Chapter 2: The Market System and the Circular Flow (Notes)

Vocabulary flashcards covering key terms and definitions from Chapter 2: The Market System and the Circular Flow.

Economic systems

Set of institutionalized arrangements coordinating economic activity; differ by the degree of market-based decision making versus centralized government control.

Laissez-Faire Capitalism

An economic system with minimal government interference; government protects private property and enforces contracts; markets allocate resources.

Command system

An economy where the government owns resources and makes decisions through a central planning board.

Market system

An economy with private markets as the dominant force, private ownership of resources, some government control, and self-interested behavior.

Private property

Legal right to own and use resources and to transfer them.

Freedom of enterprise

Right to enter any legal business and produce goods or services.

Freedom of choice

Consumers' ability to choose among various products and producers.

Self-interest

Pursuit of one's own advantage; drives market decisions and exchanges.

Competition

Rivalry among buyers and sellers that leads to better products and lower prices.

Market and prices

Prices coordinate decisions about what to produce, how to produce, and who gets goods.

Specialization

Division of labor and geographic specialization in production.

Money

Medium of exchange that facilitates trade; without money, barter would be necessary.

Five fundamental questions

The five key questions a market system must answer: what to produce, how to produce, who gets output, how to accommodate change, and how to promote progress.

Consumer sovereignty

Consumers’ ability to influence what gets produced through their purchasing choices.

Dollar votes

Consumers' spending choices that signal preferred goods and services.

Efficient production techniques

Using technology and resource prices to minimize the cost per unit of output.

Ability to pay

The income and resources a person has to purchase goods.

Changes in the market system (change drivers)

Shifts caused by changes in consumer tastes, technology, and resource prices.

Creative destruction

The idea that technological advance creates new products and processes, destroying old ones and driving progress.

The Invisible Hand

The tendency of competition to promote social welfare as individuals pursue their own interests.

Demise of command systems

Command economies fail to deliver adequate goods due to coordination and incentive problems.

Coordination problem

Difficulty in setting output targets for all goods and services in a planned system.

Incentive problem

Lack of price signals and adjustments for surplus or shortage in a command system.

Circular Flow Model

Diagram showing the two markets (resource and product) and the flows between households and businesses in a private economy.

Resource Market

Market where households supply resources (land, labor, capital, entrepreneurship) and businesses demand them.

Product Market

Market where businesses sell goods and services to households.

Wages, rents, interest, profits

Income households receive from supplying resources.

Consumption expenditures

Households' spending on goods and services in the product market.

Revenues

Money earned by businesses from selling goods and services.

Costs

Money spent by businesses to produce goods and services.

Private closed economy

An economy with only households and businesses; no government sector.

Risk in the market system

Risks faced by business owners and investors from input shortages, changing tastes, and disasters; owners bear the risk.

Government intervention (active, limited)

Government action to alleviate market failures, recognizing that intervention can also fail.

Government failure

When government policies worsen or fail to improve market outcomes.