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AIM: The Market Economy Do Now: In your notebook, briefly explain why you think the American economy is called a “Market Economy”. 6-7. Market Economy As long ago as ancient Egypt humans began to use forms of money to trade for goods and with the free trade of goods arose what is now known as the market economic system. In a market economy producers make goods based on the amount demand they perceive to exist among consumers. Consumers in turn pay for items based on their supply. For instance, gold is greatly demanded by people across the world, but its supply is limited. Therefore, gold is expensive. Market Economy • An economic system in which production and distribution questions are answered by prices and profits (supply and demand) • Most of the resources are owned by private citizens • Economic decisions are based on Free Enterprise (competition between companies) – Important economic questions are not answered by gov. but by individuals – Gov. does not tell a business what goods to produce or what price to charge Market Economy • Who decides what to produce? – Businesses base decisions on supply and demand and free enterprise (PRICE) • Who decides how to produce goods and services? – Businesses decide how to produce goods • Who are the goods and services produced for? – consumers Market Economy • There are no truly pure Market economies, but the United States is close. • In a truly free market economy, the government would not be involved at all – There would be no laws to protect workers from unfair bosses – There would be no rules to make sure that credit cards were properly protected Why might it be a good thing for government to get involved with issues like those above? Market Economy (free enterprise, capitalism) • In a free-market country, people can own their own businesses and property. People can also buy services for private use, such as healthcare. (But most capitalist governments also provide their own education, health and welfare services. ) Market Economy (free enterprise, capitalism) Individual producers must figure out how to plan, organize, and coordinate the production of products and services. In a market economy, resources are allocated through individual decision making. Market Economy (free enterprise, capitalism) • In a market economy, prices act as signals of scarcity. When the price of something is high, that means it's more scarce. Demand for it is high relative to the supply. Market Economy (free enterprise, capitalism) • When the price of something is low, then it's less scarce. By observing prices, consumers and producers can choose their behavior to respond to scarcity. Market Economy (free enterprise, capitalism) • High prices encourage producers to switch from more scarce to less scarce resources, • and they encourage consumers to switch from products and services that require more scarce resources to products and services that require fewer scarce resources. Pure Capitalism Type of economic system generally characterized by: • Limited involvement of the government in the economy. • Individual ownership of the factors of production. • Individuals pursue their own self interest with few constraints. What is an economic system ? All of the institutional means through which the FOP are used to satisfy wants. A representative democracy facilitates the institution of a capitalistic economy. What is an economic system ? By institution we mean principally the laws of the nation and cultural practices which control the way in which individuals act. A law is something that serves to instruct. What is an economic system ? There are six basic criteria associated with a pure capitalistic system: • The institution of private property • Free enterprise and free choice • Self interest • Competition and unrestricted markets • The market system • The limited role of government The Institution of Private Property • Ownership of most property is held by individuals or groups of individuals (corporations, partnerships, etc.). • The state is not the owner of productive resources that are important forms of property. The Institution of Private Property • Private property is controlled and enforced through the legal framework of laws, police, and courts. • Therefore one function of government is the protection of private property rights. The Institution of Private Property • Individuals are usually free to use their private property as they choose, so long as they do not infringe on the legal property rights of others. • Individuals are usually allowed to enter into private contractual agreements that are mutually satisfying. Free Enterprise and Free Choice (An Extension of Property Rights) • Exists when private individuals are allowed to obtain resources, to organize those resources, and to sell the resulting product in any way the individual chooses. • As long as their actions do not infringe on the property rights of others Free Enterprise and Free Choice (An Extension of Property Rights) –Assumes there are no artificial restrictions that a government or other producer can put up to block a business's choice in the matter of purchasing its inputs and selling its outputs. Free Enterprise and Free Choice (An Extension of Property Rights) –Assumes there are no artificial restrictions that a government or other producer can put up to block a business's choice in the matter of purchasing its inputs and selling its outputs. Free Enterprise and Free Choice (An Extension of Property Rights) • Workers are free to enter any line of work for which they are qualified, and consumers can buy the desired basket of goods and services that they feel is best for them. Free Enterprise and Free Choice (An Extension of Property Rights) • The ultimate voter is the consumer, he/she votes with dollars, and decides which product will survive – This reasoning is known as consumer sovereignty, where the ultimate purchaser of goods and services determines what is