Product and Resource Markets In the market system, there exists an interdependence between all individuals. Households (that’s us) depend on the goods and services produced by business firms, and the incomes they provide us, for our survival Business firms depend on households for the workers, the capital, the land resources they need to produce the goods they hope to sell us and make profits on. These exchanges all take place in one of two categories of market present in all market economies Product Markets Resource Markets Where households buy the goods and services we desire from firms. Examples: The market for private schools The market for dental services The market for airline travel The market for football merchandise Where business firms buy the productive resources they need to make their products: The market for teachers The market for dentists The market for pilots The market for football players

In Resource Markets: In Product Markets: Households supply productive resources (land, labor, capital) Firms buy productive resources from households. In exchange for their productive resource, firms pay households: Wages: payment for labor Rent: payment for land Interest: payment for capital Profit: payment for entrepreneurship Firms seek to minimize their costs in the resource market Firms employ productive resources to make products, which they sell back to households in the product market In Product Markets: Consumers buy goods and services from firms Households use their money incomes earned in the resource market to buy goods and services Expenditures by households become revenues for firms Firms seek to maximize their profits Households seek to maximize their utility (happiness) Notice the circular flow of money payments from one market to the other

The Circular Flow of Resources The Circular Flow Market economies are characterized by a circular flow of money, resources, and products between households and firms in resource and product markets. Notice: Money earned by households in the resource market is spent on goods and services in the product market Money earned by firms in the product market is spent on resources from households in the resource market. The incentives of Households: Maximize Utility The incentive of Firms: Maximize Profits!

Entrepreneurship: Profits Resources Resource Payments (Incomes for households) In exchange for their land, labor, capital and entrepreneurship, households receive payments. The payments for the four productive resources (which are costs for firms) ar… For Land: Rent Firms pay households RENT. Landowners have the option to use their land for their own use or to rent it to firms for their use. If the landowner uses his land for his own use, the opportunity cost of doing so is the rent she could have earned by providing it to a firm. For Labor: Wages Firms pay households WAGES. To employ workers, firms must pay workers money wages. If a worker is self employed, the opportunity cost of self-employment is the wages he could have earned working for another firm. For Capital: Interest Firms pay households INTEREST. Most firms will take out loans to acquire capital equipment. The money they borrow comes mostly from households' savings. Households put their money in banks because they earn interest on it. Banks pay interest on loans, which becomes the payment to households. If a household chooses to spend its extra income rather than save it, the opportunity cost of doing so is the interest it could earn in a bank. Entrepreneurship: Profits Households earn PROFIT for their entrepreneurial skills. An entrepreneur who takes a risk by putting his creative skills to the test in the market expects to earn a normal profit for his efforts.

The Price Mechanism The Price Mechanism Prices are how resources are allocated between competing interests in a market economy. Without tradition or command determining the allocation of resources, prices send the signals to producers and consumers regarding what should be produced, how it should be produced, and for whom. Examples of how prices allocate resources: Imagine a city with two types of street food, hot dogs and kebabs. How would price assure that the right amount of these two foods is produced based on consumer demand. At present, The price of a hot dog is $2 The price of a kebab is $3 Due to a report on the negative effects of hot dogs on health, consumers now demand more kebabs. How will each of the two systems assure that the increased demand for kebabs is met? Prices are signals from buyers to sellers! As the demand for kebabs rises, they will become more scarce, causing the price to rise. Sellers will realize there are more profits in kebabs and hot dog vendors will switch to kebabs. The price mechanism led to a reallocation of resources! (THE INVISIBLE HAND)