1. Chapter 2: The Market System and the Circular Flow Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

2. What, How, and Who? In order to determine what goods are produced, how they are produced and who gets them, each society develops an economic system to respond to the economic problem. An economic system is a particular set of institutional arrangements and a coordinating mechanism. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

3. Economic Systems There are two general types of economic systems: the command system the market system They differ in terms of (1) who owns the factors of production and (2) the method used to motivate, coordinate, and direct economic activity. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

4. The Command System The command system is also known as socialism or communism. Government owns most property resources and economic decisions are made by a central government body. The government owns most of the business firms and a central planning board determines production goals and how resources will be allocated. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

5. The Market System The market system, or capitalism, is one in which property resources are privately owned and markets and prices are used to direct and coordinate economic activities. Participants act in their own self-interest resulting in competition among independent buyers and sellers of each product and resource. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

6. Characteristics of the Market System Some of the key features of the market system include:  Private Property  Freedom of Enterprise and Choice  Self-Interest  Competition  Markets and Prices  Technology and Capital Goods  Specialization  Use of Money  Active, but Limited, Government Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

7. Characteristics of the Market System Private Property is the right of persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital, and other property. Freedom of enterprise is the freedom of firms to obtain economic resources, to use those resources to produce products of the firms’ own choosing, and to sell their products in markets of their choice. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

8. Characteristics of the Market System Freedom of choice is the freedom of owners of resources to employ or dispose of them as they see fit, and the freedom of consumers to spend their incomes in a manner they think is appropriate. Self-interest is the most advantageous outcome as viewed by each firm, property owner, worker, or consumer. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

9. Characteristics of the Market System Competition is the presence in a market or independent buyers and sellers vying with one another, and the freedom of buyers and sellers to have a market. A market is an institution or mechanism that brings buyers and sellers together. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

10. Characteristics of the Market System Technology and capital goods promote efficiency and the ability to produce more goods and services. Specialization is the use of resources of an individual, region, or nation to produce one or a few goods and services rather than the entire range of products. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11. Characteristics of the Market System The use of money where money is any item that is generally acceptable to sellers in exchange for goods and services. Active, but Limited, Government where government can sometimes increase the overall effectiveness of the economic system. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

12. Four Fundamental Questions The key features of the market system help explain how market economies respond to four fundamental questions: 1)What products will be produced? 2)How will the products be produced? 3)Who will get the goods and services? 4)How will the system promote progress? Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

13. What Will Be Produced? The goods and services produced at a continuing profit will be produced. Those producing at a continuing loss will not. In a market system, consumers are sovereign. Consumer sovereignty is the determination by consumers of the types and quantities of goods and services that will be produced with the economy’s scarce resources. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

14. How Will They Be Produced? The combination of resources and technologies that minimizes the cost per unit of output will be used to produce goods and services. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

15. Who Will Get the Output? The distribution of goods and services is determined by: Consumers’ ability and willingness to pay its existing price Amount of income that consumers have, in addition to the prices, and preferences for, various goods. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

16. How Will the System Promote Progress? To achieve a higher standard of living and economic growth, or progress, the market system must promote: technological improvements capital accumulation Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.