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Slides prepared by Bruno Fullone, George Brown College

© 2010 McGraw-Hill Ryerson Limited

CHAPTER 2 The Market System

and the Circular Flow

PART 1: AN INTRODUCTION TO ECONOMICS AND THE ECONOMY

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• 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

In This Chapter You Will Learn:

3 LO2.1

Economic Systems

A particular set of institutional arrangements and a coordinating mechanism

- The command system

- The market system

2.1 Economic Systems

4 LO2.2

• 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

2.2 Characteristics of the Market System

5 LO2.2

• Private property

• Freedom of enterprise & choice

• Self-interest

– businesses seek profits

– consumers seek value

2.2 Characteristics of the Market System

6 LO2.2

• 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

2.2 Characteristics of the Market System

7 LO2.2

Other Characteristics

• Technology & Capital Goods

• Specialization

–division of labour

–ability differences

– learning by doing

– saving time switching tasks

– geographic specialization

2.2 Characteristics of the Market System

8 LO2.2

Other Characteristics

• Technology & capital goods

• Specialization

• Use of money

– Medium of exchange

• Active, but limited government

2.2 Characteristics of the Market System

9 LO2.3

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

2.3 Five Fundamental Questions

10 LO2.3

1. What will be produced?

2. How will the goods & services be produced?

-with the most efficient, least-costly methods

2.3 Five Fundamental Questions

11 LO2.3

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

2.3 Five Fundamental Questions

12 LO2.3

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

2.3 Five Fundamental Questions

13 LO2.3

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

2.3 Five Fundamental Questions

14 LO2.3

• 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

The “Invisible” Hand

15 LO2.3

Three special merits of the market system:

• Efficiency

• Incentives

• Freedom

The “Invisible” Hand

16 LO2.4

• The Coordination Problem

• The Incentive Problem

2.4 The Demise of the Command System

LO2.5 17

FACTOR MARKET

FACTORS OF PRODUCTION

INPUTS

BUSINESSES HOUSEHOLDS

The Circular Flow Diagram Figure 2-2

LO 2.5 18

GOODS & SERVICES

GOODS & SERVICES

BUSINESSES HOUSEHOLDS

FACTOR MARKET

PRODUCT MARKET

INPUTS FACTORS OF PRODUCTION

The Circular Flow Diagram Figure 2-2

19 LO2.3

• 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.

The Last Word: Shuffling the Deck

20 Chapter 2

• 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.

The Last Word: Shuffling the Deck

21 Chapter 2

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 Summary