The Market System | Information of Economics | Dr. Fouad

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Chapter 4: The Market System



Three fundamental questions: What?

How?

For whom?



What? In the words of Adam Smith:

It is not from the benevolence of the butcher, the brewer, or the baker thatwe expect our dinner, but from their regard to their self-interest. (Adam

Smith, Wealth of Nations, Book I, Chapter I) [A producer,]...by directing that industry in such a manner as its produce

may be of the greatest value, he intends only his own gain, and he is inthis, as in many other cases, led by an invisible hand to promote an endwhich was no part of his intention. Nor is it always the worse for thesociety that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intendsto promote it. I have never known much good done by those who affectedto trade for the public good. It is an affectation, not very common amongmerchants, and very few words need be employed in dissuading themfrom it. (Smith, Book IV, Chapter II)



Consumer sovereignty?

Demand P profits S P Q



How? In a market economy:

profit maximization requires least-cost

production (holding quantity and qualityconstant).

new technology is introduced only if itlowers total cost.

sellers of a resource have an incentive tosupply the resource to its most highlyvalued use.



For whom? In a market economy, both output and

resource (factor) markets determine whoreceives which goods.

Distribution of income (wages, interest, rent,and profit) is determined in the resourcemarket.

Individuals who own more highly valued resourcesreceive higher incomes.

The allocation of goods and services isdetermined in the output market (given thedistribution of income).



Government and the three

fundamental questions Government influences the responses to each

of the three fundamental questions.Examples: What?

government spending

product safety and consumer protection laws

How? safety regulations minimum wage laws

environmental protection

For whom?

tax structure welfare programs



Households As defined by the Census Bureau, ahousehold consists of one or more

individuals sharing living quarters



Firms Types of firms

sole proprietorship

partnership

corporation



Sole proprietorship Single owner

Advantages:

autonomy single taxation

Disadvantages difficult to acquire funds

unlimited liability Most common form of business organization

(by number of firms)

Accounts for a small share of total output.



Partnership Two or more individuals share ownership

Advantages:

Pooled wealth and resources Single taxation

Disadvantages:

Loss in autonomy (relative to sole proprietorship)

Unlimited liability



Corporation A legal entity separate from its owners

Advantages limited liability

Disadvantages double taxation

separation of ownership from control Most output is produced by

corporations



International sector The international sector has been

expanding as a share of output in the

U.S. Both imports and exports havebeen rising.

A trade deficit occurs when importsexceed exports

A trade surplus occurs when exportsexceed imports



Circular flow



Circular flow w/financial

intermediaries



Circular flow w/ financial

intermediaries and the foreign sector

The Market System | Information of Economics | Dr. Fouad

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