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Chapter 2: Markets and government in a modern economy. what is market and what is the invisible hand how market solve the basic economic problems the economic role of government Different terms trade, Money and Capital. Learning Objectives.

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chapter 2 markets and government in a modern economy
Chapter 2: Markets and government in a modern economy
  • what is market and what is the invisible hand
  • how market solve the basic economic problems
  • the economic role of government
  • Different terms
  • trade, Money and Capital.
learning objectives
Learning Objectives
  • 1. Describe what is meant by the term market and describe the process of achieving equilibrium in a market economy.
  • 2. Use your definition of market equilibrium to address three basic economic problems that confront all societies.
  • 3. Explain how the price system works as an invisible hand, allocating goods and services in a market economy.
  • 4. Use a circular-flow diagram to illustrate the relationships between agents and markets in a modern economy.
  • 5. Make a case for government intervention in a mixed market economy in order to promote efficiency, equity, and macroeconomic growth and stability.
market definition
Market definition
  • A market is the institution through which buyers and sellers interact and engage in exchange.
  • A market economy has at its heart the actions of buyers and sellers who exchange goods and services with one another.
a what is a market
A. What Is a Market?
  • There is no higher authority that directs the behavior of these economic agents; rather, it is the invisible handof the marketplace that allocates final goods and services, as well as factors of production.
  • Buyers and sellers receive signals from one another in the form of prices. If buyers want to buy more of a good, prices rise and sellers respond by supplying more to the marketplace.
  • If buyers want to buy less of a good, prices fall and sellers respond by supplying less to the marketplace.
  • Market equilibrium occurs when the price is such that the quantity that buyers are interested in purchasing is equal to the quantity that sellers are interested in supplying to the market.
  • The market mechanism allows an economy to simultaneously solve the three economic problems of what, how, and for whom.
economic problem
Economic problem
  • The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions?
  • To answer the three basic questions we need to study the economic systems.
economic systems
Economic Systems
  • Economic systems are the basic arrangements made by societies to solve the economic problem.
  • They includes four systems:
  • Islamic economy
  • Laissez-faire economies
  • Command economies
  • Mixed systems
islamic economy
Islamic Economy
  • Some people think that Islam has no economic system of its own
  • Islamic Economics is as Old as Islam Itself
islamic economy15
Islamic Economy
  • Islamiceconomicsis accordance withIslamic law.
  • Islamic economics can refer to the application of Islamic law to economic activity either where Islamic rule is in force or where it is not;
  • i.e. it can refer to the creation of an Islamic economic system, or to simply following Islamic law in regards to spending, saving, investing, giving, etc. where the state does not follow Islamic law.
definition of islamic economics
Definition of Islamic economics
  • The Islamic economics is both a science and an art which deals with the daily routine of a Muslim's economic life.
  • i.e. how he earns his income and how he spends it. It is a science in the sense that it involves many scientific methods in the production of material goods, their distribution and consumption.
  • The Islamic economic system is directly guided by Allah Almighty Himself.
  • all important aspects of the Islamic economic system and the applicable norms are thoroughly discussed in the Holy Quran
  • Allah created all needed provisions so that they may consume them and may satisfy their wants
other principles
Other principles
  • All wealth belongs to Allah (SWT(
  • The Muslims are the custodians and trustees of the wealth.
  • Hoarding the wealth is forbidden.
  • Circulating the wealth is obligatory
كل الثروة مملوكة وترجع إلى الله تعالى
  • المسلمون هم الحراس والأمناء على الثروة والمال
  • اكتناز الثروات ممنوع
  • تعميم وتدوير هذه الثروة واجب
the free market system
The free market system
  • In a laissez-faire economy,individuals and firms pursue their own self-interests without any central direction or regulation.
  • The central institution of a laissez-faire economy is the free-market system.
  • A market is the institution through which buyers and sellers interact and engage in exchange.
consumer sovereignty
Consumer sovereignty
  • Consumer sovereignty is the idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).
free enterprise
Free enterprise
  • Free enterprise: under a free market system, individual producers must figure out how to plan, organize, and coordinate the production of products and services.
distribution of output
distribution of output
  • In a laissez-faire economy, the distribution of output is also determined in a decentralized way. The amount that any one household gets depends on its income and wealth.
free system
Free System
  • The basic coordinating mechanism in a free market system is price. Price is the amount that a product sells for per unit. It reflects what society is willing to pay.
command economies
Command economies
  • In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices.
  • And the government determine what to produce and how much and How and for Whom to produce.
mixed systems markets and governments
Mixed Systems, Markets, and Governments

