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The Market System and Circular Flow. Chapter 2. Economic Systems. Economic System A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem . Economic Systems. Differ in 2 Ways Who owns the Factors of Production

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economic systems
Economic Systems
  • Economic System
    • A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem
economic systems1
Economic Systems
  • Differ in 2 Ways
    • Who owns the Factors of Production
    • The method used to Motivate, coordinate, and direct economic activity
economic systems2
Economic Systems
  • Types of Systems
  • Market System
    • Otherwise known as Capitalism
  • Command System
    • Otherwise known as socialism or communism
economic systems3
Economic Systems
  • Command system
    • Government owns most of the property resources
    • Decision-making occurs through a Central Economic Plan
    • A Central Committee specifies allocation of resources and production goals
    • http://youtu.be/J02RdkvI6zo
economic systems4
Economic Systems
  • Market System
    • Private Ownership of most of the property resources
    • Decision-making occurs through markets and prices
    • Participants act in their own self-interest
    • Competition between buyers and sellers
    • Increased monetary awards (Motivation)
economics systems
Economics Systems
  • Market Systems
    • Laissez-faire
      • Hand off or Let it Be
      • Government stays out of the decision making process completely
      • http://youtu.be/8fmEJ7yrnlA
economics systems1
Economics Systems
  • Market Systems –United States
    • Government does play a role
      • Promotes economic stability
      • Provides rules for economic activity
      • Provides certain goods and services that would otherwise be under produced or not produced at all
economics systems2
Economics Systems
  • Market Systems
    • Characteristics
      • Private Property
        • Individuals and firms own land and capital
        • Freedom to negotiate contracts, use, and sell property
        • Right to inherit property
        • Encourage investment and innovation (incentives)
        • Legitimizes ownership and facilitates exchange
        • Extends to intellectual property
economics systems3
Economics Systems
  • Market Systems
    • THINK About it this way:
      • Would you go out of your way do something that you were not guaranteed credit for in some way?
freedom of enterprise and choice
Freedom of Enterprise and Choice
  • Freedom of Enterprise
    • Entrepreneurs and private businesses are free to obtain and use economic resources to produce what they want and sell them when they want
  • Freedom of Choice
    • Owners are able to employ and dispose of their property and their money any way they would like
    • Workers can enter any profession
    • Consumers can buy whatever they want
self interest
Self Interest
  • Self Interest
    • Motivating force of the various economic units as they express their free choice
    • Get what you want
competition
Competition
  • Competition
    • Two or more buyers or sellers acting independently in a particular resource market
    • Freedom of sellers or buyers to leave a market based on their own self-interest
markets and prices
Markets and Prices
  • Market
    • Brings buyers and sellers into contact
    • Those who listen to what the market wants and needs are rewarded
    • Those who don’t fail
    • Example AOL
technology and capital goods
Technology and Capital Goods
  • Advanced Technology
    • The Market System encourages the develop and advancement of technology
    • More efficient production means much more abundant output
specialization
Specialization
  • Specialization
    • The use of resources of an individual of firm to produce one or a few goods or services rather than an entire range
    • Producers usually do not consume what they produce
division of labor
Division of Labor
  • Division of Labor (human specialization)Contributes by:
    • Making use of different talents and abilities
    • Fosters learning by doing
      • Develop improved techniques
    • Saves time
      • No back and forth
      • Focus and move to the next one
      • Less down time
specialization1
Specialization
  • Geographic Specialization
    • Some items are better suited to be produced in a certain area (oranges =Florida)
    • Surpluses are sold for other items
specialization2
Specialization
  • Both Human & Geographic Specialization
    • Are needed to achieve efficiency in the use of limited resources
use of money
Use of Money
  • Characteristics of Money
    • Medium of Exchange
      • Makes trade easier
      • It must be generally acceptable to sellers in exchange for their goods and services
      • Money is socially defined as:
        • Whatever society accepts as a medium of exchange
        • i.e. Flintstones use clam shells
use of money1
Use of Money
  • Barter
    • Swapping Goods for other goods
      • Main Problem you have to have a coincidence of wants
      • i.e. You have to want what the other person wants and vice versa
active government
Active Government
  • Active, but limited Government is needed
    • Due to market failures
      • Shortcomings in the market
active government1
Active Government
  • THINK ABOUT IT:
    • Why does government help the market system?
five fundamental questions
Five Fundamental Questions
  • What goods and services will be produced?
    • Those that make Profit
    • Profits or Losses = TR-TC (Total Revenue – Total Cost)
    • Economic Costs include:
      • Wages for labor
      • Interest and Rental payments for land and capital
      • Payments to the entrepreneur for organizing and combining the resources to produce a good
five fundamental questions1
Five Fundamental Questions
  • TR>TC
    • Industry Expands
    • Resources are put into the industry
    • Existing firms grow
    • New firms enter
  • TC>TR
    • Reduced production
    • Exit of resources from industry
    • Firms contract
    • Firms go out of business
    • Industry contracts

