McConnell Microeconomics Chapter 2 PDF

microeconomics McConnell Brue Flynn Chapter 2 The Market System and the Circular Flow © McGraw Hill LLC. All rights reserved. No reproduc...

microeconomics McConnell Brue Flynn Chapter 2 The Market System and the Circular Flow © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Chapter Contents Economic Systems Characteristics of the Market System Five Fundamental Questions The “Invisible Hand” The Circular Flow Model How the Market System Deals with Risk 2-2 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Economic Systems Economic systems Set of institutionalized arrangements Coordinating mechanism Differences in systems exist by Degree of decentralized use of markets and prices in decision-making Degree of centralized government control LO2.1 2-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Laissez-Faire Capitalism Keep the government from interfering. Power of government needed to: Protect private property from theft. Provide a legal environment for contract enforcement. People interact in markets to buy and sell. LO2.1 2-4 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Command System The command system is known as socialism or communism. Government ownership of resources. Decisions made by a central planning board. Examples: North Korea, Cuba, Myanmar LO2.1 2-5 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Market System The market system is a mix of decentralized decision making with some government control. Systems found in much of the world. Private markets are dominant force. Private ownership of resources. Self-interested behavior. LO2.1 2-6 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Characteristics of the Market System Private property Freedom of enterprise and choice Self-interest Competition Markets and prices Technology and capital goods Specialization LO2.2Use of money 2-7 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Global Perspective INDEX OF ECONOMIC FREEDOM, SELECTED ECONOMIES, 2021 LO2.2 2-8 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. The Heritage Foundation, www.heritage.org.  Technology and Capital Goods Advanced technology and capital goods are encouraged. Specialization Division of labor Geographic specialization LO2.2 2-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Use of Money Money makes trade easier. It is a medium of exchange. Without money, people would have to barter. LO2.2 2-10 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Figure 2.1: Money Facilitates Trade when Wants Do Not Coincide LO2.2 2-11 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Active, but Limited, Government Government may be needed to alleviate market failures. Government can increase effectiveness of a market system. Possible government failure. LO2.2 2-12 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Five Fundamental Questions What goods and services will be produced? How will the goods and services be produced? Who will get the goods and services? How will the system accommodate change? How will the system promote technological progress? LO2.3 2-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  What Will Be Produced? Goods and services that create a profit Consumer sovereignty “Dollar votes” Allow consumers to indicate which goods and services should be produced Determine which products and industries survive or fail LO2.3 2-14 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  How Will the Goods Be Produced? Minimize the cost per unit by using the most efficient techniques: Technology Prices of the necessary resources LO2.3 2-15 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Answering the Question of How to Produce Three Techniques for Producing $15 Worth of Bar Soap Units of Resource Price per Technique 1 Technique 2 Technique 3 Unit of Resource Resource Units Cost Units Cost Units Cost Labor $2 4 $8 2 $4 1 $2 Land 1 1 1 3 3 4 4 Capital 3 1 3 1 3 2 6 Entrepreneurial ability 3 1 3 1 3 1 3 Total cost of $15 worth of bar soap $15 $13 $15 LO2.3 2-16 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Who Will Get the Output? Consumers with the ability and willingness to pay will get the product. Ability to pay depends on income. LO2.3 2-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  How Will the System Accommodate Change? Changes in consumer tastes Changes in technology Changes in resource prices or availability LO2.4 2-18 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  How Will the System Progress? Technological advance Creative destruction: The hypothesis that the creation of new products and production methods destroys the market power of existing monopolies. Capital accumulation LO2.4 2-19 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Invisible Hand The tendency of competition to cause individuals and firms to unintentionally but effectively promote the interests of society even when each individual firm only attempts to pursue its own interests. 1776 Wealth of Nations by Adam Smith Unity of private and social interest Virtues of the market system LO2.4 Efficiency 2-20 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Demise of Command Systems Command systems fail to deliver adequate amounts of goods and services. Examples: Soviet Union, North Korea, and pre- reform China Coordination problem: Must correctly set output targets for all goods and services. Incentive problem: No adjustments for surplus or shortage. LO2.4 2-21 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Circular Flow Model Private closed economy: Households Businesses Product market and the resource market The real flow and the money flow LO2.5 2-22 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Circular Flow Diagram RESOURCE MARKET Households sell Businesses buy BUSINESSES HOUSEHOLDS buy resources sell resources sell products buy products PRODUCT MARKET Businesses sell Households buy 2-23 LO2.5 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  How the Market System Deals with Risk (1 of 2) Business owners and investors face risk: Losses due to input shortages Changes in consumer tastes Natural disasters that affect the supply chain Employees and suppliers have security: Paid whether the firm makes a profit or not LO2.6 2-24 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  How the Market System Deals with Risk (2 of 2) Business risks are restricted to owners. Attracts needed inputs: Inputs easier to obtain since many dislike risk. Focuses attention: Owners personally responsible for outcome. Will encourage prudent decisions. Manage LO2.6 risk well and the owners will prosper. 2-25 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Last Word: Hasta La Vista, Venezuela Venezuela’s economy is on the verge of collapse. Staples like food and gasoline are too expensive or unavailable. Bolivarian Socialism Hyperinflation Population exodus 2-26 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.