EC 201 Chapter Notes - Chapter 2: Capital Accumulation, Sole Proprietorship, Consumer Sovereignty
Chapter 2: The Market System and the Circular Flow
Economic Systems
● Economic system: set of institutional arrangements
○ Coordinating mechanism
○ Differences in systems exist by:
■ Who owns the factors of production
■ What method is used to motivate, coordinate, and direct economic activity
● Laissez-Faire Capitalism
○ Laissez-faire capitalism: “pure capitalism”
■ Government’s role would be limited to protecting private property from
theft and aggression and establishing a legal environment in which
contracts would be enforced and people could interact in markets to buy
and sell goods, services, and resources
■ Argue that government should restrict itself to preventing individuals and
firms from coercing each other
● Ensures only mutually beneficial economic transactions get
negotiated and completed
● The Command System
○ Polar opposite of laissez-faire capitalism is the command system
■ Known as socialism or communism
■ Government ownership
■ Decisions made by a central planning board
● The Market System
○ Market system: known as capitalism or the mixed economy
■ Specialize
■ Creates efficiency
■ Inequality
■ Private ownership of resources
○ Characteristics of the Market System
■ Private property: coupled with the freedom to negotiate binding legal
contracts, enables individuals and businesses to obtain, use, and dispose of
property resources as they see fit
■ Freedom of enterprise and choice
● Freedom of enterprise ensures that entrepreneurs and private
businesses are free to obtain and use economic resources to
produce their choice of goods and services and to sell them in their
chosen markets
● Freedom of choice enables owners to employ or dispose of their
property and money as they see fit
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○ Allows workers to try to enter any line of work for which
they are qualified
○ Ensures that consumers are free to buy the goods and
services that best satisfy their wants and that their budgets
allow
■ Self-interest: motivating force of the various economic units as they
express their free choices
● Each economic unit tries to achieve its own particular good
■ Competition: effort and striving between two or more independent rivals
to secure the business of one or more third parties by offering the best
possible terms
■ Markes and prices
● Market: institution or mechanism that brings buyers
(“demanders”) and sellers (“suppliers”) into contact
■ Technology and capital goods
● Most direct methods of production are often the least efficient
○ Only way to avoid that inefficiency is to rely on capital
goods
■ Specialization: using the resources of an individual, firm, region, or
nation to produce one or a few goods or services rather than the entire
range of goods and services
■ Division of Labor: the separation of the work to produce a product into a
number of different tasks that are performed by different workers
■ Specialization makes use of differences in ability
● Ex. If LeBron is strong, athletic, and good at shooting a basketball
and Beyonce is beautiful, agile, and can sing, their distribution of
talents can be most efficiently used if LeBron plays professional
basketball while Beyonce records songs and gives concerts
■ Specialization fosters learning by doing
● Ex. by devoting time to a single task, a person is more likely to
develop the skills required adn to improve techniques than by
working at a number of different tasks
■ Specialization saves time
■ Geographic Specialization
○ Use of Money
■ Medium of exchange: any item sellers generally accept and buyers
generally use to pay for a good or service
○ Barter: direct exchange of one good or service for another good or service
● Five Fundamental Questions
○ What goods and services will be produced?
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