Economic Systems

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Economic Systems

• Chapter 2 Section 2
• Free Market
• http//www.reffonomics.com/TRB/Chapter3/circularfl
  ow7.swf

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Economic Systems Section 1

• 1. What is an economic system?
• 2. How do a traditional economy, a market
  economy, a command economy, and a mixed economy
  differ?
• 3. Why arent all people paid the same amount in
  factor payments for the resources they provide?
• 4. Why do governments provide safety nets for
  their citizens?
• 5. Give at least example of a traditional, a
  command, and a market economic system.

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Economic Systems

• Objectives
• Explain why markets exist.
• Analyze a circular flow model of a free market
  economy.
• Understand the self-regulating nature of the
  marketplace.
• Identify the advantages of a free market economy.

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Economic Systems

• What does a farmers market, a sporting goods
  store, the New York Stock Exchange, and the sign
  you post on your community bulletin board
  advertising baby-sitting services have in
  common?

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Economic Systems

• All are examples of markets.
• A market is an arrangement that allows buyers and
  sellers to exchange things.

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Economic Systems

• Why Markets Exist
• Markets exist because no one is self-sufficient.
• None of us produces all that we require to
  satisfy our needs and wants.
• We dont grow many of the things we need, we buy
  them at a store.
• Markets allow us to exchange the things we have
  for the things we want.

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Economic Systems

• Why Markets Exist
• Instead of being self-sufficient, each of us
  produces just one or a few products.
• Specialization the concentration of the
  productive efforts of individuals and firms on a
  limited number of activities.
• Specialization makes us more efficient.
• It is easier to learn one task or a few tasks
  very well than to learn all the tasks we need.

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Economic Systems

• Why Markets Exist
• We need markets to sell what we have and to buy
  what we want.

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Economic Systems

• Free Market Economy
• Economic systems that are based on voluntary
  exchanges in markets are called free markets.
• Individuals and businesses use markets to
  exchange money and products.

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Economic Systems

• Free Market Economy
• Individuals answer the three key economic
  questions.
• This type of economy functions best in a system
  of decentralized decision-making governments
  (like U.S.)
• We can represent a free market economy in a
  special kind of drawing called a circular flow
  diagram.

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Economic Systems

• Free Market Economy
• A Circular Flow diagrams shows at a glance how
  individuals and businesses exchange money,
  resources, and products in the marketplace.
• The inner ring of the diagram represents the flow
  of resources and products.
• The outer ring of the diagram represents the flow
  of money.

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Economic Systems

• Households are a person or group of people
  living in the same residence.
• Households own the factors of production land,
  labor, and capital.
• Business or firm an organization that uses
  resources to produce a product which it then
  sells.
• Firms transfer inputs or factors of production
  into outputs or products.

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Economic Systems

• Factor Markets - arena of exchange.
• Profit is the financial gain made in a
  transaction.
• All businesses want a profit to stay in business.
• The next slide shows the
• Circular Flow of Economic Activity

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Economic Systems
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Economic Systems

• Circular Flow of Economic Activity Including
  Taxes

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Economic Systems

• The Self-Regulating Nature of the Marketplace
• How is it that firms and households cooperate to
  give each other what they want factor resources
  and products.
• Adam Smith said competition and our own
  self- interest is what keeps the marketplace
  functioning.

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Economic Systems

• The Self-Regulating Nature of the Marketplace
• 1. Self Interest
• In 1776 Adam Smith published a book entitled
  The Wealth of Nations
• He described how the market functions.
• He observed that an economy is made up of
  countless individual transactions.
• In each transaction, the buyer and seller
  consider only their self-interest or their own
  personal gain.
• Self-interest is the motivating force in the free
  world.

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Economic Systems

• The Self-Regulating Nature of the Marketplace
• 2. Competition
• Consumers (households) in pursuit of their
  self-interest, have the incentive to look for the
  lower prices.
• An incentive is the hope of reward or the fear of
  punishment that encourages a person to behave in
  a certain way.
• Smith observed that people respond predictably to
  both positive and negative incentives.
• As for consumers we expect they will buy more
  of an item if the price is lower. Vice-Versa,
  they will buy less of an item if the price is
  higher.

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Economic Systems

• The Self-Regulating Nature of the Marketplace
• Consumers, pursuing their self-interest will buy
  the lower priced item most of the time.
• Economists call this struggle among producers for
  the dollars of consumers competition.
• 3. Invisible Hand
• Self-interest and competition work together
  to regulate the marketplace.
• The overall result is that consumers get the
  products they want at the prices that closely
  affect the cost of producing them.

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Economic Systems

• Advantages of a Free Market
• 1. Economic Efficiency
• 2. Economic Freedom
• 3. Economic Growth
• 4. Additional Goals
• Consumers, in essence, decide what gets produced
  called consumer sovereignty

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Economic Systems

• REVIEW
• 1. How does specialization make us more
  efficient?
• 2. What is the difference between the factor
  market and the product market?
• 3. What is profit?
• 4. What are the roles of households and firms in
  a market economy?
• 5. How does competition among firms benefit
  consumers?
• 6. Explain what Adam Smith meant by the
  invisible hand of the marketplace.
• 7. What is the connection between incentives and
  consumer sovereignty in a free market economy?