PART 1: AN INTRODUCTION TO ECONOMICS AND THE ECONOMY CHAPTER 2 The Market System and the Circular Flow Slides prepared by Bruno Fullone, George Brown College 2010 McGraw-Hill Ryerson Limited 1
In This Chapter You Will Learn: Learning objective 2.1: The difference between a command system and a market system Learning objective 2.2: The main characteristics of the market system Learning objective 2.3: The five fundamental questions any economy faces Learning objective 2.4: About the demise of the command economy Learning objective 2.5: The mechanics of the circular flow model 2
2.1 Economic Systems Economic Systems A particular set of institutional arrangements and a coordinating mechanism - The command system - The market system LO2.1 3
2.2 Characteristics of the Market System Private property Freedom of enterprise & choice freedom of enterprise: businesses can buy & sell as they choose freedom of choice: owners can use or sell property as they choose workers can work where they like consumers can buy what they want LO2.2 4
2.2 Characteristics of the Market System Private property Freedom of enterprise & choice Self-interest businesses seek profits consumers seek value LO2.2 5
2.2 Characteristics of the Market System Private property Freedom of enterprise & choice Self-interest Competition independently acting sellers & buyers easy entry & exit Markets and Prices prices signal scarcity & guide resource allocation LO2.2 6
2.2 Characteristics of the Market System Other Characteristics Technology & Capital Goods Specialization division of labour ability differences learning by doing saving time switching tasks geographic specialization LO2.2 7
2.2 Characteristics of the Market System Other Characteristics Technology & capital goods Specialization Use of money Medium of exchange Active, but limited government LO2.2 8
2.3 Five Fundamental Questions 1. What will be produced? -those goods & services that can be produced at a profit -what consumers vote for with their dollars -market restraints on freedom Consumer Sovereignty LO2.3 9
2.3 Five Fundamental Questions 1. What will be produced? 2. How will the goods & services be produced? -with the most efficient, least-costly methods LO2.3 10
2.3 Five Fundamental Questions 1. What will be produced? 2. How will the goods & services be produced? 3. Who will get the goods & services? -those with the greatest willingness & ability to pay LO2.3 11
2.3 Five Fundamental Questions 1. What will be produced? 2. How will the goods & services be produced? 3. Who will get the goods & services? 4. How will the system accommodate change? -by responding to price & profit signals LO2.3 12
2.3 Five Fundamental Questions 1. What will be produced? 2. How will the goods & services be produced? 3. Who will get the goods & services? 4. How will the system accommodate change? 5. How will the system promote progress? -Technological advance -Capital accumulation LO2.3 13
The Invisible Hand Prices communicate information about scarcity & value Competition forces producers & resource suppliers to respond Firms, acting in their own best interest, also promote society s interests in terms of efficiency LO2.3 14
The Invisible Hand Three special merits of the market system: Efficiency Incentives Freedom LO2.3 15
2.4 The Demise of the Command System The Coordination Problem The Incentive Problem LO2.4 16
The Circular Flow Diagram Figure 2-2 FACTOR MARKET FACTORS OF PRODUCTION INPUTS BUSINESSES HOUSEHOLDS LO2.5 17
The Circular Flow Diagram Figure 2-2 FACTOR MARKET FACTORS OF PRODUCTION INPUTS BUSINESSES HOUSEHOLDS GOODS & SERVICES GOODS & SERVICES PRODUCT MARKET LO 2.5 18
The Last Word: Shuffling the Deck If one thoroughly shuffles a deck of cards, there is a virtual 100% chance that the resulting arrangement of cards will be unlike any previous arrangement. Yet, even though there are tens of billions of resources in the world, these resources are arranged in such a way as to produce the products and services that serve human needs. LO2.3 19
The Last Word: Shuffling the Deck Private property eliminates the possibility that resource arrangements will be random because each resource owner will choose a particular course of action if it promises rewards to the owner that exceed the rewards promised by all other available actions. The result is a complex and productive arrangement of countless resources. Chapter 2 20
Chapter 2 Summary 2.1 The difference between a command system and a market system 2.2 The main characteristics of the market system 2.3 The five fundamental questions any economy faces 2.4 The demise of the command system 2.5 The mechanism of the Circular Flow model Chapter 2 21