Lecture Macroeconomics (19/e) - Chapter 2: The market system and the circular flow

02
The Market System and the Circular Flow

McGraw­Hill/Irwin

        Copyright © 2012 by The McGraw­Hill Companies, Inc. All rights reserved.


The Market System

• Known as capitalism
• Characteristics of market systems:
Private property
Freedom of enterprise and choice
Self-Interest
Competition
Markets and prices

• Australia, Switzerland, and the U.K.
LO1

2-2


Global Perspective
Index of Economic
Freedom,
Selected Nations

LO2

2-3


Technology and Capital Goods

• Advanced technology and capital
•

LO2

goods are encouraged
Specialization
• Division of labor
• Geographic specialization

2-4


Active, but Limited Government

• Government may be needed to
•

LO2

alleviate market failures
Government can increase
effectiveness of a market system

2-5

The Five Fundamental Questions

• What goods and services will be
•
•
•
•
LO3

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?
2-6


What Will Be Produced?

• Goods and services that create a
•

LO3

profit

“Dollar Votes”
• Method for consumers to determine
which goods will be produced
• Determines which products and
industries survive or fail

2-7


How Will the Goods Be Produced?

• Minimize the cost per unit by using
the most efficient techniques
• Technology
• Prices of the necessary resources

LO3

2-8


Who Will Get the Output?

• Consumers with the ability and
•

LO3

willingness to pay will get the product
Ability to pay depends on income

2-9


How Will the System Change?

• Changes in consumer tastes
• Changes in technology
• Changes in resource prices

LO4

2-10


How Will the System Promote Progress?

• Technological advance
• Creative destruction
• Capital accumulation

LO4

2-11


The “Invisible Hand”

• 1776 Wealth of Nations by Adam
•

LO4

Smith
• Unity of private and social interest
Virtues of the market system
• Efficiency
• Incentives
• Freedom
2-12


Demise of Command Systems

• Soviet Union, Eastern Europe, and
•
•
•

LO4

China
System was a failure
The coordination problem
• Set output targets for all goods
The incentive problem
• No adjustments for surplus or
shortage
2-13

The Circular Flow System
RESOURCE
MARKET
•Households sell
•Businesses buy

BUSINESSES
• buy resources
• sell products

HOUSEHOLDS
• sell resources
• buy products

PRODUCT
MARKET
•Businesses sell
•Households buy

LO5

2-14


Businesses

• Three main categories of businesses
• Sole proprietorship
• Partnership

• Corporation

LO5

2-15