1. The Market System and Circular Flow
Chapter 2

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

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

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

5. 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

6. 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)

7. Economics Systems Market Systems Laissez-faire Hand off or Let it Be
Government stays out of the decision making process completely

8. 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

9. 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

10. 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?

11. 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

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

13. 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

14. 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

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

16. 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

17. 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

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

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

20. 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

21. 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

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

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

24. 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

25. 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

26. 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

27. 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

28. 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)

29. 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)

30. 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

31. 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)

32. 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

33. 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

34. 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

35. 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

36. 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

37. 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

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