The Market System and Circular Flow Chapter 2

Economic Systems Economic System A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem

Economic Systems Differ in 2 Ways Who owns the Factors of Production The method used to Motivate, coordinate, and direct economic activity

Economic Systems Types of Systems Market System Command System Otherwise known as Capitalism Command System Otherwise known as socialism or communism

Economic Systems Command system Government owns most of the property resources Decision-making occurs through a Central Economic Plan A Central Committee specifies allocation of resources and production goals http://youtu.be/J02RdkvI6zo

Economic Systems Market System Private Ownership of most of the property resources Decision-making occurs through markets and prices Participants act in their own self-interest Competition between buyers and sellers Increased monetary awards (Motivation)

Economics Systems Market Systems Laissez-faire Hand off or Let it Be Government stays out of the decision making process completely http://youtu.be/8fmEJ7yrnlA

Economics Systems Market Systems –United States Government does play a role Promotes economic stability Provides rules for economic activity Provides certain goods and services that would otherwise be under produced or not produced at all

Economics Systems Market Systems Characteristics Private Property Individuals and firms own land and capital Freedom to negotiate contracts, use, and sell property Right to inherit property Encourage investment and innovation (incentives) Legitimizes ownership and facilitates exchange Extends to intellectual property

Economics Systems Market Systems THINK About it this way: Would you go out of your way do something that you were not guaranteed credit for in some way?

Freedom of Enterprise and Choice Entrepreneurs and private businesses are free to obtain and use economic resources to produce what they want and sell them when they want Freedom of Choice Owners are able to employ and dispose of their property and their money any way they would like Workers can enter any profession Consumers can buy whatever they want

Self Interest Self Interest Motivating force of the various economic units as they express their free choice Get what you want

Competition Competition Two or more buyers or sellers acting independently in a particular resource market Freedom of sellers or buyers to leave a market based on their own self-interest

Markets and Prices Market Brings buyers and sellers into contact Those who listen to what the market wants and needs are rewarded Those who don’t fail Example AOL

Technology and Capital Goods Advanced Technology The Market System encourages the develop and advancement of technology More efficient production means much more abundant output

Specialization Specialization The use of resources of an individual of firm to produce one or a few goods or services rather than an entire range Producers usually do not consume what they produce

Division of Labor Division of Labor (human specialization)Contributes by: Making use of different talents and abilities Fosters learning by doing Develop improved techniques Saves time No back and forth Focus and move to the next one Less down time

Specialization Geographic Specialization Some items are better suited to be produced in a certain area (oranges =Florida) Surpluses are sold for other items

Specialization Both Human & Geographic Specialization Are needed to achieve efficiency in the use of limited resources

Use of Money Characteristics of Money Medium of Exchange Makes trade easier It must be generally acceptable to sellers in exchange for their goods and services Money is socially defined as: Whatever society accepts as a medium of exchange i.e. Flintstones use clam shells

Use of Money Barter Swapping Goods for other goods Main Problem you have to have a coincidence of wants i.e. You have to want what the other person wants and vice versa

Active Government Active, but limited Government is needed Due to market failures Shortcomings in the market

Active Government THINK ABOUT IT: Why does government help the market system?

Five Fundamental Questions What goods and services will be produced? Those that make Profit Profits or Losses = TR-TC (Total Revenue – Total Cost) Economic Costs include: Wages for labor Interest and Rental payments for land and capital Payments to the entrepreneur for organizing and combining the resources to produce a good

Five Fundamental Questions TR>TC Industry Expands Resources are put into the industry Existing firms grow New firms enter TC>TR Reduced production Exit of resources from industry Firms contract Firms go out of business Industry contracts Expansion & Growth Contraction & Death

Five Fundamental Questions What goods and services will be produced? Consumer Sovereignty Consumers are in control Dollar Votes Crucial in determining the types and quantities to produce Customers spend their money on what they want to buy If people want it, it will be made Influences producers and resource suppliers

Five Fundamental Questions 2. How will goods and services be produced? In combinations and ways that minimize the cost per unit of output Competition will eliminate high-cost producers Profitability will require that firms produce output at a minimum cost per unit

Five Fundamental Questions 2. What goods and services will be produced? Least-cost production Firms must employ the most economically efficient technique of production in producing their output Depends on the available technology (combination of resources needed) Depends on prices of the needed resources (See page 36 and worked problem 2.1)

Five Fundamental Questions 3. Who will get the goods and services? Distributed based on the willingness and ability to pay (if you can buy it at the price offered you get it!!) And your preference (if you want it)

Five Fundamental Questions 4. How will the system accommodate change? Market systems are dynamic and change Consumer preferences Technology Allocation of resources Directed and guided by consumer preferences

Five Fundamental Questions 5. How will the system promote progress? Technological Advance Create technologies that will reduce cost and therefore increase market share and profit Competitors will have to keep up or fail Creative Destruction New technology that totally makes other technology or processes obsolete (Cell Phones pay phones)

Five Fundamental Questions 5. How will the system promote progress? Capital Accumulation Entrepreneur and business owners uses dollar votes for capital goods Will result in greater future profit Can get money for these investments from selling shares

The “Invisible Hand” Individuals will promote the public good of society by doing what is best for them as an individual This invisible hand will guide resources to areas where they are needed

Benefits of the Market System Efficiency Encourages and guides resources to the most efficient way of production Incentives Risk can equal great reward Working harder and acquiring more skills will result in higher individual gains Freedom Personal freedom to make choices that benefit the individual

Demise of the Communist System Coordination Problem Central Planning committee had to coordinate the decisions of numerous people and industries Failure of one decision would set off a domino effect Managers would get bonuses based on qty not quality so they would sacrifice quality Also many things were not spelled out i.e. needed 1 lb of nails, company made 1, 1 lb nail i.e. needed 1,000 nails, company made 1,000 tiny nails

Demise of the Communist System Incentive Problem No profit incentive No one then cared Could not gain unless you were political Got paid no matter what

Circular Flow Model Resource Market Product Market The place where resources or the services of resource suppliers are sold Product Market The place where goods and services are bought and sold

Circular Flow Model Now create your own Circular Flow Model using the desks in the room