ECO Chapter 2

the system of markets and prices is the _______________ mechanism

organizing and coordinating

households

Economic entities (of one or more persons occupying a housing unit) that provide resources to the economy and use the income received to purchase goods and services that satisfy economic wants

self-interest

That which each firm, property owner, worker, and consumer believes is best for itself and seeks to obtain.

dollar votes

The "votes" that consumers and entrepreneurs cast for the production of consumer and capital goods, respectively, when they purchase those goods in product and resource markets.

private property

The right of private persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital, and other property. (extends to intellectual property like patents and copyrights)

market systems are

dynamic and subject to change

advanced tech and capital goods are important b/c the most direct methods of production are often the ________ efficient

least; should instead rely on capital goods (tools, machines)

active but __________ gov

limited

when an industry goes out of business it

contracts

barter

the direct exchange of one set of goods or services for another

creative destruction

the hypothesis that the creation of new products and production methods simultaneously destroys the market power of existing monopolies

Two main problems of the command system

- coordination problem (central planners had to coordinate millions of individual decisions by consumers, suppliers, and businesses; caused sacrifice of certain products and was bad b/c focused on quantitative production) - incentive problem (persistent shortages and surpluses b/c of failed projections, but managers were still being rewarded so no incentive to fix)

examples of self-interest

- entrepreneurs: maximize profit or minimize loss - property owners: get highest price for sale or rent their resources - workers maximize utility in job they choose - consumers get products at lowest price

freedom of enterprise and of choice are only free within what legal limitations

- human and drug trafficking are illegal and punished through fines and prison

five fundamental questions of market economic system

- what goods/services will be produced - how will the goods/services be produced - who will get the output - how will the system accommodate change - how will the system promote progress

characteristics of market system

-competition - widely dispersed decision making - high potential monetary rewards that are powerful incentives to innovate - gov sets some rules and promotes stability and growth in the economy - the force is the market and who is participating in it

virtues of the market system

-efficiency - incentives (encourages skill acquisition and hardwork) - freedom

property rights also encourage

-investment, innovation, maintenance of property, and economic growth - use own time and resources to increase its value

pros of specialization

-makes use of differences in ability -fosters learning by doing -saves time

competition requires

-two or more buyers and two or more sellers acting independently in a particular product or resource market -freedom of sellers and buyers to enter or leave markets, on the basis of their economic self-interest

economic systems differ as to

1. who owns the factors of production 2. the method used to motivate, coordinate, and direct economic activity

product market

A market in which products are sold by firms and bought by households.

command system

A method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; command economy; communism (soviet union, cuba, and china)

businesses

Economic entities (firms) that purchase resources and provide goods and services to the economy.

circular flow diagram

An illustration showing the flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firms to households and from households to firms. (further divided into resource and product market)

Sole Proprietorship

An unincorporated firm owned and operated by one person (independent accountant)

medium of exchange

Any item sellers generally accept and buyers generally use to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter.

money

Any item that is generally acceptable to sellers in exchange for goods and services.

Benefits of Restricting Business Risk to Owners

Attracting Inputs- suppliers want to get paid in full. Full ownership gives sense of security. Focusing attention- profit system focuses on both responsibility and rewards.

consumer sovereignty

Determination by consumers of the types and quantities of goods and services that will be produced with the scarce resources of the economy; consumers' direction of production through their dollar votes.

resource market

Households sell resources and businesses buy them. Businesses buy resources from households because they are necessary for producing goods and services. Households provide economic resources directly as workers or entrepreneurs.

residual claimants

In a market system, the economic agent who receives (is claimant to) whatever profit or loss remains (is residual) at a firm after all other input providers have been paid. The residual is compensation for providing the economic input of entrepreneurial ability and flows to the firm's owners.

competition

The effort and striving between two or more independent rivals to secure the business of one or more third parties by offering the best possible terms. -KEY REGULATORY FORCE IN MARKET SYSTEM

freedom of enterprise

The freedom of firms to obtain economic resources, to use those resources to produce products of the firm's own choosing, and to sell their products in markets of their choice.

