Chapter 02: The Market System and the Circular Flow

The Market System and the Circular Flow02McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.The Market SystemKnown as capitalismCharacteristics of market systems: Private property Freedom of enterprise and choice Self-Interest Competition Markets and pricesAustralia, Switzerland, and the U.K.LO12-*Global PerspectiveLO2Index of Economic Freedom, Selected Nations2-*Technology and Capital GoodsAdvanced technology and capital goods are encouragedSpecializationDivision of laborGeographic specializationLO22-*Active, but Limited GovernmentGovernment may be needed to alleviate market failuresGovernment can increase effectiveness of a market systemLO22-*The Five Fundamental QuestionsWhat 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 accommodate change?How will the system promote progress?LO32-*What Will Be Produced?Goods and services that create a profit“Dollar Votes”Method for consumers to determine which goods will be producedDetermines which products and industries survive or failLO32-*How Will the Goods Be Produced?Minimize the cost per unit by using the most efficient techniquesTechnologyPrices of the necessary resourcesLO32-*Who Will Get the Output?Consumers with the ability and willingness to pay will get the productAbility to pay depends on incomeLO32-*How Will the System Change?Changes in consumer tastesChanges in technologyChanges in resource pricesLO42-*How Will the System Promote Progress?Technological advanceCreative destructionCapital accumulationLO42-*The “Invisible Hand”1776 Wealth of Nations by Adam SmithUnity of private and social interestVirtues of the market systemEfficiencyIncentivesFreedomLO42-*Demise of Command SystemsSoviet Union, Eastern Europe, and ChinaSystem was a failureThe coordination problemSet output targets for all goodsThe incentive problemNo adjustments for surplus or shortageLO42-*The Circular Flow SystemRESOURCEMARKETHouseholds sellBusinesses buyPRODUCTMARKETBusinesses sellHouseholds buyBUSINESSES buy resources sell productsHOUSEHOLDS sell resources buy productsLO52-*BusinessesThree main categories of businessesSole proprietorshipPartnershipCorporationLO52-*