Chapter 2 Section 2 The Free Market

The Free Market Economic freedom is the chief characteristic of a free market economy A market is any arrangement that allows buyers and sellers to exchange things Markets eliminate the need for any one person to be self-sufficient

Specialization Instead of being self-sufficient, everyone specializes in a few products or services Specialization is the concentration of the productive efforts of individuals and businesses on a limited number of activities Leads to efficient use of resources

Buying and Selling Without specialization, markets would not be necessary, therefore we need a system that allows us to sell what we have produced and buy what we want In a modern market-based economy, people typically earn income by specializing in particular jobs and use that income to buy the products they want to consume

Free Market Economy Market economies are also called capitalist economies because the capital that entrepreneurs invest in businesses is a vital part of the system Individuals and privately owned businesses own the factors of production, make what they want, and buy what they want

Households and Firms Households and Firms are the participants in a free market economy Household – a person or group of people living in a single residence Firm – an organization that uses resources to produce a product or service, which then it sells

Factor and Product Markets Factor Market – when firms purchase factors of production from households Product Market – households buy the goods and services that firms produce

Draw this circular flow model on pg. 148 in your notebook.

Self-Interest Adam Smith wrote The Wealth of Nations in 1776 He observed that an economy is made up of countless individual transactions in which the buyer and seller consider only their self- interest or personal gain Self-interest is the motivating force in the free market

Competition Consumers pursuing their own interests have the incentive to look for lower prices An incentive is the hope of reward or fear of penalty that encourages a person to behave a certain way Competition is the struggle among producers for the dollars of the consumers Competition is the regulating force of the free market economy

The Invisible Hand Self-interest and competition work together to regulate the marketplace without any central planning or direction Adam Smith referred to this as the “Invisible Hand”

Advantages Economic Efficiency Economic Freedom Economic Growth Because it is self-regulating, it responds efficiently to rapidly changing conditions Economic Freedom The highest degree of economic freedom Economic Growth Encourage growth because entrepreneurs are always seeking profitable opportunities Additional Goals Consumer sovereignty – consumers have the power to decide what gets produced because producers have the incentive to meet consumers’ desires