The Free Market

Why do markets exist?

Markets enable people to buy what they need and sell the goods and services they produce.

What "invisible hand" regulates the free market economy?

competition and self-interest

consumer sovereignty

consumer's desires determine what manufacturers produce

Circular Market Economy Flow

households purchase the products made by firms with the money they received from firms in the factor market

Which occupation is not an example of specialization?

student

Why are free market economies able to attain economic growth?

Competition encourages innovation, which causes growth.

self-interest

DEFINITION: acting in own personal gain It is also the motivating force in the free market.

free market economies

DEFINITION: economic systems that are based on voluntary exchanges in markets. HOW IT WORKS: individuals and businesses use markets to exchange money and products. individuals and privately owned businesses own the factors of production, make what they want, and buy what they want. In other words, individuals answer the three key economic questions of what to produce, how to produce it, and who consumes that which is produced. A free market economy functions best in an environment of decentralized decision-making, such as what exists in the United States.

factor market

DEFINTION: firms purchase factors of production from households HOW IT WORKS: Firms purchase or rent land (natural resources). They hire workers, paying them wages or salaries for their labor. They also borrow money from households to purchase capital, paying households interest or profits in return.

Advantages of the free market

Economic efficiency Because it is self-regulating, a free market economy responds efficiently to rapidly changing conditions. Producers make only what consumers want, when they want it, and generally at prices they are willing to pay. Economic freedom Free market economies have the highest degree of economic freedom of any system. This includes the freedom of workers to work where they want, of firms to produce what they want, and of individuals to consume what they want. Economic growth Because competition encourages innovation, free markets encourage growth. Entrepreneurs are always seeking profitable opportunities, contributing new ideas and innovations. Additional goals Free markets offer a wider variety of goods and services than any other system, because producers have incentives to meet consumers' desires. Consumers, in essence, decide what gets produced. This is called consumer sovereignty.

Why do people need to buy and sell products or services?

In today's world, no one is completely self-sufficient.

What is one of the most important advantages of a free market?

It encourages growth

How does specialization affect an economy?

It prevents duplication of effort.

The Invisible Hand

Self-interest spurs consumers to purchase certain goods and services and firms to produce them. Competition causes more production and moderates firms' quests for higher prices. The overall result is that consumers get the products they want at prices that closely reflect the cost of producing them. All of this happens without any central plan or direction.

How will consumers react to the incentive of a higher price on a good or service?

The negative incentive will cause consumers to purchase less of the good or service if it is of lower quality.

household

a person or group of people living in the same residence

market

an arrangement that allows buyers and sellers to exchange things

Which of the following is not an advantage of a free market economy?

economic equity

Households pay firms for goods and services. Firms supply households with goods and services. The purchase and supply of goods and services takes place in the _____.

product market

competition

struggle among producers for the dollars of consumers This is the the regulating force behind the free market. It causes more production and moderates firms' quests for higher prices.

specialization

the concentration of the productive efforts of individuals and firms on a limited number of activities

profit

the financial gain made in a transaction EXAMPLE: monetary incentive

Product Market

the goods and services that firms produce are purchased by households

incentive

the hope of reward or the fear of punishment that encourages a person to behave in a certain way EXAMPLE: monetary incentive, nonmonetary incentive

What does the circular flow model show?

the interactions between households and businesses in the free market

Which of the following does not own the factors of production?

the market

What is the purpose of competition?

to act as a regulating force in the marketplace