, Government Chapter 2.2

  9. Five Fundamental Questions • What will be produced? • those goods and services that can be produced at a profit • what consumers vote for with their dollars • market restraints on freedom Consumer Sovereignty Chapter 2.3

  10. Five Fundamental Questions • What will be produced? • How will the goods and services be produced? • with the most efficient, least-costly methods Chapter 2.3

  11. Five Fundamental Questions • What will be produced? • How will the goods and services be produced? • Who will get the goods and services? • those with the greatest willingness and ability to pay Chapter 2.3

  12. Five Fundamental Questions • What will be produced? • How will the goods and services be produced? • Who will get the goods and services? • How will the system accommodate change? • by responding to price and profit signals • guiding function of prices • role in promoting progress • technological advance • creative destruction • capital accumulation Chapter 2.3

  13. Five Fundamental Questions • What will be 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? • technological advance • capital accumulation Chapter 2.3

  14. The “Invisible Hand” • Prices communicate information about scarcity and value • Competition forces producers and resource suppliers to respond • Firms, acting in their own best interest, also promote society’s interests in terms of efficiency Chapter 2.3

  15. The “Invisible Hand” Three special merits of the market system: • Efficiency • Incentives • Freedom Chapter 2.3

  16. The Demise of the Command System • The Coordination Problem • The Incentive Problem Chapter 2.4

  17. Market Failure Spillovers or Externalities • spillover costs • correction through • Legislation • Specific Taxes Chapter 2.5

  18. Market Failure Spillovers or Externalities • spillover benefits • correction through • Subsidization of consumers/suppliers • Provision of goods via government Chapter 2.5

  19. Market Failure Public Goods and Services • non-rivalry • non-excludability • free-rider problem Examples • Airport security Chapter 2.5

  20. Market Failure Limitations of the Market System • market system has remarkable virtues • it also has well-known limitations Chapter 2.5

  21. Figure 2-2 The Circular Flow Diagram $ COSTS $ INCOMES FACTOR MARKET FACTORS OF PRODUCTION INPUTS BUSINESSES HOUSEHOLDS Chapter 2.5

  22. Figure 2-2 The Circular Flow Diagram $ COSTS $ INCOMES FACTOR MARKET FACTORS OF PRODUCTION INPUTS BUSINESSES HOUSEHOLDS GOODS & SERVICES GOODS & SERVICES PRODUCT MARKET $ CONSUMPTION $ REVENUE Chapter 2.5

  23. Chapter Summary • 2.1 The Difference Between a Command System and a Market System • 2.2 The Main Characteristics of the Market System • 2.3 The Five Fundamental Questions Any Economy Faces • 2.4 The Demise of the Command Economy • 2.5 Market Failure • 2.6 The Mechanism of the Circular Flow Model Chapter 2

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