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The main goals of this chapter are to: Differentiate between a command system and a market system; list the main characteristics of the market system; explain how the market system decides what to produce, how to produce it, and who obtains it; discuss how the market system adjusts to change and promotes progress; describe the mechanics of the circular flow model.
02 TheMarketSystemandtheCircularFlow McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved TheMarketSystem Known as capitalism Characteristics of market systems: Private property Freedom of enterprise and choice Self-Interest Competition Markets and prices • Australia, Switzerland, and the U.K LO1 2-2 Global Perspective Index of Economic Freedom, Selected Nations LO2 2-3 Technology and Capital Goods • Advanced technology and capital • LO2 goods are encouraged Specialization • Division of labor • Geographic specialization 2-4 Active, but Limited Government • Government may be needed to • LO2 alleviate market failures Government can increase effectiveness of a market system 2-5 The Five Fundamental Questions • What goods and services will be • • • • LO3 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? 2-6 What Will Be Produced? • Goods and services that create a • LO3 profit “Dollar Votes” • Method for consumers to determine which goods will be produced • Determines which products and industries survive or fail 2-7 How Will the Goods Be Produced? • Minimize the cost per unit by using the most efficient techniques • Technology • Prices of the necessary resources LO3 2-8 Who Will Get the Output? • Consumers with the ability and • LO3 willingness to pay will get the product Ability to pay depends on income 2-9 How Will the System Change? • Changes in consumer tastes • Changes in technology • Changes in resource prices LO4 2-10 How Will the System Promote Progress? • Technological advance • Creative destruction • Capital accumulation LO4 2-11 The “Invisible Hand” • 1776 Wealth of Nations by Adam • LO4 Smith • Unity of private and social interest Virtues of the market system • Efficiency • Incentives • Freedom 2-12 Demise of Command Systems • Soviet Union, Eastern Europe, and • • • LO4 China System was a failure The coordination problem • Set output targets for all goods The incentive problem • No adjustments for surplus or shortage 2-13 The Circular Flow System RESOURCE MARKET •Households sell •Businesses buy BUSINESSES • buy resources • sell products HOUSEHOLDS • sell resources • buy products PRODUCT MARKET •Businesses sell •Households buy LO5 2-14 Businesses • Three main categories of businesses • Sole proprietorship • Partnership • Corporation LO5 2-15 ... private and social interest Virtues of the market system • Efficiency • Incentives • Freedom 2-1 2 Demise of Command Systems • Soviet Union, Eastern Europe, and • • • LO4 China System was a failure The. .. goods and services will be • • • • LO3 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. . .The Market System • Known as capitalism • Characteristics of market systems: Private property Freedom of enterprise and choice Self-Interest Competition Markets and prices • Australia,