Ch.2 The Market System and the Circular Flow

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Economic System

A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem; a method of organizing an economy, of which the market system and the command system are the two general types.

command system

A method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; command economy; communism.

market system

All the product and resource markets of a market economy and the relationships among them; a method that allows the prices determined in those markets to allocate the economy's scarce resources and to communicate and coordinate the decisions made by consumers, firms, and resource suppliers.

private property

The right of private persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital, and other property.

freedom of enterprise

The freedom of firms to obtain economic resources, to use those resources to produce products of the firm's own choosing, and to sell their products in markets of their choice.

freedom of choice

The freedom of owners of property resources to employ or dispose of them as they see fit, of workers to enter any line of work for which they are qualified, and of consumers to spend their incomes in a manner that they think is appropriate.

self-interest

That which each firm, property owner, worker, and consumer believes is best for itself and seeks to obtain.

competition

The presence in a market of independent buyers and sellers competing with one another along with the freedom of buyers and sellers to enter and leave the market.

market

Any institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of a particular good or service.

specialization

The use of the resources of an individual, a firm, a region, or a nation to concentrate production on one or a small number of goods and services.

division of labor

The separation of the work required to produce a product into a number of different tasks that are performed by different workers; specialization of workers.

medium of exchange

Any item sellers generally accept and buyers generally use to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter.

barter

The exchange of one good or service for another good or service.

money

Any item that is generally acceptable to sellers in exchange for goods and services.

consumer sovereignty

Determination by consumers of the types and quantities of goods and services that will be produced with the scarce resources of the economy; consumers' direction of production through their dollar votes.

dollar votes

The "votes" that consumers and entrepreneurs cast for the production of consumer and capital goods, respectively, when they purchase those goods in product and resource markets.

creative destruction

The hypothesis that the creation of new products and production methods simultaneously destroys the market power of existing monopolies.

invisible hand

The tendency of firms and resource suppliers that seek to further their own self-interests in competitive markets to also promote the interests of society.

circular flow diagram

An illustration showing the flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firms to households and from households to firms.

households

Economic entities (of one or more persons occupying a housing unit) that provide resources to the economy and use the income received to purchase goods and services that satisfy economic wants.

businesses

Economic entities (firms) that purchase resources and provide goods and services to the economy.

sole proprietorship

An unincorporated firm owned and operated by one person.

partnership

An unincorporated firm owned and operated by two or more persons.

corporation

A legal entity ("person") chartered by a state or the Federal government that is distinct and separate from the individuals who own it.

product market

A market in which products are sold by firms and bought by households.

resource market

A market in which households sell and firms buy resources or the services of resources.

market, command

The market system and the command system are the two broad types of economic systems used to address the economizing problem. In the BLANK system (or capitalism), private individuals own most resources, and markets coordinate most economic activity. In the BLANK system (or socialism or communism), government owns most resources and central planners coordinate most economic activity.

market, Self-interest

The BLANK system is characterized by the private ownership of resources, including capital, and the freedom of individuals to engage in economic activities of their choice to advance their material well-being. BLANK-BLANK is the driving force of such an economy and competition functions as a regulatory or control mechanism.

market

In the BLANK system, markets, prices, and profits organize and make effective the many millions of individual economic decisions that occur daily.

money

Specialization, use of advanced technology, and the extensive use of capital goods are common features of market systems. Functioning as a medium of exchange, BLANK eliminates the problems of bartering and permits easy trade and greater specialization, both domestically and internationally.

produced, How, Who, change, progress

Every economy faces five fundamental questions: (a) What goods and services will be BLANKED? (b) BLANK will the goods and services be produced? (c) BLANK will get the goods and services? (d) How will the system accommodate BLANK? (e) How will the system promote BLANK?

revenue, cost, Competition

The market system produces products whose production and sale yield total BLANK sufficient to cover total BLANK. It does not produce products for which total revenue continuously falls short of total cost. BLANK forces firms to use the lowest-cost production techniques.

profit

Economic BLANK (total revenue minus total cost) indicates that an industry is prosperous and promotes its expansion. Losses signify that an industry is not prosperous and hasten its contraction.

sovereignty, output

Consumer BLANKTY means that both businesses and resource suppliers are subject to the wants of consumers. Through their dollar votes, consumers decide on the composition of BLANK.

income, output

The prices that a household receives for the resources it supplies to the economy determine that household's BLANK. This determines the household's claim on the economy's BLANK. Those who have it to spend get the products produced in the market system.

resources, technological, capital

By communicating changes in consumer tastes to entrepreneurs and resource suppliers, the market system prompts appropriate adjustments in the allocation of the economy's BLANKS. The market system also encourages BLANKAL advance and BLANK accumulation, both of which raise a nation's standard of living.

Competition

BLANK, the primary mechanism of control in the market economy, promotes a unity of self-interest and social interests. As if directed by an invisible hand, it harnesses the self-interest motives of businesses and resource suppliers to further the social interest.

coordination, profit

The command systems of the Soviet Union and prereform China met their demise because of BLANK difficulties caused by central planning and the lack of a BLANK incentive. The first problem resulted in bottlenecks, inefficiencies, and a focus on a limited number of products. The incentive problem discouraged product improvement, new product development, and entrepreneurship.

circular flow model

The BLANKAR BLANK BLANK illustrates the flows of resources and products from households to businesses and from businesses to households, along with the corresponding monetary flows. Businesses are on the buying side of the resource market and the selling side of the product market. Households are on the selling side of the resource market and the buying side of the product market.

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