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Markets and Governments in a Modern Economy

Chapter 2

Samuelson, Nordhaus 18e

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Markets & Government in a Modern Economy

• What is a Market?– A market is a mechanism through which buyers and

sellers interact to determine prices and exchange goods and services.

– Market System and Price• Prices serve as signals to producers and consumers.

– Prices coordinate the decisions of producers and consumers in a market

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Markets & Government in a Modern Economy

• What is a Market? Cont.

– How Markets Solve the Problem of the Three Economic Problems?

• By matching sellers and buyers (supply and demand) in each market, a market economy simultaneously solves the three problems of what, how and for whom.

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The Circular Flow of Economic ActivityHere goods and services flow clockwise: Labor services supplied by households flow to firms, and goods and services produced by firms flow to households.

Payment (usually money) flows in the opposite (counterclockwise) direction: Payment for goods and services flows from households to firms, and payment for labor services flows from firms to households.

Markets & Government in a Modern Economy

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Markets & Government in a Modern Economy

• What is a Market? Cont.

– Labor Market: The input/factor market in which households supply work for wages to firms that demand labor.

– Capital Market: The input/factor market in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.

– Land Market: The input/factor market in which households supply land or other real property in exchange for rent.

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The Market System Relies on Supply & Demand to Solve the Trio of Economic

Problems

Chapter 2 Figure 2-1

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• Trade, Money and Capital

– Trade, Specialization, and Division of Labor

– Money: The Lubricant of Exchange

– Capital

Markets & Government in a Modern Economy

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• Trade, Money and Capital (cont.)

– Trade, Specialization, and Division of Labor• As individuals and countries become increasingly

specialized, they tend to concentrate on particular commodities and trade their surplus output for goods produced by others.

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• Trade, Money and Capital (cont.)

– Money: The Lubricant of Exchange• Money is the universally acceptable medium of

exchange.

Markets & Government in a Modern Economy

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• Trade, Money and Capital (cont.)

– Capital• Inputs such as machinery, structures, and

inventories of goods in process.

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• The Economic Role of Government

– Governments have three main economic functions in a market economy.

• Efficiency– Imperfect Competition– Externalities– Public Goods

• Equity• Macroeconomic Growth

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• The Economic Role of Government

– Efficiency• Governments increase efficiency by promoting

competition, curbing externalities like pollution, and providing public goods.

Markets & Government in a Modern Economy

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• The Economic Role of Government

– Efficiency (cont.)• Perfect Competition

– A market in which no firm or consumer is large enough to affect the market price.

• Imperfect Competition– When a buyer or seller can affect a good’s price.

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• The Economic Role of Government

– Efficiency (cont.)• Externalities

– Externalities (or spillover effects) occur when firms or people impose cost or benefits on others outside the marketplace.

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• The Economic Role of Government

– Efficiency (cont.)• Public Goods

– Commodities or services which can be enjoyed by everyone and from which no one can be excluded.

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• The Economic Role of Government

– Equity (fairness)• Governments promote equity by using tax and

expenditure programs to redistribute income toward particular groups.

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• The Economic Role of Government

– Macroeconomic Stability and Growth• Governments use the tools of fiscal and monetary

policies to encourage economic growth.

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Chapter 2 Table 2-1Markets & Government in a

Modern Economy