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Chapter 4. The Market System and the Private Sector. Private vs. Public Sectors. The private sector is made up of households, businesses, and the international sector. The public sector refers to activity by the various levels of government.
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Chapter 4 The Market System and the Private Sector
Private vs. Public Sectors • The private sector is made up of households, businesses, and the international sector. • The public sector refers to activity by the various levels of government. • Productive activity occurs in both sectors. A basic problem is determining which sector can best produce a given good or service.
The Market System • In the market systemof the private sector, the consumer is supreme. • Consumer Sovereignty: consumers determine what is produced through their purchases of goods and services. • In contrast, in centrally planned economies, a government planning group decides what will and will not be produced. • In a centrally planned economy, there is a limited private sector and the market does not fully function.
Agents • Household: • A group of people living in the same unit of housing. The householder is the person in whose name the housing is owned or rented. • Household spending is called “consumption”. • Firm: • A business organization controlled by a single management. It may operate in more than one location. It is also referred to as a company, an enterprise, or a business. • Firm spending on capital goods used in producing other goods is called “investment”.
Profit and the Allocation of Resources Adam Smith argued that under the usual assumptions of a market economy, production and distribution decisions would be made in a decentralized way, maximizing individual, personal freedoms, as if the economy were coordinated by an invisible hand. No one person is at the mercy of any other one person, yet the standard of living is the highest possible, products are sold at fair prices, and people are paid according to their contributions.
Production Decisions • The profit motive drives firms: • to allocate their resources toward the production of the products the consumers want (demand), hence consumer sovereignty. • to produce as efficiently as possible, therefore at the lowest cost. • Competitive markets drive prices down to economic costs, therefore providing products to consumers at the lowest possible prices. Cet. par., this improves the average standard of living.
Income Distribution Decisions • Ownership of resources determines who gets what goods and services in a market system. • Firms pay the factors of production according to their marginal product (according to what they contribute to production). • Workers receive wages equal to the marginal product of labor. • Contributors of capital receive interest equal to the marginal product of capital. • Owners of land receive rents equal to the marginal product of land.
Forms of Business Organization • Sole Proprietorship: • a business owned by a single person, who receives all the profits and is responsible for all its debts. • Partnership: • A business owned by two or more partners, who share the profits and share the responsibility for debts or losses. • There are far more sole proprietorships and partnerships in the U.S. than there are corporations.
Forms of Business Organization • Corporation: • A legal fictitious person. The law sees the corporation as a distinct person from its owners. • The owners are shareholders who share the profits but are not held liable beyond their investment (stock). They enjoy limited liability. (Hence ltd.) • A multinational business is one that operates in several countries.
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