THE MARKET SYSTEM AND THE CIRCULAR FLOW
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
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
After completing this chapter, students should be able to:
Highlight the main features of a market economy and a command economy.
An economic system in which most property resources are owned
by the government and economic decisions are made by a central government body.
An economic system in which property resources are privately
owned and markets and prices are used to direct and coordinate economic
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
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.
List and explain nine important characteristics of a market system.
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