The Market System and Circular Flow

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 • 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 • http://youtu.be/J02RdkvI6zo

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 • http://youtu.be/8fmEJ7yrnlA

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 • Freedom of Enterprise • 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 • 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