1. Chapter 2.2 The Free Market Economic System
Essential Question: What are the characteristics of a free market economy?

2. Objectives Explain why markets exist.
Analyze a circular flow model of a free market economy.
Describe the self-regulating nature of the marketplace.
Identify the advantages of a free market economy.
Households not self-sufficient. Trade/exchange to get goods/services to satisfy needs/wants
Product market: Households buy goods/services from firms
Factor market: Households sell factors of prod. To firms
Self-interest provides incentive for competition and efficiency in markets
Economic goals valued: Efficiency, Growth, Freedom, Security

3. Why do Markets Exist?
Markets eliminate the need for any one person to be self-sufficient.
Rather than being self-sufficient, each of us specializes in a few products or services.
Specialization leads to efficient use of land, labor, and capital.
Specialization means to focus on a limited number of related products or services.
Checkpoint Answer: Markets exist to eliminate the need for any one person to be self-sufficient and to allow us to exchange the things we have for the things we want.

4. Why do Markets Exist?
Because of specialization, markets are needed
Markets allow us to exchange the things we have for the things we want.

5. Free Market Economy In a free market,
answers to the three key economic questions are made by voluntary exchange in the marketplace.
Choices made by individuals determine what gets made, how it is made, and how much people can consume.
individuals and privately owned businesses own the factors of production.

6. Free Market Economy
What are the characteristics of a free market economy?
Households and firms
Factor and product markets
Specialization
Self-interest
Competition
Economic freedom, efficiency, and growth

7. OUTPUT Product Mkt INPUT Factor Mkt
Circular Flow of Income and Output
Product Markets
Consumer Spending ($)
Goods &
Services
Bought
OUTPUT
Product Mkt
Revenue ($)
Goods &
Services
Sold
Taxes ($)
services
Households /
Consumers
Government
Firms /
Producers
services
Taxes ($)
Inputs for Production
Land, Labor, Capital, Entrepreneurs
Wages, Rent, Interest and Profits
INPUT
Factor Mkt
Factor Markets
Factor Payment Income ($)

8. Self-Regulation of the Market: Self-Interest and Competition
In the product and factor markets, the buyer and seller consider only their self-interest.
Self-interest is the motivating force in the free market.
Households have the incentive to look for lower prices.
Firms have the incentive to charge the highest prices and make the most profits
Competition among other firms makes it hard for firms to raise prices
Self-interest and competition work together to regulate the marketplace

9. Free Market and Economic Goals
The Free Market economic system values the following economic goals:
Economic Freedom
Households and firms make individual choices to participate in markets
Economic Efficiency
Competition ensures efficient use of resources
Firms produce only goods/services households will buy
Economic Growth
Self-interest encourages innovation
Creators of new ideas will capture markets
Answer: Consumer sovereignty.

10. Key Terms
market: any arrangement that allows buyers and sellers to exchange things
specialization: the concentration of the productive efforts of individuals and businesses on a limited number of activities
free market economy: an economic system in which decisions on the three key economic questions are based on the voluntary exchange in markets
household: a person or group living in a single residence

11. Key Terms, cont.
firm: an organization that uses resources to produce a product or service, which it then sells
factor market: the arena of exchange in which firms purchase the factors of production from households
product market: the arena of exchange in which households purchase goods and services from firms
self-interest: an individual’s own personal gain

12. Key Terms, cont.
incentive: the hope of reward or fear of penalty that encourages a person to behave a certain way
competition: the struggle among producers for the dollars of consumers
consumer sovereignty: the powers of consumers to decide what gets produced