The Market System and the Circular Flow Notes

The three core choices that confront every nation: * What to produce with our limited resources * How to produce goods and services we select * For whom good and services are produced (who should get them) Economic Systems: * Set of institutional arrangements * Differ based on: * A) Who owns the factors of production? * B) What method directs economic activity?

The three economic systems: Planned economy: * Called a command economy * Production, distribution, and prices, are all made by the government * Market forces have very little role in such an economy This type of economy lacks the kind of flexibility that is present in a market economy, and because of this, the planned economy reacts slower to changes in consumer needs Mixed economy: * Combines elements of both the planned and the market economies in one cohesive system * Certain features from both market and planned economic systems are taken to form this type of economy * This system prevails in many countries where neither the government nor the business entities control the economic activities of that country – both sectors play an important role in the economic decision-making of the country * Includes both capitalist and socialist economic policies Market economy: * In a market economy, national and state governments play a minor role * Consumers and their buying decisions drive the economy * In this type of economic system, the assumption of the market plays a major role in deciding the right path for a country’s economic development * The absence of central planning is one of the major features of this economic system * Market decisions are mainly dominated by supply and demand * The role of the government in a market economy is to simply make sure that the market is stable enough to carry out its economic activities Market System Characteristics: * Private property Freedom of enterprise and choice * Self-interest * Competition * Markets and prices Chapter 2: the Market System and the Circular Flow Notes By Cabinetmaker * The market value of output (GAP) is a basic measure of an economy’s size The US Economy – A Global View: * US output and population growth since 1900 * Over time, the growth of output in the US has greatly exceeded population growth. As a consequence, GAP per capita has grown tremendously.

GAP per capita was five times higher in 2000 than in 1900 * The US gets richer almost every year How America Produces: * Resources * Resource inputs used to produce goods and services Human Capital * The US has invested heavily in human capital. Such work force possess knowledge and skills * Capital Stock * Production processes use a highly ratio of capital to labor inputs. That makes the US business so efficient * High Productivity * The output per unit of input in US production systems is high * Factor Mobility * Every year some industries expand and others contract or even disappear depending on resources reallocation * Outsourcing and Trade * By utilizing foreign resources and pursue the comparative advantage, the net national gains increases * Resources – Human Capital – High Productivity – Factor

Mobility – Capital Stock – Outsourcing and Trade Role of Government: * The government plays an important role in establishing a framework in which private businesses can operate * Providing a legal framework and enforce the rules of the game by establishing ownership rights, contract rights, and lays the foundation for market transaction * Protecting the environment * Protecting the consumers * Protecting labor * Striking a Balance * Market alone might not always select the best possible way of producing goods and services (Market Failure) * Government interventions are designed to change he way resources are used (Government Failure) * Striking is the right balance between market reliance and government regulation Circular Flow: Study Questions: Which of the following is a feature of a command system? -Central planning Which of the following is a distinguishing feature of a market system? Wide-spread private ownership of capital Examples of command economies are: -Cuba and North Korea -Is a particular set of institutional arrangements and a coordinating mechanism used to respond to the economizing problem The term laissez-fairer suggests that: -The government should not interfere with the operation of the economy Copyrights and trademarks are examples of: -Property rights The regulatory mechanism of the market system is: -Competition The presence of market failures implies that: -There is an active role for government, even in a market system From society point of view the economic function of profits and losses is to: – reallocate resources from less desired to more desired uses Economic profits and losses: -Are essential to the reallocation of resources from less desired goods to more desired goods The invisible hand refers to the: -Notion that, under competition, decisions motivated by self-interest promote the social interest

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