The Market System and the Circular Flow

Flashcards covering key economic concepts related to market and command economic systems, their characteristics, the four fundamental economic questions, the virtues and problems of different systems, and the circular flow model with its components (households, businesses, markets).

Economic Systems

Set of institutional arrangements and a coordinating mechanism that determines who owns factors of production and what method is used to motivate, coordinate, and direct economic activity.

Command System

An economic system, also known as socialism or communism, characterized by government ownership of resources and decisions made by a central planning board, with North Korea and Cuba as examples.

Market System

An economic system, also known as capitalism, characterized by private ownership of resources and decisions based on markets, with a varied role for government.

Private Property

A characteristic of the market system allowing individuals and firms to obtain, own, control, employ, dispose of, and bequeath economic property.

Freedom of Enterprise and Choice

A characteristic of the market system ensuring entrepreneurs can produce chosen goods and services, and consumers are free to buy goods and services that satisfy their wants.

Self-Interest

A characteristic of the market system where each economic unit attempts to achieve its own particular goal, typically maximizing profit, income, or satisfaction.

Competition

A characteristic of the market system involving two or more buyers and two or more sellers acting independently, providing choices and limiting the power of any single participant.

Markets and Prices

A characteristic of the market system that brings buyers and sellers together to determine the prices of goods, services, and resources.

Specialization

The use of resources to produce one or a few goods or services rather than the entire range, including division of labor and geographic specialization.

Division of Labor

A form of human specialization that makes use of differences in abilities, fosters learning by doing, and saves time.

Geographic Specialization

A form of specialization where particular regions or countries produce specific goods due to resource availability or other factors.

The Four Fundamental Questions

The core questions for any economic system: What goods and services will be produced? How will they be produced? Who will get the goods and services? How will the system promote progress?

Dollar Votes

The method by which consumers register their wants in the market, determining which goods and services will be produced and influencing which products and industries survive or fail.

Creative Destruction

The process within a market system where the creation of new products and production methods simultaneously destroys the market power of existing firms and products, promoting technological advance.

Capital Accumulation

The process of increasing the stock of capital goods (e.g., machinery, equipment) to facilitate future production and promote progress within the economic system.

Invisible Hand

A concept introduced by Adam Smith, stating that in a market system, the pursuit of private self-interest by individuals and firms, without direct government intervention, collectively promotes the well-being of society as a whole through efficiency, incentives, and freedom.

Coordination Problem (Command Systems)

A difficulty faced by centrally planned economies in setting accurate output targets for all goods, leading to imbalances, inefficiencies, and economic failures.

Incentive Problem (Command Systems)

A difficulty faced by centrally planned economies due to a lack of adjustments for surplus or shortage, resulting in poor product quality, limited innovation, and persistent shortages.

Circular Flow System

An economic model illustrating the continuous flow of resources, goods and services, and money between households and businesses within an economy.

Resource Market

Within the circular flow, this is where households sell resources (labor, land, capital, entrepreneurial ability) to businesses, and businesses pay money income (wages, rents, interest, profits) for these resources.

Product Market

Within the circular flow, this is where businesses sell goods and services to households, and households make consumption expenditures to purchase these items.

Households

In the circular flow, these are the ultimate suppliers of resources and the major spenders in the economy, earning income and purchasing goods and services.

Businesses

In the circular flow, these entities buy resources from households and sell products to households, categorized into sole proprietorships, partnerships, and corporations.

Sole Proprietorship

A type of business owned and operated by a single individual.

Partnership

A type of business owned and operated by two or more individuals.

Corporation

A type of business that is a separate legal entity from its owners, providing limited liability to them.

Durable Goods

Consumer goods that are expected to have a useful life of three years or longer.

Nondurable Goods

Consumer goods that are expected to have a useful life of less than three years.

Services

Intangible acts or uses for which people are willing to pay, such as haircuts, legal advice, or medical care.