Expansion & Growth

Contraction & Death

five fundamental questions2
Five Fundamental Questions
  • What goods and services will be produced?
    • Consumer Sovereignty
      • Consumers are in control
      • Dollar Votes
      • Crucial in determining the types and quantities to produce
      • Customers spend their money on what they want to buy
      • If people want it, it will be made
      • Influences producers and resource suppliers
five fundamental questions3
Five Fundamental Questions

2. How will goods and services be produced?

  • In combinations and ways that minimize the cost per unit of output
  • Competition will eliminate high-cost producers
  • Profitability will require that firms produce output at a minimum cost per unit
five fundamental questions4
Five Fundamental Questions

2. What goods and services will be produced?

  • Least-cost production
    • Firms must employ the most economically efficient technique of production in producing their output
    • Depends on the available technology (combination of resources needed)
    • Depends on prices of the needed resources
    • (See page 36 and worked problem 2.1)
five fundamental questions5
Five Fundamental Questions

3. Who will get the goods and services?

  • Distributed based on the willingness and ability to pay (if you can buy it at the price offered you get it!!)
  • And your preference (if you want it)
five fundamental questions6
Five Fundamental Questions

4. How will the system accommodate change?

  • Market systems are dynamic and change
    • Consumer preferences
    • Technology
    • Allocation of resources
  • Directed and guided by consumer preferences
five fundamental questions7
Five Fundamental Questions

5. How will the system promote progress?

  • Technological Advance
    • Create technologies that will reduce cost and therefore increase market share and profit
      • Competitors will have to keep up or fail
    • Creative Destruction
      • New technology that totally makes other technology or processes obsolete (Cell Phones pay phones)
five fundamental questions8
Five Fundamental Questions

5. How will the system promote progress?

  • Capital Accumulation
    • Entrepreneur and business owners uses dollar votes for capital goods
    • Will result in greater future profit
    • Can get money for these investments from selling shares
the invisible hand
The “Invisible Hand”
  • Individuals will promote the public good of society by doing what is best for them as an individual
  • This invisible hand will guide resources to areas where they are needed
benefits of the market system
Benefits of the Market System
  • Efficiency
    • Encourages and guides resources to the most efficient way of production
  • Incentives
    • Risk can equal great reward
    • Working harder and acquiring more skills will result in higher individual gains
  • Freedom
    • Personal freedom to make choices that benefit the individual
demise of the communist system
Demise of the Communist System
  • Coordination Problem
    • Central Planning committee had to coordinate the decisions of numerous people and industries
    • Failure of one decision would set off a domino effect
    • Managers would get bonuses based on qty not quality so they would sacrifice quality
    • Also many things were not spelled out
    • i.e. needed 1 lb of nails, company made 1, 1 lb nail
    • i.e. needed 1,000 nails, company made 1,000 tiny nails
demise of the communist system1
Demise of the Communist System
  • Incentive Problem
    • No profit incentive
    • No one then cared
    • Could not gain unless you were political
    • Got paid no matter what
circular flow model
Circular Flow Model
  • Resource Market
    • The place where resources or the services of resource suppliers are sold
  • Product Market
    • The place where goods and services are bought and sold
circular flow model1
Circular Flow Model
  • Now create your own Circular Flow Model using the desks in the room