The Market System and the Circular Flow 2 C H A P T E R

PROPERTY RESOURCES 1. LAND 2. CAPITAL HUMAN RESOURCES 3. LABOR 4. ENTREPRENEURIAL ABILITY SCARCE RESOURCES ECONOMIC RESOURCES

Resource payments: correspond to resource categories RENTALINCOME INTERESTINCOME WAGES PROFIT & LOSS PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEUR

Macroeconomics Starts Here

Economic Systems Definition: A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem. Economic systems differ as to: 1) who owns the factors of production 2) the method used to motivate, coordinate, and direct economic activity.

The Command System The government owns most property resources and economic decision making occur through a central economic plan. The central planning board determines production goals for each firm and resources to be allocated.

The Market System There is private ownership of resources. Markets and prices coordinate and direct economic activity. Each participant acts in its own self-interest. In pure capitalism the government plays a very limited role.

Characteristics of the Market System Private Property. Freedom of firms to choose. Self interest. Competition. Markets and prices. Technology and capital goods. Specialization. Use of money. Active, but limited government.

The Circular Flow Model There are two groups of decision makers in the private economy: households (resource owners) and businesses (resource users)There are two groups of decision makers in the private economy: households (resource owners) and businesses (resource users) The market system (resource markets and product markets) coordinates these decisions.The market system (resource markets and product markets) coordinates these decisions.

What happens in the resource markets? a.Households sell resources directly or indirectly (through ownership of corporations) to businesses. a.Households sell resources directly or indirectly (through ownership of corporations) to businesses. b. Businesses buy resources in order to produce goods and services. c.Interaction of these sellers and buyers determines the price of each resource, which in turn provides income for the owner of that resource. d.Flow of payments from businesses for the resources constitutes business costs and resource owners’ incomes.

What happens in the product markets? a. Households are on the buying side of these markets, purchasing goods and services. b.Businesses are on the selling side of these markets, offering products for sale. c.Interaction of these buyers and sellers determines the price of each product. d.Flow of consumer expenditures constitutes sales receipts for businesses.

CIRCULAR FLOW MODEL BUSINESSES HOUSEHOLDS RESOURCE MARKET PRODUCT MARKET

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS PRODUCT MARKET CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES GOODS & SERVICES SERVICES PRODUCT MARKET CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES $ CONSUMPTION$ REVENUE CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES $ CONSUMPTION$ REVENUE

More Realistic Circular Flow

Macroeconomic Policies

Limitations of the model: 1. Does not depict transactions between households and between businesses (inter- businesses). 2.Ignores government and the “rest of the world” in the decision-making process (we will take care of them later on). 3.Does not explain how prices of products and resources are actually determined.