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The Market System and the Circular Flow

2. The Market System and the Circular Flow. Chapter Objectives. Command Systems vs. Market Systems Characteristics of a Market System How Markets Determine What to Produce, How to Produce, and Who Receives the Output How Market System Adjusts to Change and Promotes Progress

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The Market System and the Circular Flow

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  1. 2 The Market System and the Circular Flow

  2. Chapter Objectives • Command Systems vs. Market Systems • Characteristics of a Market System • How Markets Determine What to Produce, How to Produce, and Who Receives the Output • How Market System Adjusts to Change and Promotes Progress • The Mechanics of the Circular Flow

  3. 2.1 Economic Systems • Economic System Defined • Ownership of Factors of Production • Method Used to Motivate, Coordinate, and Direct Economic Activity • Command System • Socialism or Communism • Market System • Capitalism • Pure Capitalism – Laissez-Faire

  4. GLOBAL PERSPECTIVE The Market System Characteristics • Private Property • Freedom of Enterprise • Freedom of Choice Free Mostly Free Mostly Unfree Repressed 1- Hong Kong 3- Ireland 9- United States 22- Belgium 33- Spain 44- France 81- Brazil 111- China 122- Russia 150- Cuba 152- Venezuela 157- North Korea Source: Heritage Foundation (www.heritagefoundation.com) and The Wall Street Journal

  5. 2.2 2.3 The Market System Characteristics • Self-Interest • Competition • Markets and Prices • Technology and Capital Goods • Specialization • Division of Labor

  6. The Market System Characteristics • Geographic Specialization • Use of Money • Medium of Exchange • Barter • Active but Limited Government

  7. The Market System Five Fundamental Questions • What Goods Will Be Produced? • Consumer Sovereignty • Dollar Votes • How Will the Goods Be Produced? • Available Technology • Prices of Needed Resources

  8. The Market System Five Fundamental Questions • Who Will Get the Output? • How Will the System Accommodate Change? • How Will the System Promote Progress? • Technological Advance • Creative Destruction • Capital Accumulation

  9. The Market System The “Invisible Hand” • 1776 Wealth of Nations by Adam Smith • Efficiency • Incentives • Freedom

  10. The Market System Demise of Command Systems • Two Insurmountable Problems • The Coordination Problem • The Incentive Problem USSR East Germany Yugoslavia

  11. 2.4 Circular Flow Resource Market Businesses Households Product Market

  12. 2.4 Circular Flow Resource Market Money Income Costs Input Factors Resources Businesses Households Goods & Services Goods & Services Product Market Consumption Revenue

  13. 2.4 Circular Flow Both Flows Are Equal Resource Market Money Income Costs Input Factors Resources Businesses Households Goods & Services Goods & Services Product Market Consumption Revenue

  14. Shuffling the Deck Last Word Markets Systematically and Purposefully Rearrange the World’s Resources • Extreme Number of Playing Card Combinations • Tens of Billions of Worldwide Resources • Many Combinations Useless • Private Property Facilitates Best Choice Selections – Mutual Accommodations • Result is a Complex and Productive Arrangement of Resources • Many Small Decisions that Others Find Helpful

  15. economic system command system market system private property freedom of enterprise freedom of choice self-interest competition market specialization division of labor medium of exchange barter money consumer sovereignty dollar votes creative destruction “invisible hand” circular flow diagram resource market product market Key Terms Page

  16. Next Chapter Preview… Demand, Supply, and the Market Equilibrium Chapter 3

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