1. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 1 of 40 Unit I: Basic Economic Concepts Topic C: The Market System and the Circular Flow

2. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 2 of 40 Economic Systems The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions?

3. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 3 of 40 Economic Systems Economic systems are the basic arrangements made by societies to solve the economic problem. They include: Command economies Laissez-faire economies Mixed systems

4. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 4 of 40 Economic Systems In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices. In a laissez-faire economy, individuals and firms pursue their own self- interests without any central direction or regulation.

5. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 5 of 40 Economic Systems The central institution of a laissez- faire economy is the free-market system. A market is the institution through which buyers and sellers interact and engage in exchange.

6. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 6 of 40 Economic Systems Consumer sovereignty is the idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

7. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 7 of 40 Economic Systems Free enterprise: under a free market system, individual producers must figure out how to plan, organize, and coordinate the production of products and services.

8. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 8 of 40 Economic Systems In a laissez-faire economy, the distribution of output is also determined in a decentralized way. The amount that any one household gets depends on its income and wealth.

9. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 9 of 40 Economic Systems The basic coordinating mechanism in a free market system is price. Price is the amount that a product sells for per unit. It reflects what society is willing to pay.

10. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 10 of 40 Mixed Systems, Markets, and Governments Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to: Minimize market inefficiencies Provide public goods Redistribute income Stabilize the macroeconomy: Promote low levels of unemployment Promote low levels of inflation

11. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 11 of 40 Let’s recap Characteristics of a market economy: private property; freedom of enterprise and choice; self-interest; competition; market and prices; technology and capital goods; specialization—division of labor and geographic specialization; use of money; active but limit government.

12. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 12 of 40 Adam Smith What is the invisible hand and how do I know it’s there?

13. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 13 of 40 Circular Flow Model

14. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 14 of 40 Firms and Households: The Basic Decision-Making Units A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. Households are the consuming units in an economy.

15. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 15 of 40 Input Markets and Output Markets: The Circular Flow The circular flow of economic activity shows how firms and households interact in input and output markets.

16. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 16 of 40 Input Markets and Output Markets: The Circular Flow Product or output markets are the markets in which goods and services are exchanged. Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged.

17. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 17 of 40 Input Markets and Output Markets: The Circular Flow Goods and services flow clockwise. Firms provide goods and services; households supply labor services.Goods and services flow clockwise. Firms provide goods and services; households supply labor services. Payments (usually money) flow in the opposite direction (counterclockwise) as the flow of labor services, goods, and services.Payments (usually money) flow in the opposite direction (counterclockwise) as the flow of labor services, goods, and services.

18. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 18 of 40 Input Markets and Output Markets: The Circular Flow Input or factor markets are the markets in which the resources used to produce products are exchanged. They include: The labor market, in which households supply work for wages to firms that demand labor.

19. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 19 of 40 Input Markets and Output Markets: The Circular Flow And... The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. The land market, in which households supply land or other real property in exchange for rent.

20. C H A P T E R 2: The Economic Problem: Scarcity and Choice © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 20 of 40 Input Markets and Output Markets: The Circular Flow Inputs into the production process are also called factors of production.