produced. Free Enterprise and Free Choice (An Extension of Property Rights) • The ultimate voter is the consumer, he/she votes with dollars, and decides which product will survive – This reasoning is known as consumer sovereignty, where the ultimate purchaser of goods and services determines what is produced. Self Interest Normally implies the maximization of profits or the minimization of losses. • Consumers: strive to maximize the amount of satisfaction possible from spending a given amount of money income. (as little as possible!) Self Interest • Producers : strive to maximize the amount of net income possible from selling commodities at the highest possible price (get as much as possible!) Self Interest • Consumers: strive to maximize the amount of satisfaction possible from spending a given amount of money income. (as little as possible!) • Producers : strive to maximize the amount of net income possible from selling commodities at the highest possible price (get as much as possible!) Self Interest • Employees (Workers): strive to obtain the highest level of income possible for least amount of work. • Employers :strive to obtain the most amount of work from employees for the least cost. Self Interest • Owners of resources: strive to obtain the highest possible price when that resource is sold or leased. • Users of resources: strive to obtain the lowest possible price for a resource so that THEY can make the most profit. Competition and Unrestricted Markets • Competition is Rivalry among sellers who wish to attract customers and rivalry among buyers to obtain desired goods and services. Competition and Unrestricted Markets • Competition requires a minimum of two conditions: – A relatively large number of independently acting sellers and buyers. – Freedom of sellers and buyers to enter or exit a particular industry without restrictions (unrestricted markets). Competition and Unrestricted Markets • Economic competition imposes limits on the self interest of buyers and sellers. Competition is a regulating force in capitalist systems. – i.e. Raise prices Consumers go to another one of many sellers. – Economic profit earned New firms will enter the industry. Unrestricted Markets – Economic profit earned the industry. New firms will enter The Market System • An institution that develops from the – Private Property Rights – Free Choice and Free Enterprise – Self-Interest – Competition and Unrestricted Markets • Also referred to as the “Price System” The Market System • Capitalism is a market economy. That is, buyers and sellers relate their opinions by expressing how much they are willing to pay for, or how much they demand of goods and services. The Market System • Prices are used to signal the value of individual resources and commodities. Therefore, prices provide valuable information to consumers and producers. • Prices are the "guiding light" to which resource owners, businesses, and consumers follow when economic choices must be made. The Market System • Therefore, we can say that the market system (price system) IS the organizing force in capitalist systems. – Organization is the coordination of individuals in the furtherance of a common goal. The Market System • Resources tend to flow where they yield the highest rate of return or highest profit. The Market System • Prices generate the signals for resource movements, provide information cheaply and quickly, and affect incentives. – i.e. The current movement of resources out of the farming sector and into the ornamentals, landscape and turf sectors. Market Economic System: (Free Market, Capitalism) Buyers and Sellers: Dollars “Vote” The Basic economic questions are answered: by having buyers and sellers make economic decisions. Advantages • Overtime, can adjust to change • Individual freedom for everyone • Little government interference • Decentralized – not concentrated in the hands of a few • Variety of goods and services • High degree of consumer satisfaction Disadvantages • Rewards only productive resources; does not provide for people too young, too, old, or too sick to work • Workers/businesses face uncertainty as a result of competition and change: no guarantee for job • Does not produce enough public goods such as defense, universal education, or health care 6-7. Market Economy As long ago as ancient Egypt humans began to use forms of money to trade for goods and with the free trade of goods arose what is now known as the market economic system. In a market economy producers make goods based on the amount demand they perceive to exist among consumers. Consumers in turn pay for items based on their supply. For instance, gold is greatly demanded by people across the world, but its supply is limited. Therefore, gold is expensive. 8-10. Market Economy= Capitalism Another word for market economic systems is capitalism. Capitalism is an economic and political ideology written about by an 18th century thinker- Adam Smith in a book entitled “The Wealth of Nations.” Smith claimed that the more the people of different people trade with each other the less likely they are to go to war. Moreover, he claimed that the government must not interfere with the economy or it may disrupt trade and people’s ability to prosper. Smith claimed that instead of a government running an economy an “invisible free hand” known as a market would. Today this concept is referred to as laissez faire or hands off economics. Market Economy Adam Smith claimed that people who trade with each other don’t go to war with each other. 