The Market System and the Circular Flow2McGraw-Hill/IrwinCopyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

The Market SystemKnown as capitalismCharacteristics of market systems:Private property Freedom of enterprise and choiceSelf-InterestCompetitionMarkets and pricesAustralia, Switzerland, and the U.K.LO1

Global PerspectiveLO2Index of Economic Freedom, Selected Nations

Technology and Capital GoodsAdvanced technology and capital goods are encouragedSpecializationDivision of laborGeographic specializationLO2

Active, but Limited GovernmentGovernment may be needed to alleviate market failuresGovernment can increase effectiveness of a market systemLO2

The Five Fundamental QuestionsWhat goods and services will be produced?How will the goods and services be produced?Who will get the goods and services?How will the system accommodate change?How will the system promote progress?LO3

What Will Be Produced?Goods and services that create a profitMoney VotesMethod for consumers to determine which goods will be producedDetermines which products and industries survive or failLO3

How Will the Goods Be Produced?Minimize the cost per unit by using the most efficient techniquesTechnologyPrices of the necessary resourcesLO3

Who Will Get the Output?Consumers with the ability and willingness to pay will get the productAbility to pay depends on incomeLO3

How Will the System Change?Changes in consumer tastesChanges in technologyChanges in resource pricesLO4

How Will the System Promote Progress?Technological advanceCreative destructionCapital accumulation

LO4

The Invisible Hand1776 Wealth of Nations by Adam SmithUnity of private and social interestVirtues of the market systemEfficiencyIncentivesFreedomLO4

Demise of Command SystemsSoviet Union, Eastern Europe, and ChinaSystem was a failureThe coordination problemSet output targets for all goodsThe incentive problemNo adjustments for surplus or shortageLO4

The Circular Flow SystemRESOURCEMARKETHouseholds sellBusinesses buyPRODUCTMARKETBusinesses sellHouseholds buyBUSINESSES buy resources sell productsHOUSEHOLDS sell resources buy productsLO5

BusinessesThree main categories of businessesSole proprietorshipPartnershipCorporationLO5

**************