freedom of choice

The freedom of owners of property resources to employ or dispose of them as they see fit, of workers to enter any line of work for which they are qualified, and of consumers to spend their incomes in a manner that they think is appropriate.

division of labor

The separation of the work required to produce a product into a number of different tasks that are performed by different workers; specialization of workers.

invisible hand

The tendency of competition to cause individuals and firms to unintentionally but quite effectively promote the interests of society even when each individual or firm is only attempting to pursue its own interests.

specialization

The use of the resources of an individual, a firm, a region, or a nation to concentrate production on one or a small number of goods and services.

partnership

Two or more people legally agree to become co-owners of a business

resource market

a market in which households sell and firms buy resources or the services of resources

economic systems can be classified by their degree of

centralized or decentralized decision making (one extreme is laissez-faire capitalism (little gov interference) and the other are command systems (gov total control over economy)

diffusion of economic power in competition limits

abuse of power

market system

an economic system in which individuals, not the government control the production and distribution of goods and services; also called capitalism - market and prices serve as dominant coordinating mechanism used to allocate resources

markets

any institution or mechanism that brings together buyers (demanders) and sellers (suppliers) or a particular good or service

invisible hand example

businesses seek to build new and improved products to increase profits; least cost production also is in interest because it frees up resources to produce other products

European nations have transformed many country's command economies into

capital-market oriented systems (only real command economies remaining are north korea and cuba)

a pure command economy would rely exclusively on a

central plan to allocate the gov-owned property resources (in reality usually some private ownership is allowed)

laissez-faire capitalism: "pure capitalism"

economic system where the govs role is limitied to protecting private property and establishing legal environment appropriate to operation of markets where only mutual agreement transactions take place

freedom of entry and exit allows

economy to adjust to changes in consumer tastes, tech and resource availability (producers can enter or leave industry)

what do households provided

economy's abor, land, capital, and entrepreneurial ability

reward for owners bearing risk

employees don't have to share in their profits

who counts the dollar votes for capital goods

entrepreneurs and business owners (often use some of their profits to purchase capital goods); do this b/c their additional capital may generate greater profits in the future

property rights encourage people to cooperate by

helping ensure only mutually agreeable transactions take place

all resources in our no-gov economy are owned or provided by... and own all land and capital in the economy

households

how will production be organized

in combos and ways that minimize the cost per unit of output; efforts will be intensified in face of competition

who will get the output depends on

income of consumers, prices, preferences

corporation

independent legal entity that can acquire resources, own assets, produce/sell products, extend credit, sue/be sued, incur debts, and engage in any legal business activity

systems promote progress through

technological advances and capital accumulation (market system acknowledges dollar voting for capital goods as well as consumer goods )

most economies fall somewhere in the

middle; market systems or mixed economies

under the market system are owners and employees subject to same risk

no only owners are b/c employees are under contracted wages

does any society have a laissez-faire system?

no; instead take under industrial safety regulations, taxes, licensing requirements, and income redistribution

since corporation is an independent legal entity means that its owners bear no

personal financial responsibility for the corporation's debts and obligations

most consumers...

produce virtually none of the goods they consume, and consume little to none of the goods they produce

firm managers are guided toward sensible decisions by

profit systems (gives entrepreneurs a large financial incentive to avoid unnecessary risks and make prudent decisions)

Economic System

set of institutional arrangements and coordinating mechanism for solving the economizing problem; method of organizing an economy, of which market and command system are the two general types

3 categories of businesses

sole proprietorship, partnership, corporation

geographic specialization

the production of goods in which a country or region has absolute or comparative advantage; increase efficiency in use of limited resources

profits and losses are the difference between the

total revenue (TR) a firm receives from the sale of its products and the total cost (TC) of production

product market

where businesses sell goods and services and households buy goods and services