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The Free Market System

  • Chapter 2: Section 2
  • Pages 28-32 and 33

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So What is a Market?

  • A market is an arrangement that allows buyers and sellers to exchange goods or services.
  • Markets exist because no one is self-sufficient.
  • - None of us produces all we require in order to satisfy all of our wants and needs.
  • Markets allow us to exchange the things we have for the things we want.

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Specialization

  • Instead of being self-sufficient, each of us produces just one or a few products.

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  • Specialization is the concentration of the productive efforts of individuals and firms on a limited number of activities.

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  • Specialization leads to efficient use of resources, including land, labor, and capital.

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Buying and Selling

  • The typical person earns an income (factor payments) and uses this income to buy the products he or she wants to consume.

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The Free Market Economy

  • The Free Market Economy is based on voluntary exchanges in markets.
  • - The exchange of money for goods/services.

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  • Individuals and privately owned businesses own the factors of production, make what they want, and buy what they want.
  • - They answer the “3 Economic Questions”…
  • What? - How? - Who?

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Circular Flow Diagram

  • Shows how individuals and businesses exchange money, resources, and products in the marketplace.

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  • The inner ring of the diagram represents the flow of resources and products.

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  • The outer ring represents the flow of money.

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Product and Factor Markets

  • Product Market – households purchase goods and services produced by firms using the money they receive in the factor market due to their labor.

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  • Factor Market – firms purchase factors of production from households in exchange for wages with an incentive of financial gain or profit.

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Self-Regulation

  • “It is competition and our own self-interest that keeps the marketplace functioning.”

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  • Adam Smith (1723-1790)
  • - The Wealth of Nations
  • Observed that the free market was made up of countless individual transactions that were made strictly with self-interest in mind.

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The “Invisible Hand”

  • Incentive is the hope of reward that drives consumers and businesses in their pursuit of self-interest.
  • Competition then is the regulating force of the market.

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Advantages of a Free Market

  • Economic Efficiency

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  • Economic Freedom – Laissez-Faire
  • Economic Growth

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  • Consumer Sovereignty

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A Slight Problem

  • Despite the advantages of a Free Market Economy…
  • - No such economy exists!

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  • The Free Market System has been modified by various countries in order to meet the needs of their people.