I. Capitalist Ideology
II. The Market System at Work
Select the BEST answer:
TO DECIDE HOW TO USE ITS LIMITED RESOURCES TO SATISFY HUMAN WANTS PURE CAPITALISM RELIES ON:
A. CENTRAL PLANNING
B. FREE TRADE
C. A PRICE SYSTEM
D. FULL EMPLOYMENT
Pure Capitalism and the Market System:
The Market and the 5 Es
Characteristics of a Market Economy [Capitalism]
A. private property
B. markets and prices
C. role of self interest: incentives
D. freedom of enterprise and choice
E. competition1. large numbers
2. free entry and exit
3. produce standardized productsF. limited role for government
The Market and the 5Es
1. Economic GrowthCapitalist economies tend to have more rapid rates of growth2. Allocative Efficiency: Producing what consumers want
a. Capitalism and incentives[1] more profits = produce more[2] losses = produce less
[3] consumer sovereignty and "dollar votes"
b. Capitalism tends to achieves allocative efficiency
3. Productive Efficiency: Producing at a minimum cost
a. Capitalism and incentives[1] profits = total revenues - total cost[2] minimizing costs means more profits
b. Capitalism tends to achieve productive efficiency
4. Equity
There is no characteristic of capitalism which will guarantee equityOften, the government gets involved to help achieve equity
5. Full Employment
Economists disagree over whether capitalism will result in full employment
- Some say yes, and if there is unemployment it is usually caused by government interference
- Some say no, and at times government involvement is needed to move the economy towards full employment
This chapter begins with a discussion of the institutional framework of the American market system. Brief explanations are given for these characteristics of the market system: private property, freedom of enterprise and choice, the role of self-interest, competition, markets and prices, the reliance on technology and capital goods, specialization, use of money, and the active, but limited role of government. In the final section of the chapter, the authors address the Four Fundamental Questions faced by every economy and explain how a market economy answers each one.
I. Characteristics of the Market System
A. Private individuals and firms own most of the private property [land and capital].
1. Private property, coupled with the freedom to negotiate binding legal contracts, enables individuals and businesses to obtain, control, use, and dispose of this property.2. Private property rights encourage investment, innovation, exchange of assets, maintenance of property, and economic growth.
3. Property rights extend to intellectual property through patents, copyrights, and trademarks.
B. Freedom of enterprise and choice exist.
1. Freedom of enterprise means that entrepreneurs and businesses have the freedom to obtain and use resources, to produce products of their choice, and to sell these products in the markets of their choice.2. Freedom of choice means:
a. Owners of property and money resources can use resources as they choose.b. Workers can choose the training, occupations, and job of their choice.
c. Consumers are free to spend their income in such a way as to best satisfy their wants [consumer sovereignty].
C. Self-interest
1. Self interest is one of the driving forces in a market system. Entrepreneurs try to maximize profits or minimize losses; resource suppliers try to maximize income; consumers maximize satisfaction.2. As each tries to maximize profits, income, satisfaction, the economy will benefit if competition is present.
[NOTES FROM YOUR INSTRUCTOR: This "self-interest" is very important. Although some people call it "greed", it is the driving force behind capitalism and fundamental in capitalism's success in achieving productive efficiency, allocative efficiency, and economic growth. "Greedy" business owners will produce at a minimum cost [achieve productive efficiency] to increase their profits. Also, they will use the limited resources to produce what consumers want [achieve allocative efficiency] to also increase their profits.]
D. Competition among buyers and sellers is a controlling mechanism.
1. Large numbers of sellers mean that no single producer or seller can control the price or market supply.2. Large number of buyers means that no single consumer or employer can control the price or market demand.
3. Depending upon market conditions, producers can enter or leave industry easily.
[NOTES FROM YOUR INSTRUCTOR: Without competition market economies may not achieve efficiency. This is a major concept studied in microeconomics and the reason why the promotion of competition is a policy of Structural Adjustment Programs in the Transition Economics.]
E. Markets and prices
1. A market system conveys the decisions of the many buyers and sellers of the product and resource markets.2. A change in the market price signals that a change in the market has occurred.
3. Those who respond to the market signals will be rewarded with profits and income.
NOTES FROM YOUR INSTRUCTOR: This is why we will study chapter 3. We have already discussed the importance of prices in achieving allocative and productive efficiency.
Prices are very important in a market economy. The "right" product price is necessary to achieve allocative efficiency and the "right" resource price is necessary to achieve productive efficiency.
F. Reliance on technology and capital goods
1. Competition, freedom of choice, self-interest, and the potential of profits provide the incentive for capital accumulation [investment].2. Advanced technology and capital goods uses the more efficient roundabout method of technology.
G. Specialization
1. Division of labor allows workers to specialize.a. People can take advantage of differences in abilities and skills.b. People with identical skills may still benefit from specialization and improving
certain skills.
c. Specialization saves time involved in shifting from one task to another.
