Ch 2: The Market System and Circular Flow

An Economic System responds to the economizing problem by … Answering 3 Fundamental Economic Questions (1) What goods and services will be produced? (2) How will the g/s be produced? (3) For whom? Who will get the g/s?

What good/services should be produced? Those that satisfy needs and wants and provide economic profit (Total Revenue>Total Cost) Think about what is produced for our consumption today compared to what was produced 5 years ago: iPhone 7, Madden16, Tesla, Volt how about 10 yrs ago? 25 yrs ago?

How should goods and services be produced? How to fuel cars?: Gas, Electric, Hybrid, Ethanol How to teach?: Large lecture with 100 students per class (less labor) Smaller discussions with 15 students per class (more labor) In other words, how should land, labor, and capital be combined to achieve maximum profits/efficiency in producing g/s?

For Whom? Who gets what? Who is the “market?” …those with the willingness and ability to pay desiring to satisfy a need or want. Q: How do we distribute income? A: Through Factor Payments: The income received for supplying factors of production (land, labor, capital, entrepreneurial ability) This represents a cost to producers for factors of production

How are the 3 questions answered? It depends on the economic system… Command System a.k.a. socialism or communism Controlled by strong, centralized government, which owns most resources Usually focuses on planning Problems: incentives and coordination

It’s Constitution Day!! Article I, Section 9, Clause 4 DIRECT TAXES No capitation, or other direct tax shall be laid, unless in proportion to the census or enumeration herein before directed to be taken. Amendment XVI (1913) The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.

Economic Systems Market System Capitalism, based upon Supply and Demand by individuals, who own most resources Private property rights Choice, competition, profit/loss

Chaos? Why does it all work? Self interest "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest." – A. Smith (1776) Acting in our own self interest to satisfy needs and wants (Not the same as selfish!) Laissez Faire: “let them do”…No Govt intervention, G exists to protect private property rights and promote competition.

Invisible Hand “Invisible hand” is how the market regulates itself “he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” – A. Smith, Wealth of Nations

Competition – the struggle among producers for the dollars of consumers, driving force for innovation

Pros and Cons of a Market System Advantages Economic Efficiency Responsive to change (coordination) Economic Freedom People can buy/sell what they want (mostly) Economic Growth Innovation/Progress Disadvantages Equity Not equality, but “fairness” Security For income, necessary g/s? Market failure Too much of a “bad” or too little of a “good” produced?

“Our” System (and most of the world’s) Markets with active, but limited government Combination of Market and Command economic systems Protect property rights! Regulations to solve market failures, promote competition, provide equity, other goals?

Oh no, circular flow!

Definitions Household Firm Person or group living in the same residence; consumers of products May own resources (land, labor, capital) Firm Organization that uses resources (factors or production) to produce a product Firm transforms “inputs” into “outputs”

Definitions Resource (Factor) market Product market where firms purchase the factors of production from households Most notably, labor Also borrow money to obtain resources Product market Households purchase goods and services that firms produce

Oh no, circular flow!