Sunday, October 5, 2008

Chapter 4

Chapter 4 – The Market System

Characteristics of the Market System

Private Property – In a freemarket system capital is privately owned

Property ownership encourages investment, innovation, exchange, maintenance of property and economic growth because it is in their best interests because they will reap the rewards

Private Property is also in the form of copyrights, Property rights facilitate exchange (ie property deeds)

Freedom of Enterprise and Choice

Freedom of Enterprise – lets entrepreneurs produce and sell their products

Freedom of Choice – enables owners to do whatever they want with their capital, for workers to work wherever they want to, and for consumers to buy whatever the fuck they want

Self Interest

Everyone is trying to do as well for themselves as they can (entrepreneurs, workers and consumers)

Competition – Freedom of choice exercised in the pursuit of economic gain

Independently acting sellers and buyers and the freedom of these sellers and buyers to enter/leave markets creates competition

When there are many buyers/sellers nobody controls market prices

Nobody can “rig the market” by monopolizing on supply/demand

The diffusion of economic power inherent in competition limits the potential abuse of that power

Markets and Prices – A vast network of communication that governs supply and demand

Reliance on Technology and Capital Goods – innovation promises to earn money for the developer

Roundabout Production – Not direct production ie someone doesn’t build a car with their bare hands they use machines, economy of scale etc


Much more efficient to have someone produce only one component of a larger product/service (ie someone who only installs roofing rather then jack of all trades)

Division of Labor – in order to facilitate specialization

Makes use of differences in ability – some people are better suited to be doctors then others

Fosters learning by doing – because someone does the same thing constantly they have a greater opportunity to develop skills

Saves time – no need to constantly shift jobs

Geographic Specialization

Many areas are much better suited to a particular industry, for example Oranges aren’t grown in New York

Also internationally it makes sense to export one good in exchange for another, ie USA exports Airplanes and imports bananas from Honduras

Use of Money

 Money is a medium of exchange, a convenient medium of exchange allows for greater specialization because bartering relies on a coincidence of wants between the two traders.  For example if you are trading Corn for a car, the car seller must need corn and you must need a car

Money must be universally acceptable to the sellers in exchange for goods and services

Active but limited Gov’t

While gov’t serves to limit the free market economy, it can also increase the overall efficiency of the economy

The Market System at Work


1.       What goods and services will be produced? – Because businesses seek profits and avoid losses, the goods and services produced at a continuing profit will be produced and those produced at a continuing loss will be not… Economic Profit = Total revenue – total costs

a.       Economic Costs are the payments that must be made to secure and retain the needed amounts of those resources

b.       The Cost of the entrepreneurs contribution is called the normal contribution

c.       Revenue – total economic costs is the economic profit (aka pure profit) which goes to the entrepreneur

d.       A positive economic profit is the mark of a successful industry – one that will likely become an expanding industry otherwise its called a declining industry

e.       Consumer Soverignity – consumers are soverign (in command) in the market system because they control what is bought and therefore what is sold

                                                                           i.      Dollar votes – when a consumer buys a good/service, they are “voting” with their dollar for a particular industry, thus controlling demand

f.        Market Restraints on Freedom

                                                                           i.      Firms produce have to produce what consumers demand or they’ll go bankrupt

                                                                         ii.      The demand for resources is a derived demand (derived from the demand for the goods they are used to produce)

2.      How will these goods be produced

a.       Market system steers resources towards profitable industries b/c they can afford them

b.       The most efficient production technique depends on the available technology and the prices of the required resources

3.      Who will get these goods and Services

a.       Distributed based on consumers ability and willingness to pay for goods

b.       The amount of income they have (their ability to purchase items) depends on how much property/human resources they can supply and the value of those resources on the market

4.      How will the system accommodate change

a.       Must economize to a specific pattern of consumer tastes, technological resources and amount of resources

b.       Guiding function of prices – As consumer preferences change, self interest will cause entrepreneurs to join the market for popular products and encourage the decrease of the depressed industry

c.       Higher prices allow producers to pay higher prices for resources and expand the business

d.       Guiding function of prices – prices that are changed by consumer demand allow for the expansion/depression of markets, this results in changes the flow of resources to various markets

Role in Promoting Progress – How does the market prompote technological improvements and capital accumulation-which lead to greater efficiency, higher productivity and a higher level of economic well-being.

Technological Advance – strong incentive b/c it results in a revenue increase w/o needing to increase demand

The market system is conducive to rapid spread of technology through an industry

Creative Destruction – the creation of new products and production methods destroys the market positions of old goods or services

Capital Accumulations – Entrepreneurs often put some of their profits towards technological innovation

Competition and the Invisible hand

The invisible hand is from Adam Smith’s 1776 book the wealth of nation, it represents self interests

                The operation of a market system creates a unity between private interests and social interests.  By being efficient, producing revenue, the self interest of businesses translates into the welfare of the people

Competition controls and guides self-interest

Market system – Facilitates

Efficiency – efficient use of resources, incentive for technological advancements, organizes resources for production

Incentives – encourages skill acquisition, hard work and innovation.  Entrepreneurship is highly profitable, leading to innovation and greater work skills lead to a higher standard of living

Freedom – personal freedom allows people to further their own self interest, therefore aiding society as a whole

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