Chapter 2: The Market System and the Circular Flow

Chapter 2The Market System and the Circular FlowCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinEconomic SystemsSet of institutional arrangementsCoordinating mechanismDifferences in systems exist by:Who owns the factors of productionWhat method is used to motivate, coordinate, and direct economic activityLO12-*The Command SystemKnown as socialism or communismGovernment ownershipDecisions made by a central planning boardNorth Korea and Cuba are last remaining examples of largely centrally planned economiesLO12-*Global SnapshotLO1North KoreaSouth KoreaGDP$40 billion$1.3 trillionGDP per Capita$1800$27,700Exports$2.0 billion$355 billionImports$3.5 billion$313 billionAgriculture as % of GDP23 percent3 percentThe Two Koreas2-*The Market SystemKnown as capitalismPrivate ownership of resourcesDecisions based on marketsLO12-*Characteristics of the Market SystemPrivate property Freedom of enterprise and choiceSelf-interestCompetitionMarkets and pricesLO22-*The Market SystemLO22-*Technology and Capital GoodsAdvanced technology and capital goods are encouragedSpecializationDivision of laborGeographic specializationLO22-*Use of MoneyMakes trade easierLO22-*Active, but Limited GovernmentGovernment may be needed to alleviate market failuresGovernment can increase effectiveness of a market systemLO22-*The Four 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 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 Promote Progress?Technological advanceCreative destructionCapital accumulationLO42-*Invisible Hand1776 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 businesses:Sole proprietorshipPartnershipCorporationLO52-*BusinessesLO5Corporations(18%)Sole Proprietorships (72%)Corporations(82%)Partnerships (10%)2-*The World’s 10 Largest CorporationsLO52-*U.S. HouseholdsLO5Percentage of Earned IncomePercentage of Consumer Expenditures2-*