Free Market Economy Chapter 2 Section 2

Main Goal: Economic Freedom Free to own property Free to spend money you earn Free to get a job

Voluntary Exchange People voluntarily exchange ‘this’ for ‘that’ Typically money becomes the medium of exchange because it makes it easier and more efficient to do so

Specialization Arises Naturally Specialization: Concentration of productive efforts of individuals and businesses on a limited number of activities Gives rise to “Markets” –Arrangement that allows buyers and sellers to exchange

Circular Flow Model Household: person or group living in single residence Two roles: –Consumer – buys G & S –Supplier – Supplies Factors of Production to the firm Firm: Business that produces Goods & Services Two Roles: –Supplier (Producer) – Supplies G & S –Consumer (Buyer) – Buys the Factors of Production to use for production

Product Market (G & S Market): –Exchange of Final G & S –Supply & Demand of OUTPUTS Factor Market (Resource Market): –Exchange Factors of Production –Supply & Demand of INPUTS Monetary Flow: Flow of Money (payment for G & S & Payment for F of P – Factor Payments, WIRP) Physical Flow: Flow of items purchased/produced (G & S in Product Market & F of P for the Factor Market)

Circular Flow Model HouseholdsFirms $$$ Factor Payments G & S Factors of Production

Characteristics Based on Capitalism –Private ownership of property –Freedom to engage in business activities Specialization –Concentration of efforts on limited activities Profit-Motive drives business –Desire to maximize financial gains Competition is vital –Drives prices down and equalizes supply

In-depth look at key concepts 1.Profit Motive 2.Invisible Hand 3.Competition 4.Price System

Profit Motive: Self-Interest People want to maximize their Profit Relies on Human Nature –Pride ??? –Greed??? Creates inventive minds and a strong work ethic

Invisible Hand No centralized regulatory center Driven by competition and the Price System Prices are controlled and supplies are kept high

Competition Economic Rivalry among sellers, buyers, workers, and employers Keeps sellers of goods and services from charging excessively high prices Substitution also helps with price regulation –People will choose an alternative product if something is too expensive

The Price System This is the basic coordination and communication system in a market economy Operates on the principle that everything has a price Buyers communicate to sellers by their purchasing habits Employees and employers communicate through their job choices and wage levels

Incentive The hope of reward or fear of penalty that encourages or discourages people’s behaviors Sales, Discounts, Free with Purchase… et cetera

Advantages of Free Market 1.Economic Efficiency –Self-regulating –Responds quickly to changing conditions –Provides G & S that consumers want at prices they are willing to pay 2.Economic Freedom –Workers work where they want –Firms produce what they want –People consume what they want

3.Economic growth –Competition encourages innovation –Growth encouraged via profit motive 4.Additional Goals –Wider variety of G & S than other systems –Consumer Sovereignty: consumers have power to decide what is produced

Disadvantage of Free Market Market Failures 1.Contradictions in the system (conflict of goals such as Security & Freedom) 2.Fairness… (monopolies??? Rich-Poor gap???) 3.Allocation of Future Resources 4.Political Process