I. Learning objectives – After the reading this chapter, students should be able to: A. Differentiate between a command system and a market system. B. List main characteristics of the market system. C. Explain how the market system decides what to produce, how to produce it, and who obtains it. D. Discuss how the market system adjusts to change and promotes progress. E. Describe the mechanics of the circular flow model.
II. Economic Systems Economic systems differ in two important ways: Who owns the factors of production and the method used to coordinate economic activity. A. Command economy, socialism or communism: 1. There is public (state) ownership of resources. 2. Economic activity is coordinated by central planning B. The market system: 1. There is private ownership of resources. 2. Markets and prices coordinate and direct economic activity. 3. Each participant acts in his or her own self-interest. 4. In pure capitalism the government plays a very limited role. 5. In the U.S. version of capitalism, the government plays a substantial role.
III. Characteristics of the Market System A. Private individuals and firms own most of the private property (land and capital). 1. Private property, coupled with the freedom to negotiate binding legal contracts, enables individuals and businesses to obtain, control, use, and dispose of this property. 2. Private property rights spur mutually agreeable transactions. 3. Private property rights encourage investment, innovation, exchange of assets, maintenance of property, and economic growth. 4. Property rights extend to intellectual property through patents, copyrights, and trademarks. B. Freedom of enterprise and choice exist. 1. Freedom of enterprise means that entrepreneurs and businesses have the freedom to obtain and use resources, to produce products of their choice, and to sell these products in the markets of their choice. 2. Freedom of choice means: a. Owners of property and money resources can use resources as they choose. b. Workers can choose the training, occupations, and job of their choice. c. Consumers are free to spend their income in such a way as to best satisfy their wants. C. Self-interest a. Self interest is one of the driving forces in a market system. Entrepreneurs try to maximize profits or minimize losses; resource suppliers try to maximize income; consumers maximize satisfaction. b. As each tries to maximize profits, income, satisfaction, the economy will benefit if competition is present. D. Competition among buyers and sellers is a controlling mechanism. 1. Large numbers of sellers mean that no single producer or seller can control the price or market supply. 2. Large number of buyers means that no single consumer or employer can control the price or market demand. 3. Depending upon market conditions, producers can enter or leave industry easily. E. Markets and prices 1. A market system conveys the decisions of the many buyers and sellers of the product and resource markets. 2. A market is an institution or mechanism that brings buyers and sellers into contact.
3. Individual decisions by buyers and sellers in the market determine the product and resource prices that, in turn, guide further decisions by resource owners, producers, and consumers. 4. Those who respond to the market signals will be rewarded with profits and income. F. Reliance on technology and capital goods 1. Competition, freedom of choice, self-interest, and the potential of profits provide the incentive for capital accumulation (investment). 2. Advanced technology and capital goods…