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The Market System and the Circular Flow

The Market System and the Circular Flow. 2. Economic Systems. Set of institutional arrangements Coordinating mechanism Differences in systems exist by: Who owns the factors of production What method is used to motivate, coordinate, and direct economic activity. LO1. The Command System.

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The Market System and the Circular Flow

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  1. The Market System and the Circular Flow 2

  2. Economic Systems Set of institutional arrangements Coordinating mechanism Differences in systems exist by: Who owns the factors of production What method is used to motivate, coordinate, and direct economic activity LO1

  3. The Command System Known as socialism or communism Government ownership Decisions made by a central planning board North Korea and Cuba are last remaining examples of largely centrally planned economies LO1

  4. Global Snapshot The Two Koreas LO1

  5. The Market System Known as capitalism Private ownership of resources Decisions based on markets LO1

  6. Characteristics of the Market System Private property Freedom of enterprise and choice Self-interest Competition Markets and prices LO2

  7. The Market System LO2

  8. Technology and Capital Goods Advanced technology and capital goods are encouraged Specialization Division of labor Geographic specialization LO2

  9. Use of Money Makes trade easier LO2

  10. Active, but Limited Government Government may be needed to alleviate market failures Government can increase effectiveness of a market system LO2

  11. The Four Fundamental Questions What goods and services will be produced? How will the goods and services be produced? Who will get the goods and services? How will the system promote progress? LO3

  12. What Will Be Produced? Goods and services that create a profit “Dollar votes” Method for consumers to determine which goods will be produced Determines which products and industries survive or fail LO3

  13. How Will the Goods Be Produced? Minimize the cost per unit by using the most efficient techniques Technology Prices of the necessary resources LO3

  14. Who Will Get the Output? Consumers with the ability and willingness to pay will get the product Ability to pay depends on income LO3

  15. How Will the System Promote Progress? Technological advance Creative destruction Capital accumulation LO4

  16. Invisible Hand 1776 Wealth of Nations by Adam Smith Unity of private and social interest Virtues of the market system Efficiency Incentives Freedom LO4

  17. Demise of Command Systems Soviet Union, Eastern Europe, and China System was a failure The coordination problem Set output targets for all goods The incentive problem No adjustments for surplus or shortage LO4

  18. The Circular Flow System • RESOURCE • MARKET • Households sell • Businesses buy Costs Rent, Wages, Interest, Profits Land, Labor, Capital, Entrepreneur Land, Labor, Capital, Entrepreneur • BUSINESSES • buy resources • sell products • HOUSEHOLDS • sell resources • buy products Goods and Services Goods and Services • PRODUCT • MARKET • Businesses sell • Households buy Consumption Expenditures Revenues LO5

  19. Businesses Three main categories of businesses: Sole proprietorship Partnership Corporation LO5

  20. Businesses Partnerships (10%) Corporations (18%) Corporations (82%) Sole Proprietorships (72%) LO5

  21. The World’s 10 Largest Corporations LO5

  22. U.S. Households Percentage of Earned Income Percentage of Consumer Expenditures LO5

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