Slides prepared by Dr. Amy Peng, Ryerson University Part One: An Introduction Part One: An Introduction to Economics and the to Economics and the Economy Economy CHAPTER 2 CHAPTER 2 THE MARKET THE MARKET SYSTEM AND THE SYSTEM AND THE CIRCULAR FLOW CIRCULAR FLOW
Slides prepared by Dr. Amy Peng, Ryerson University Part One: An Introduction to Economics and the Economy CHAPTER 2 THE MARKET SYSTEM AND THE CIRCULAR.
Jan 01, 2016
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Slides prepared by Dr. Amy Peng, Ryerson University
Part One: An Introduction Part One: An Introduction to Economics and the to Economics and the
EconomyEconomy
CHAPTER 2CHAPTER 2THE MARKET THE MARKET
SYSTEM AND THE SYSTEM AND THE CIRCULAR FLOWCIRCULAR FLOW
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2 2
In this chapter you will learn: In this chapter you will learn:
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 About the demise of the command economy
2.5 About market failure and how government can rectify it
2.6 The mechanics of the circular flow model
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.1 3
Economic SystemsEconomic Systems
Economic System:A particular set of institutional
arrangements and a coordinating mechanism
– The command system– The market system
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.2 4
• Private Property• Freedom of Enterprise and Choice
– Freedom of enterpriseFreedom of enterprise: : businesses can buy and sell as they choose
– Freedom of choiceFreedom of choice: : • owners can use or sell property as they
choose• workers can work where they like• consumers can buy what they want
Characteristics of the Market Characteristics of the Market SystemSystem
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.2 5
• Private Property• Freedom of Enterprise and
Choice• Self-Interest
– businesses seek profits– consumers seek value
Characteristics of the Market Characteristics of the Market SystemSystem
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.2 6
• Private Property• Freedom of Enterprise and Choice• Self-Interest• Competition
– independently acting sellers and buyers– easy entry and exit of markets
• Markets and Prices– prices signal scarcity and guide resource
allocation
Characteristics of the Market Characteristics of the Market SystemSystem
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.2 7
Other Characteristics:• Technology and Capital Goods• Specialization
– Division of Labour– ability differences– learning by doing– saving time switching tasks
– Geographic Specialization
Characteristics of the Market Characteristics of the Market SystemSystem
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.2 8
Other Characteristics:• Technology and Capital Goods• Specialization• Use of money
– Medium of exchange
• Active, but Limited, Government
Characteristics of the Market Characteristics of the Market SystemSystem
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.3 9
Five Fundamental QuestionsFive Fundamental Questions
1. What will be produced?• those goods and services that can
be produced at a profit• what consumers vote for with
their dollars• market restraints on freedom
Consumer Sovereignty
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.3 10
Five Fundamental QuestionsFive Fundamental Questions
1. What will be produced?2. How will the goods and
services be produced?• with the most efficient, least-
costly methods
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.3 11
Five Fundamental QuestionsFive Fundamental Questions
1. What will be produced?2. How will the goods and
services be produced?3. Who will get the goods and
services?• those with the greatest
willingness and ability to pay
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.3 12
Five Fundamental QuestionsFive Fundamental Questions
1. What will be produced?2. How will the goods and services
be produced?3. Who will get the goods and
services?4. How will the system
accommodate change?• by responding to price and profit
signals
– guiding function of pricesguiding function of prices– role in promoting progressrole in promoting progress
– technological advancetechnological advance– creative destructioncreative destruction
– capital accumulationcapital accumulation
– guiding function of pricesguiding function of prices– role in promoting progressrole in promoting progress
– technological advancetechnological advance– creative destructioncreative destruction
– capital accumulationcapital accumulation
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.3 13
Five Fundamental QuestionsFive Fundamental Questions
1. What will be produced?2. How will the goods and services be
produced?3. Who will get the goods and
services?4. How will the system accommodate
change?5. How will the system promote
progress?• technological advance• capital accumulation
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.3 14
The “Invisible Hand”The “Invisible Hand”
• Prices communicate information about scarcity and value
• Competition forces producers and resource suppliers to respond
• Firms, acting in their own best interest, also promote society’s interests in terms of efficiency
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.3 15
Three special merits of the market system:
• Efficiency• Incentives• Freedom
The “Invisible Hand”The “Invisible Hand”
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.4 16
The Demise of the Command The Demise of the Command SystemSystem
• The Coordination Problem• The Incentive Problem
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.5 17
Market FailureMarket Failure
Spillovers or Externalities• spillover costs
– correction through• Legislation• Specific Taxes
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.5 18
Market FailureMarket Failure
Spillovers or Externalities• spillover benefits
– correction through• Subsidization of consumers/suppliers• Provision of goods via government
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.5 19
Market FailureMarket Failure
Public Goods and Services• non-rivalry• non-excludability• free-rider problemExamples• Airport security
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.5 20
Market FailureMarket Failure
Limitations of the Market System• market system has remarkable
virtues• it also has well-known
limitations
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.5 21
FACTORFACTORMARKETMARKET
FACTORSFACTORSOF PRODUCTIONOF PRODUCTION
INPUTSINPUTS
BUSINESSESBUSINESSES HOUSEHOLDSHOUSEHOLDS
Figure 2-2 Figure 2-2 The Circular Flow DiagramThe Circular Flow Diagram
$ COSTS
$ COSTS
$ INCOMES
$ INCOMES
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2.5 22
GOODS &GOODS &SERVICESSERVICES
GOODS &GOODS &SERVICESSERVICES
$ CONSUM
PTION
$ CONSUM
PTION
$ REVENUE
$ REVENUE
BUSINESSESBUSINESSES HOUSEHOLDSHOUSEHOLDS
FACTORFACTORMARKETMARKET
PRODUCTPRODUCTMARKETMARKET
INPUTSINPUTS
$ COSTS
$ COSTS
$ INCOMES
$ INCOMES
FACTORSFACTORSOF PRODUCTIONOF PRODUCTION
Figure 2-2 Figure 2-2 The Circular Flow DiagramThe Circular Flow Diagram
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2 23
Chapter SummaryChapter 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 Economy
2.5 Market Failure2.6 The Mechanism of the Circular Flow
Model
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