1. Ch 2 Sec 2 “The Free Market”
Market arrangement where buyers and sellers exchange things
Specialization concentration of production on a limited number of activities
Household person or group living in the same residence
Firm an organization that uses its resources to make a product
- turning “input” (FOP) into “output” (finished products)
Factor (Resource) Market firms purchase FOP from households in exchange for money
Profit financial gain made in a transaction
Product Market goods produced by firms are purchased by households
Adam Smith wrote The Wealth of Nations (1776) to explain market functions
Self Interest buyer/seller consider their own person gain in transactions
Incentive hope of a reward or the fear of punishment that encourages certain behavior
Competition the struggle among producers for the $$$ of consumers
“the invisible hand” how the free market tends to regulate itself
SECTION

2. The Free Market How do free markets operate?
How can markets regulate themselves?
What are the advantages of a free market economy?

3. Why Do Markets Exist?
Markets exist because none of us produces all the goods and services we require to satisfy our needs and wants.
A market is an arrangement that allows buyers and sellers to exchange goods and services.

4. Why Do Markets Exist?
Specialization is the concentration of the productive efforts of individuals and firms on a limited number of activities.
- People tend to focus on one primary “full time” profession
*earn income to purchase what you don’t produce
- Businesses tend to focus on one product or area of service
- Helps lead to efficiency

5. The Free Market Economy
monetary flow
physical flow
Circular Flow Diagram of a Market Economy
Households
Firms
In a free market economy, households and business firms use markets to exchange money and products.
Households own the Factors of Production (land, labor and capital) and consume goods and services
Firms produce goods by taking inputs (FOP) and turning them into outputs (finished products)

6. The Free Market Economy
Factor (Resource) Market
Households
Supply the labor (workers) to firms as well as land (resources) and capital (investors)
Physical exchange
Firms
Pay households for labor (salaries) and land as well as paying back investors (profits)
Monetary exchange
monetary flow
physical flow
Circular Flow Diagram of a Market Economy
Households
Firms
Households supply firms with land, labor, and capital.
Firms pay households for land, labor, and capital.
Factor (Resource) Market

7. The Free Market Economy
Product Market
Firms
Supply the goods and services that they produce to the households
Physical Exchange
Households
Pay the firms for goods and services that they need
Monetary Exchange
monetary flow
physical flow
Circular Flow Diagram of a Market Economy
Households
Firms
Product market
Households pay firms for goods and services.
Firms supply households with goods and services.

8. The Free Market Economy
monetary flow
physical flow
Circular Flow Diagram of a Market Economy
Households
Firms
Product market
Households pay firms for goods and services.
Product Market = the exchange of finished products (G/S) for money
Firms supply households with goods and services.
Households supply firms with land, labor, and capital.
Factor Market = the exchange of Factors of Production (FOP) for money
Firms pay households for land, labor, and capital.
Factor (Resource) market

9. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>

10. Circular Flow Model Review (Worksheet)
MARKET FLOW
A. Taco Bell just hired you to assemble tacos ________ _____
B. You receive your first paycheck ($68.24) ________ _____
C. You order two tickets online for a concert ________ _____
D. Your tickets arrive by mail ________ _____
E. In which market are households buyers?
F. In which market are households sellers?
G. In which market are businesses buyers?
H. In which market are businesses sellers?

11. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
Taco Bell just hired you to assemble tacos
Market:
Flow:
Resource (FOP)
Household provides FOP (Labor)

12. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
Taco Bell gives you first paycheck ($68.24)
Market:
Flow:
Resource (FOP)
Business Pay for FOP (Resources)

13. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
You buy two tickets online for a concert
Market:
Flow:
Product
Household pays for G/S

14. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
Your concert tickets arrive online
Market:
Flow:
Product
Business Provide for G/S

15. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
In which market are households buyers?
Product

16. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
In which market are households sellers?
Resource (FOP)

17. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
In which market are businesses buyers?
Resource

18. Circular Flow Model Review (Worksheet)
<<<<<<Business Provide G/S (Products)
Households Pay for G/S (Products) >>>>>>
<<<<<<<Business Pay for FOP (Resources)
Households Provide FOP (Resources)>>>>>>
In which market are businesses sellers?
Product

19. Adam Smith – The Wealth of Nations (1776)
Adam Smith was a Scottish philosopher who published “The Wealth of Nations” (1776) to describe how the market economy functioned
The market economy is based on countless individual transactions
In every transaction, the buyer and seller consider only their self-interest, or their own personal gain.
Self-interest is the motivating force in the free market.

20. Adam Smith - Market’s Self-Regulating Nature
Adam Smith observed that people responded predictably to incentives (both positive and negative)
Consumers are more likely to purchase a good at a lower price (on sale) than when the price goes up.
Workers are more loyal to a company that pays them well.
Businesses are more likely to produce a product that results in a profit than one that results in a loss.

21. Adam Smith - Market’s Self-Regulating Nature
Producers in a free market struggle for the dollars of consumers. This is known as competition, and is the regulating force of the free market.
If Macy’s offers a pair of jeans for $50 and Kohl’s offers the same jeans for $40, where will the consumers go?
How does Macy’s react?
How does TJ Maxx offer even lower prices?

22. Adam Smith – “The Invisible Hand”
Adam Smith believed that the interaction of buyers and sellers, motivated by self- interest and regulated by competition, all happens without a central plan. This phenomenon is called “the invisible hand of the marketplace.”
Overall result – consumers get the products they want at prices that closely reflect the cost of producing them

23. Advantages of the Free Market
Economic Efficiency
As a self-regulating system, a free market economy is efficient.
Producers only make
the products that consumers want
when they want them
at prices they are willing to pay for them
Economic Freedom
Free market economies have the highest degree of economic freedom of any economic system.
Workers may work where they want
Firms may produce what they want
Individuals may consume what they want

24. Advantages of the Free Market
Economic Growth
Because competition encourages innovation, free markets encourage growth.
Always looking for new products or innovations of old ideas… Snuggie $100 million in 2009
Additional Goals
Free markets offer a wider variety of goods and services than any other economic system.
Producers are always trying to entice consumers so in essence consumers decide what is to be produced
Consumer Sovereignty

25. Section 2 Assessment
1. Why do people need to buy and sell goods or services?
(a) People need to buy and sell goods to make a profit.
(b) People buy and sell to maintain a competitive society.
(c) No one is self-sufficient.
(d) People need to provide the market with goods and services.
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26. Section 2 Assessment
1. Why do people need to buy and sell goods or services?
(a) People need to buy and sell goods to make a profit.
(b) People buy and sell to maintain a competitive society.
(c) No one is self-sufficient.
(d) People need to provide the market with goods and services.
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27. Section 2 Assessment
2. What factors create the phenomenon of the “invisible hand”?
(a) incentives and efficiency
(b) specialization and efficiency
(c) competition between firms
(d) competition and self-interest
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28. Section 2 Assessment
2. What factors create the phenomenon of the “invisible hand”?
(a) incentives and efficiency
(b) specialization and efficiency
(c) competition between firms
(d) competition and self-interest
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