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Economics chapter 2; the market system and circular flow summary

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  • January 5, 2024
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  • 2020/2021
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Chapter 2
The market system and the circular flow
1. Role players in the system and the circular flow
1. Households - single person, a family or a group of people who live together.
Depend on common income. Supply primary production factors.
Function: supply primary production factors to private business enterprises as well as the
government. Use the income to purchase final goods and services.
2. Business enterprises - economic decision taker whose purpose is to earn
income or profit by supplying goods and services.
Function: production of goods and services. Combine the 4 production factors effectively to
produce the goods and services.
3. Government - to create the environment (economy can operate freely and
fairly). Redistribute income through transfer payments, market intervention and
taxation.
Function: provide the legal framework and the services needed for a market economy to
operate effectively. Ensure fair competition. Take care of market failures (provide wrong
amount of goods and services or fails to allocate any resources. The role of government is not
always perfectly carried out.
4. Foreign sector - Consists of a large number of individual states, each with
its own government, consumers and business enterprises. Interaction with other
countries (open economy ). Welfare benefits. Sensitive to global changes/events.


1. The mechanics of the circular flow model
 The role players in the economy decisions and actions are
fulfilled in 3 imaginary markets:
 Resource market - where resources are bought and sold. Households sells and
businesses buy. The funds that businesses pay for resources are costs to businesses, but
flows of wage, rent, interest and profit.
 Product market - where goods and services are bought and sold. Households buy
and businesses sell. Revenues for businesses.
 Financial market - takes care of the flow of surplus funds. Savings in all forms are
pooled together to create a source of funds for investment purposes.

The behaviour of one of the participants in the economy can affect the whole system.

,  The difference between a command system and a
market system
Economic systems: a particular set of institutional arrangements and a coordinating
mechanism. The systems differ as to who owns the factors of production and the method
used to motivate, coordinate and direct economic activity.
 The command system ( socialism or communism ) - the government owns
most property resources, and economic decision making occurs through a central
economic plan. A central planning board makes nearly all the decisions.
 The market system ( capitalism ) - private ownership of resources and the
use of markets and prices to coordinate and direct economy activity. Participants act
in their own self interest. Seeks to achieve goals through their own decisions. Allows
private ownership of capital, communicates through prices and coordinates activity
through markets. The result is competition

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