Chapter 2: The Market System and the Circular Flow

Vocabulary terms covering economic systems, the characteristics and mechanics of the market system, and the circular flow model as presented in the lecture notes.

Economic systems

A set of institutionalized arrangements and a coordinating mechanism used to respond to the economizing problem.

Laissez-Faire Capitalism

An ideal economy where government intervention is kept to a minimum, limited to protecting private property and providing a legal environment for contract enforcement.

The Command System

Also known as socialism or communism, a system where resources are government-owned and economic decisions are made by a central planning board.

The Market System

An economic system characterized by the private ownership of resources and a mix of decentralized decision-making with some government control.

Private Property

The right of private persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital, and other property.

Freedom of Enterprise

The freedom of firms to obtain economic resources and use those resources to produce products of the firm's own choosing and to sell them in markets of their choice.

Freedom of Choice

The freedom of owners of property resources to employ or dispose of them as they see fit, and of consumers to spend their incomes as they see fit.

Self-interest

The motivating force of the various economic units as they express their free choices to achieve their own particular goal.

Competition

The effort and rivalry between independent sellers to secure the business of buyers by offering the best possible terms.

Specialization

The use of resources of an individual, firm, region, or nation to produce one or a few goods or services rather than the entire range of goods and services.

Division of Labor

The separation of the work required to produce a product into a number of different tasks that are performed by different workers; human specialization.

Medium of Exchange

Any item sellers generally accept and buyers generally use to pay for a good or service; a function of money that eliminates the need for barter.

Barter

The direct exchange of one good or service for another good or service.

Consumer Sovereignty

The determination by consumers of the types and quantities of goods and services that will be produced with the scarce resources of the economy.

Dollar Votes

The "votes" that consumers cast for the production of preferred products when they purchase those products rather than the alternatives.

Creative Destruction

The hypothesis that the creation of new products and production methods simultaneously destroys the market power of existing monopolies and older ways of doing business.

The Invisible Hand

A concept described by Adam Smith in the 1776 book "Wealth of Nations" where the tendency of firms and resource suppliers seeking their own self-interest promotes the interest of society.

Coordination Problem

A failure of the command system where central planners were unable to efficiently coordinate the production and distribution of millions of goods.

Incentive Problem

A failure of the command system where the lack of profit motive and price signals meant there were no adjustments for surpluses or shortages.

Circular Flow Model

A diagram that illustrates the continuous flow of goods and services, resources, and money among households and businesses.

Households

Economic units that provide resources to the resource market and use the income received to purchase goods and services from the product market.

Sole Proprietorship

A business owned and managed by a single person.

Partnership

A form of business organization in which two or more individuals pool their resources and share profits and losses.

Corporation

A legal entity chartered by a state or the Federal government that is distinct and separate from the individuals who own it.

Product Market

A market in which products are sold by businesses and bought by households.

Resource Market

A market in which households sell and firms buy resources or the services of resources.