Chapter 2: The Market System and the Circular Flow

Economic system

A particular set of institutional arrangements + coordinating mechanism used to respond to the economizing problem

Command system

Socialism/communism; gov’t owns most property + economic decision-making occurs through central economic plan

Market system

Capitalism; private ownership of resources + use of markets/prices to coordinate economic activity

Private property

Private individuals + firms own most property resources; encourages investment, innovation, economic growth

Freedom of enterprise

Entrepreneurs + businesses can obtain resources to produce + sell goods

Freedom of choice

Owners can employ property/money as they see fit; consumers can buy goods and services that best satisfy their wants

Self-interest

Each economic unit tries to achieve its own particular goal, usually delivering something of value to others

Competition

Between economic units; based on freedom of choice in pursuit of monetary return; spreads economic power between businesses + households

Markets

Institution/mechanism that brings buyers + sellers into contact

Specialization

Use of resources to produce a few goods instead of an entire range

Division of labor

Human specialization

Medium of exchange

Function of money; makes trade easier

Barter

Swapping goods and services for each other; requires coincidence of wants between buyers and sellers

Money

Convenient social invention to facilitate exchanges of goods and services

Consumer sovereignty

Consumers spend income on goods they are willing + able to buy

Least cost production

________- Most economically efficient techniques of production.

“Dollar votes”

Consumers using dollars to show what goods + services they want in the market; determine which industries survive and fail

Creative destruction

Creation of new products + production methods destroys market positions of firms relying on existing products and older business ways

“Invisible hand”

As firms seek to further their own self-interest in a market system, they simultaneously promote social interests

Circular flow diagram

Shows repetitive flows of goods, services, resources, and money through the economy

Resource market

Where resources by households sold to businesses

Product market

Where goods and services produced by businesses sold to households