11. Characteristics of Market Economies • Entrepreneurship and risk taking are rewarded with big financial gains. • Private property rights are strictly enforced even when they result in many poor people and few very wealthy people. • Producers decide what to produce based on consumer tastes and demands. • Productivity results in more personal wealth • Government’s role in the economy is limited • The economy is based on almost entirely on supply and demand • Private individuals and companies own businesses and industry. Examples of Market Economies • To a large extent the US has a market economy. Compared to the rest of the world taxes are low and supply is determined by demand • Singapore is also an example of a market economy. In Singapore there are very few taxes and businesses can decide on how and what to produce. • In reality there is no such thing as a true market economy because the government in almost every nation around the world plays a significant role in the economy including the US “It’s Your money, not the government’s”President Ronald Reagan Market economies are based on the open and free trade of goods. In the New York Stock Exchange individuals buy and sell stocks (ownership) of companies (below) The World Trade Center was seen as a symbol of American capitalism because things were sold and bought there from around the world. The New York Stock Exchange is on the left. 12. Criticism of Market Economies • Market economies often result in unequal societies where there are a few very wealthy individuals and many poor people. • Market economies often encourage free trade that enables large private companies to exploit the laborers or the resources of less-developed nations. For instance, most of the clothing worn by Americans is made in China by workers who earn less than a $1 an hour. • Market economies often result in economic monopolies (when one company controls a business sector) that stop competition and result in higher prices Market System • Market economy – system in which individuals own the factors of production and make economic decisions through free interaction while looking out for their own and their families’ best interests • Limited government, individuals control factors of production and economy driven by market price Market System • Market – freely chosen activity between buyers and sellers of goods and services • Circular flow of economic activity – economic model that pictures income as flowing continuously between businesses and consumers • Advantages – free to choose career and how to spend $, own private property, take risks, & many goods for purchase • Disadvantages – How to provide for elderly, young & sick Mixed System • Mixed economy – system combining characteristics of more than one type of economy • Most countries have a mixed economy • Most individuals make decisions but are regulated to various extents by the government Characteristics of the American Economy • Freedom of choice – can choose to produce or not produce or to buy or not to buy • 6 Characteristics of a pure market system – – – – – – 1. 2. 3. 4. 5. 6. Little or no government control Freedom of enterprise Freedom of choice Private property Profit incentive Competition Characteristics of the American Economy • Limited role of government – Adam Smith – founder of modern economics - Wealth of Nations – people will use resources efficiently to achieve the maximum good for society – Capitalism – economic system in which private individuals own the factors of production & decide how to use them within legislated limits – Laissez-faire – pure capitalism – economic system in which the government minimizes its interference with the economy – Government has increased its role since the 1880s Characteristics of the American Economy • Freedom of enterprise – Free enterprise system – economic system in which individuals own the factors of production and decide how to use them within legal limits; same as capitalism – Regulations – zoning, child labor, pollution & taxes – examples – May make money or may lose money • Freedom of choice – Buyers, not sellers, make decisions about what is to be produced – Government influences the market to protect consumers – safety standards & price controls Characteristics of the American Economy • Profit Incentive – Profit – money left after all the costs of production have been paid – wages, bills & taxes – Profit incentive – desire to make money that motivates people to produce and sell goods and services Characteristics of the American Economy • Private Property – Private property – whatever is owned by individuals rather than by government – Constitution guarantees an owner’s right to private property and its use (eminent domain) • Competition – Competition – rivalry among producers and sellers of similar goods and services to win more business – Leads to lower prices, better quality and an efficient use of resources – Low barriers to entry are needed The Goals of the Nation • Goals of free enterprise in the U.S. – Economic freedom – allows members of society to make choices and possibly fail – Economic efficiency – wise use of available resources so that costs do not exceed benefits – Economic equity – attempt to balance an economic policy so that everyone benefits fairly – (equal pay, hiring practices & disabled) The Goals of the Nation • Economic security – protection against accidents, natural disasters, bank failures etc. • Economic stability – reduce extreme ups & downs in standard of living – Standard of living – the material well-being of an individual, group, or nation measured by how well their necessities and luxuries are satisfied • Economic growth – expansion of the economy to produce more goods, jobs and wealth • Trade-Offs among goals – limits on what you can do with resources due to scarcity (Social Security) Market System • Market economy – system in which individuals own the factors of production and make economic decisions through free interaction while looking out for their own and their families’ best interests • Limited government, individuals control factors of production and economy driven by market price Market System • Market – freely chosen activity between buyers and sellers of goods and services • Circular flow of economic activity – economic model that pictures income as flowing continuously between businesses and consumers • Advantages – free to choose career and how to spend $, own private property, take risks, & many goods for purchase • Disadvantages – How to provide for elderly, young & sick Mixed System • Mixed economy – system combining characteristics of more than one type of economy • Most countries have a mixed economy • Most individuals make decisions but are regulated to various extents by the government Characteristics of the American Economy • Freedom of choice – can choose to produce or not produce or to buy or not to buy • 6 Characteristics of a pure market system – – – – – – 1. 