2. Geographic specialization: Regional and international specialization take advantage of localized resources.
H. Use of money as a medium of exchange
1. Money substitutes for barter, which requires a coincidence of wants. [I may want what you produce but you may not want to exchange for what I have.]2. Willingness to accept money in place of goods permits 3-way trades [or multilateral trades]. See Figure 4-1 and examples in text.
a. Floridians give money to Nebraskans for wheat who give money to Idahoans for potatoes who give money to Florida for oranges.b. Foreign exchange markets permit Americans, Japanese, Germans, Britons, and Mexicans to complete international exchanges of goods and services.
c. Detroit autoworker produces crankshafts for Buicks. If the worker were paid in crankshafts, he would have to find grocers, clothing retailers, etc., who would be willing to exchange their products for a crankshaft. It is much more efficient to use money wages than to accept one’s wages in crankshafts!
I. Active, but limited government
1. Although the market system promotes efficiency, it has certain shortcomings [over production of goods with social costs, under production of goods with social benefits, tendency for business to increase monopoly power, macro instability].2. Chapter 5 deals with how the government can increase the overall effectiveness of the market system.
III. The Market System at Work
A. The market system is made up of millions of individual decision makers who make trillions of decisions all of which are attempting to maximize their individual or business self-interest.
B. The market is a mechanism by which the consumers and producers can come together to respond to each other’s desires and wants in an efficient way.
C. Although the focus of this chapter is on the market system, the four fundamental questions must be answered by all economic systems.
1. What goods and services will to be produced?2. How will these goods and services be produced?
3. Who will get the goods and services?
4. How will the system accommodate change?
D. What will be produced?
1. In order to be profitable, businesses must respond to consumers’ [individuals, other businesses, and the government] wants and desires.2. When businesses allocate resources in a way that is responsive, businesses will be profitable and allocative efficiency will be achieved.
3. Accounting profits are total revenue minus total accounting costs.
4. In economics, the return to the entrepreneur is treated just like the return to the worker, i.e., it is an economic cost and must be received if the entrepreneur is going to continue to produce in that industry.
5. Normal profits are the return to the entrepreneur that is necessary for him/her to continue to produce that product. Any revenue received beyond normal profits is pure or economic profit.
6. If producers in an industry are receiving pure or economic profits, additional producers will move into the industry, the industry supply will increase, and the price will decrease thus squeezing out the economic profits. Refer to Figure 3-6[c].
7. If producers in an industry are experiencing economic losses, some of these producers will exit the industry, the industry supply will decrease, and the price will increase thus eliminating the economic losses. Refer to 3-6[d].
8. Consumer sovereignty is the key to determining the types and quantities of the various products that will be produced. "Dollar votes" for a product when purchases are made and "dollar votes" against a product when products are ignored will determine which industries continue to exist and which individual products survive or fail.
9. Businesses are not really "free" to produce what they wish. They must match their production choices with consumer choices or face losses and eventual bankruptcy. Profit-seeking firms must consider the allocation of the "dollar votes" when they make their production decisions.
10. Resource demand is a "derived" demand, i.e., it depends on the demand for the products produced by the resource.
E. How will the goods and services be produced?
1. The market system encourages and rewards those producers who are achieving productive efficiency, i.e., least-cost production.2. Least-cost production techniques include: locating firms in the optimum location considering resource prices, resource productivity, and transportation costs, available technology, and resource prices in general.
3. The most efficient technique will be the one that produces a given amount of output with the smallest input of scarce resources when both inputs and outputs are measured in dollars and cents. [Key Question 7]
F. Who will get the goods and services?
1. The answer to this question is directly related to how the income is distributed among the individuals and the households and the tastes and preferences of consumers.2. Products go to those who are willing and able to pay for them.
3. The productivity of the resources, the relative supply of particular resources, and the ownership of the resources will determine the income of individuals and households.
4. The resource markets, which determine income, are linked to this decision.
G. How will the system accommodate change?
1. Accommodating changes in consumer tastes and the guiding function of prices:a. An increase in demand for some products will lead to higher prices in those markets.b. A decrease in demand for other products will lead to lower prices in those markets.
c. Increased demand leads to higher prices that induce greater quantities of output. The opposite is true for a decrease in demand.
d. Higher prices lead to more profits and new firms entering the market.
e. Lower prices lead to losses and firms leaving the industry.
2. The market system promotes technological improvements and capital accumulation. [Economic Growth]
a. An entrepreneur or firm that introduces a popular new product will be rewarded withincreased revenue and profits.
b. New technologies that reduce production costs, and thus product price, will spread
throughout the industry as a result of competition.
c. Creative destruction occurs when new products and production methods destroy the market positions of firms that are not able or willing to adjust.
III. Competition and the "Invisible Hand":
IV. LAST WORD: Shuffling the Deck