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Chapter 2: Markets and government in a
modern economy
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What is market and what is the invisible hand
how market solve the basic economic problems
the economic role of government
Different terms
trade, Money and Capital.
Learning Objectives
1. Describe what is meant by the market and
describe the process of achieving equilibrium
in a market economy.
2. Use your definition of market equilibrium to
address three basic economic problems that
confront all societies.
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Objectives
3. Explain how the price system works as an invisible
hand, allocating goods and services in a market
economy.
4. Use a circular-flow diagram to illustrate the
relationships between agents and markets in a
modern economy.
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Objectives
5. Make a case for government intervention
in a mixed market economy in order to
promote
efficiency,
equity,
and
macroeconomic growth and stability.
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Market definition
A market is the institution through which
buyers and sellers interact and engage in
exchange.
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A. What Is a Market?
• There is no higher authority that directs the
behavior of these economic agents; rather, it
is the invisible hand of the marketplace
that allocates final goods and services, as well
as factors of production.
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Markets
• Buyers and sellers receive signals from one
another in the form of prices. If buyers want
to buy more of a good, prices rise and sellers
respond by supplying more to the
marketplace.
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Markets
• If buyers want to buy less of a good, prices fall
and sellers respond by supplying less to the
marketplace.
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Markets
• Market equilibrium occurs when the price is such
that the quantity that buyers are interested in
purchasing is equal to the quantity that sellers
are interested in supplying to the market.
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Markets
• The market mechanism allows an economy
to solve the three economic problems of
what, how, and for whom.
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Economic problem
• The economic problem: Given scarce
resources, how, exactly, do large, complex
societies go about answering the three
basic economic questions?
• To answer the three basic questions we
need to study the economic systems.
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Economic Systems
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Economic systems are the basic
arrangements made by societies to solve
the economic problem.
Systems
They includes four systems:
1. Islamic economy
2. Laissez-faire economies
3. Command economies
4. Mixed systems
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Islamic Economy
• Some people think that Islam has no
economic system of its own
• Islamic Economics is as Old as Islam Itself
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Islamic Economy
• Islamic economics is accordance with Islamic
law .
• Islamic economics can refer to the application
of Islamic law to economic activity either
where Islamic rule is in force or where it is
not;
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Definition of Islamic economics
• The Islamic economics is both a science and an art
which deals with the daily routine of a Muslim's
economic life.
• i.e. how he earns his income and how he spends it. It
is a science in the sense that it involves many
scientific methods in the production of material
goods, their distribution and consumption .
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Principles
• The Islamic economic system is directly guided
by Allah Almighty Himself .
• all important aspects of the Islamic economic
system and the applicable norms are
thoroughly discussed in the Holy Quran
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Cont.
• Allah created all needed provisions so that
they may consume them and may satisfy their
wants
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‫•‬
‫•‬
‫•‬
‫•‬
‫كل الثروة مملوكة وترجع إلى هللا تعالى‬
‫المسلمون هم الحراس واألمناء على الثروة والمال‬
‫اكتناز الثروات ممنوع‬
‫تعميم وتدوير هذه الثروة واجب‬
‫‪19‬‬
Other principles
1. All wealth belongs to Allah (SWT(
2. The Muslims are the custodians and trustees of the
wealth.
3. Hoarding the wealth is forbidden.
4. Circulating the wealth is obligatory
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The free market system
• In a laissez-faire economy, individuals and firms
pursue their own self-interests without any
central direction or regulation.
• The central institution of a laissez-faire economy
is the free-market system.
• A market is the institution through which buyers
and sellers interact and engage in exchange.
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Consumer sovereignty
(‫) سيادة المستهلك‬
• Consumer sovereignty is the idea that
consumers ultimately dictate what will be
produced (or not produced) by choosing
what to purchase (and what not to
purchase).
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Free enterprise
• Free enterprise: under a free market
system, individual producers must figure
out how to plan, organize, and coordinate
the production of products and services.
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distribution of output
• In a laissez-faire economy, the distribution
of output is also determined in a
decentralized way. The amount that any
one household gets depends on its income
and wealth.
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Free System
• The basic coordinating mechanism in a free
market system is price. Price is the amount
that a product sells for per unit. It reflects
what society is willing to pay.
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Command economies
• In a command economy, a central
government either directly or indirectly sets
output targets, incomes, and prices.
• And the government determine what to
produce and how much and How and for
Whom to produce.
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Mixed Systems, Markets, and
Governments
Since markets are not perfect,
governments intervene and often play a
major role in the economy.
Some of the goals of government are to:
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goals of government in mixed
economy
• Minimize market inefficiencies
• Provide public goods
• Redistribute income
• Stabilize the macro economy:
– Promote low levels of unemployment
– Promote low levels of inflation
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The Market System Relies on Supply and Demand to Solve the Trio of
Economic Problems
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The Basic Decision-Making Units
Firms and Households and
An entrepreneur
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A firm
• A firm is an organization that transforms
resources (inputs) into products (outputs).
Firms are the primary producing units in a
market economy.
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An entrepreneur
• An entrepreneur is a person who organizes,
manages, and assumes the risks of a firm,
taking a new idea or a new product and
turning it into a successful business.
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Households
• Households are the consuming units in an
economy
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Input Markets and Output Markets: The
Circular Flow
• The circular flow of
economic activity shows
how firms and households
interact in input and output
markets.
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B. Trade, Money, and Capital
• Advanced economies use complex systems of
trade in order to accumulate the bundle of
goods and services that the people in that
economy want to consume.
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Cont.
• People produce the goods and services that
they can produce most efficiently, and then
they trade their excess for other items that
they need.
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Money
• Money is not an input or factor of production.
Consumers and firms use money in order to
more efficiently carry out market transactions;
it is a kind of lubricating oil (‫ )زيت التشحيم‬that
allows the machinery of an economy to
operate with a minimum of friction (‫)احتكاك‬.
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Capital
• In this course, the term capital does not refer to
money. Instead, the term refers to productive
inputs.
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Cont.
• capital includes durable items like factory buildings,
machine tools, electric drills, jack hammers, and so
on.
• It also includes stocks of semi finished goods. These
are goods which are on the way to becoming
consumer goods but which are still manufactured
inputs to be used in later stages of the production
process.
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Capital accumulation
(‫)تراكم راس المال‬
• Capital accumulation is an important
determinant of economic growth. An
economic system that builds a strong capital
base is investing in a factor of production that
will make all other factors more productive or
useful.
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The Economic Role of Government
• In the real world, markets do not always
operate as smoothly as we might like. Market
imperfections (‫ )نقائص‬lead to a wide range of
problems, and governments step in to address
them.
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Gov. intervention
• Governments intervene in a market economy
in order to promote efficiency.
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Role of Government
• Governments intervene in a market economy in
order to promote equity, or fairness, in the
distribution of resources and income.
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Cont.
• This is a difficult concept because there is
no universal definition of fairness. Markets
distribute goods and services to those who
have the money to purchase them, not
necessarily to those who need or deserve
them the most.
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Role of Government
• Governments intervene in a market economy in
order to promote macroeconomic growth and
stability using monetary and fiscal policy.
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Fiscal policies
• Fiscal policies of government (the power to
tax and spend) that try to affect the
economic stability
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Monetary policy
Includes:
• interest rate policies
• Money creation and issuing
• So It is (the power to adjust the money
supply and interest rates)
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The effect of M. & F. policy
• M. & F. policy help to move an economy
along a stable path, avoiding periods of
excessive inflation and unemployment.
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