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CHAPTER TWO THE MARKET SYSTEM AND THE CIRCULAR FLOW CHAPTER OVERVIEW This chapter begins with a brief comparison of command and market system, followed by a more detailed description of the characteristics of a 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. The authors then introduce the Four Fundamental Questions faced by every economy, explain how a market economy answers each one, and why command systems have struggled to answer them in recent years. The chapter concludes by introducing the circular flow model, a graphical representation of a market economy. INSTRUCTIONAL OBJECTIVES After completing this chapter, students should be able to: 1. Highlight the main features of a market economy and a command economy. Command System: An economic system in which most property resources are owned by the government and economic decisions are made by a central government body. Market System: An economic system in which property resources are privately owned and markets and prices are used to direct and coordinate economic activities. The Command System is also known as socialism or Communism. In Command, the gov’t owns most of the property resources. A central planning board selected by the gov’t formulates a central economic plan and makes nearly all decisions concerning resources, composition and distribution of output, and organization of production. All consumer goods and capital goods are divided according to the board’s long-term priorities for the system. The Market System is also known as Capitalism. It uses private ownership of resources as well as markets and prices to direct economic activity. Self-interest is key, and the system allows private ownership of capital. It also communicates through prices, and coordinates through places where buyers and sellers come together, i.e. markets. This results in competition and independent buyers and sellers, allowing economic decision-making to become widely dispersed and monetary rewards to create powerful incentives for existing industries to pioneer new products and processes, ultimately helping the economy grow. 2. List and explain nine important characteristics of a market system. Private Property Private Property: The right of persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital, and other property. Property rights encourage investments, innovation, exchange, maintenance of property, and economic growth. They extend to intellectual property through
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patents, copyrights, and trademarks. This protection encourages people to write books, computer programs, etc. Property rights facilitate exchange. Titles and deeds assure the buyer that the seller is the legitimate owner of the good. Property rights enable people to use their time and resources to produce more goods and services
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