2. 3. 4. 5. 6. Little or no government control Freedom of enterprise Freedom of choice Private property Profit incentive Competition Characteristics of the American Economy • Limited role of government – Adam Smith – founder of modern economics - Wealth of Nations – people will use resources efficiently to achieve the maximum good for society – Capitalism – economic system in which private individuals own the factors of production & decide how to use them within legislated limits – Laissez-faire – pure capitalism – economic system in which the government minimizes its interference with the economy – Government has increased its role since the 1880s Characteristics of the American Economy • Freedom of enterprise – Free enterprise system – economic system in which individuals own the factors of production and decide how to use them within legal limits; same as capitalism – Regulations – zoning, child labor, pollution & taxes – examples – May make money or may lose money • Freedom of choice – Buyers, not sellers, make decisions about what is to be produced – Government influences the market to protect consumers – safety standards & price controls Characteristics of the American Economy • Profit Incentive – Profit – money left after all the costs of production have been paid – wages, bills & taxes – Profit incentive – desire to make money that motivates people to produce and sell goods and services Characteristics of the American Economy • Private Property – Private property – whatever is owned by individuals rather than by government – Constitution guarantees an owner’s right to private property and its use (eminent domain) • Competition – Competition – rivalry among producers and sellers of similar goods and services to win more business – Leads to lower prices, better quality and an efficient use of resources – Low barriers to entry are needed The Goals of the Nation • Goals of free enterprise in the U.S. – Economic freedom – allows members of society to make choices and possibly fail – Economic efficiency – wise use of available resources so that costs do not exceed benefits – Economic equity – attempt to balance an economic policy so that everyone benefits fairly – (equal pay, hiring practices & disabled) The Goals of the Nation • Economic security – protection against accidents, natural disasters, bank failures etc. • Economic stability – reduce extreme ups & downs in standard of living – Standard of living – the material well-being of an individual, group, or nation measured by how well their necessities and luxuries are satisfied • Economic growth – expansion of the economy to produce more goods, jobs and wealth • Trade-Offs among goals – limits on what you can do with resources due to scarcity (Social Security) Types of Economic Systems cont. • Market Economy – driven by choices of consumers and producers • consumers spend money, go into business, sell their labor as they wish • producers decide how to use their resources to make the most money – Consumers, producers benefit each other when they act in self-interest Fundamentals of a Market Economy • 1: Private Property and Markets • 2:Limited Government Involvement – Laissez faire—government should not interfere in economy – Capitalism—system having private ownership of factors of production • says producers will create products consumers demand – Actual market economies all have some government involvement Fundamentals of a Market Economy • 3: Voluntary Exchange in Markets – Voluntary exchange—traders believe they get more than they give up • 4: Competition and Consumer Sovereignty – Consumer sovereignty—buyers choose products, control what is produced – Competition controls self-interested behavior • sellers offer low price or high value to please consumers, make profit Fundamentals of a Market Economy • 5: Specialization and Markets – Specialization—people concentrate their efforts in the activities they do best • encourages efficient use of resources • leads to higher-quality, lower-priced products Circular Flow in Market Economies • KEY CONCEPTS – Circular flow model illustrates how interactions occur in a market – Represents the two key decision makers: households, businesses – Shows the two markets where households and businesses meet • goods and services • resources Circular Flow in Market Economies • Factor Markets – Factor market—market for the factors of production • land, labor, capital, entrepreneurship • Product Markets – Product market—market where goods and services bought and sold • includes all purchases by individuals from businesses Circular Flow in Market Economies • Circular Flow – Circular flow model shows how market economies operate • outside arrow shows flow of money • inside arrow shows flow of resources and products Impact of Market Economies • Advantages – Individuals free to make economic choices, pursue own work interests – Less government control means political freedom – Locally made decisions mean better use of resources, productivity – Profit motive ensures resources used efficiently, rewards hard work • resulting competition leads to higher-quality, more diverse products Impact of Market Economies • Disadvantages – Pure market economy has no way to provide public goods and services – Does not give security to sick or aged – During U.S. industrial boom, business owners rich, workers low pay – Businesses did not address problems caused by industrialization – Industrialized societies adopt some government control of economy