Since markets are not perfect, governments intervene and often play a major role in the economy.

Some of the goals of government are to:

goals of government in mixed economy
goals of government in mixed economy
  • Minimize market inefficiencies
  • Provide public goods
  • Redistribute income
  • Stabilize the macro economy:
    • Promote low levels of unemployment
    • Promote low levels of inflation
the basic decision making units
The Basic Decision-Making Units

Firms and Households and An entrepreneur

a firm
A firm
  • A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy.
an entrepreneur
An entrepreneur
  • An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.
  • Households are the consuming units in an economy
input markets and output markets the circular flow
Input Markets and Output Markets: The Circular Flow
  • The circular flow of economic activity shows how firms and households interact in input and output markets.
b trade money and capital
B. Trade, Money, and Capital
  • Advanced economies use complex systems of trade in order to accumulate the bundle of goods and services that the people in that economy want to consume.
  • People produce the goods and services that they can produce most efficiently, and then they trade their excess for other items that they need.
  • Money is not an input or factor of production. Consumers and firms use money in order to more efficiently carry out market transactions; it is a kind of lubricating oil that allows the machinery of an economy to operate with a minimum of friction.
  • In this course, the term capital does not refer to money. Instead, the term refers to productive inputs.
  • capital includes durable items like factory buildings, machine tools, electric drills, jack hammers, and so on. It also includes stocks of semi finished goods. These are goods which are on the way to becoming consumer goods but which are still manufactured inputs to be used in later stages of the production process.
capital accumulation
Capital accumulation
  • Capital accumulation is an important determinant of economic growth. An economic system that builds a strong capital base is investing in a factor of production that will make all other factors more productive or useful.
the economic role of government
The Economic Role of Government
  • In the real world, markets do not always operate as smoothly as we might like. Market imperfections lead to a wide range of problems, and governments step in to address them.
gov intervention
Gov. intervention
  • Governments intervene in a market economy in order to promote efficiency.
role of government
Role of Government
  • Market allocations are only efficient when conditions of perfect competition hold; this means that no firm or consumer is large enough to affect input or output market prices.
  • When there are many small firms in a market, competition forces all firms to operate with lowest possible costs and prices.
role of government46
Role of Government
  • Market allocations become inefficient when externalities occur. Externalities are the positive or negative effects on outside parties that production or consumption in an industry yields. For example,
  • When people receive education, schools and students benefit, but so do others in the community who now have neighbors who are better educated.
role of government48
Role of Government
  • Governments intervene in a market economy in order to promote equity, or fairness, in the distribution of resources and income.
  • This is a difficult concept because there is no universal definition of fairness. Markets distribute goods and services to those who have the money to purchase them, not necessarily to those who need or deserve them the most.
role of government50
Role of Government
  • Governments intervene in a market economy in order to promote macroeconomic growth and stability using monetary and fiscal policy.
fiscal policies
Fiscal policies
  • Fiscal policies of government (the power to tax and spend) that try to affect the economic stability
monetary policy
Monetary policy


  • interest rate policies
  • Money creation and issuing
  • So It is (the power to adjust the money supply and interest rates)
the effect of m f policy
The effect of M. & F. policy
  • M. & F. policy help to move an economy along a stable path, avoiding periods of excessive inflation and unemployment.