PART 1: AN INTRODUCTION TO
ECONOMICS AND THE ECONOMY
CHAPTER 2
The Market System
and the Circular Flow
Slides prepared by Bruno Fullone, George
Brown College
© 2010 McGraw-Hill Ryerson Limited
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In This Chapter You Will Learn:
•
•
•
•
•
Learning objective 2.1: The difference
between a command system and a market
system
Learning objective 2.2: The main
characteristics of the market system
Learning objective 2.3: The five
fundamental questions any economy faces
Learning objective 2.4: About the demise
of the command economy
Learning objective 2.5: The mechanics of
the circular flow model
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2.1 Economic Systems
Economic Systems
A particular set of institutional arrangements and a
coordinating mechanism
- The command system
- The market system
LO2.1
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2.2 Characteristics of the Market System
• Private property
• Freedom of enterprise & choice
– freedom of enterprise: businesses can buy & sell
as they choose
– freedom of choice:
• owners can use or sell property as they choose
• workers can work where they like
• consumers can buy what they want
LO2.2
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2.2 Characteristics of the Market System
• Private property
• Freedom of enterprise & choice
• Self-interest
– businesses seek profits
– consumers seek value
LO2.2
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2.2 Characteristics of the Market System
•
•
•
•
Private property
Freedom of enterprise & choice
Self-interest
Competition
– independently acting sellers & buyers
– easy entry & exit
• Markets and Prices
– prices signal scarcity & guide resource allocation
LO2.2
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2.2 Characteristics of the Market System
Other Characteristics
• Technology & Capital Goods
• Specialization
– division of labour
– ability differences
– learning by doing
– saving time switching tasks
– geographic specialization
LO2.2
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2.2 Characteristics of the Market System
Other Characteristics
• Technology & capital goods
• Specialization
• Use of money
– Medium of exchange
• Active, but limited government
LO2.2
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2.3 Five Fundamental Questions
1. What will be produced?
-those goods & services that can be produced at a
profit
-what consumers vote for with their dollars
-market restraints on freedom
Consumer Sovereignty
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
-with the most efficient, least-costly methods
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
3. Who will get the goods & services?
-those with the greatest willingness & ability to pay
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
3. Who will get the goods & services?
4. How will the system accommodate change?
-by responding to price & profit signals
LO2.3
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2.3 Five Fundamental Questions
1. What will be produced?
2. How will the goods & services be produced?
3. Who will get the goods & services?
4. How will the system accommodate change?
5. How will the system promote progress?
-Technological advance
-Capital accumulation
LO2.3
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The “Invisible” Hand
• Prices communicate information about
scarcity & value
• Competition forces producers & resource
suppliers to respond
• Firms, acting in their own best interest, also
promote society’s interests in terms of
efficiency
LO2.3
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The “Invisible” Hand
Three special merits of the market system:
• Efficiency
• Incentives
• Freedom
LO2.3
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2.4 The Demise of the Command System
• The Coordination Problem
• The Incentive Problem
LO2.4
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The Circular Flow Diagram Figure 2-2
FACTOR
MARKET
FACTORS
OF PRODUCTION
INPUTS
BUSINESSES
HOUSEHOLDS
LO2.5
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The Circular Flow Diagram Figure 2-2
FACTOR
MARKET
FACTORS
OF PRODUCTION
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
LO 2.5
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The Last Word: Shuffling the Deck
• If one thoroughly shuffles a deck of cards, there is
a virtual 100% chance that the resulting
arrangement of cards will be unlike any previous
arrangement.
• Yet, even though there are tens of billions of
resources in the world, these resources are
arranged in such a way as to produce the
products and services that serve human needs.
LO2.3
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The Last Word: Shuffling the Deck
• Private property eliminates the possibility that
resource arrangements will be random
because each resource owner will choose a
particular course of action if it promises
rewards to the owner that exceed the rewards
promised by all other available actions.
• The result is a complex and productive
arrangement of countless resources.
Chapter 2
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Chapter 2 Summary
2.1 The difference between a command
system and a market system
2.2 The main characteristics of the market
system
2.3 The five fundamental questions any
economy faces
2.4 The demise of the command system
2.5 The mechanism of the Circular Flow model
Chapter 2
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