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Chapter 2.2 Free Market GN

The free market is based on voluntary exchanges between households and businesses using markets. In a free market, households own resources and answer the basic economic questions, while businesses use resources to produce goods. The circular flow diagram shows exchanges between businesses and households in factor and product markets. Self-interest is the motivating force as both buyers and sellers act in their own interest, which creates competition among producers and regulates the market through an invisible hand mechanism. This leads to economic efficiency as producers make what consumers want at lowest cost, as well as economic freedom, growth, and consumer sovereignty.

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Jessica Trawick
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157 views

Chapter 2.2 Free Market GN

The free market is based on voluntary exchanges between households and businesses using markets. In a free market, households own resources and answer the basic economic questions, while businesses use resources to produce goods. The circular flow diagram shows exchanges between businesses and households in factor and product markets. Self-interest is the motivating force as both buyers and sellers act in their own interest, which creates competition among producers and regulates the market through an invisible hand mechanism. This leads to economic efficiency as producers make what consumers want at lowest cost, as well as economic freedom, growth, and consumer sovereignty.

Uploaded by

Jessica Trawick
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter 2: Economic Systems 

Section 2: The Free Market 


 
Market Economy
- Market Economy: Economic decisions are made by individuals and are based on exchange, or trade
What is a Market?
- Any place goods and services are exchanged is a market
- Market​: an arrangement that allows buyers and sellers to exchange things.
- Specialization: is the concentration of the productive efforts of individuals and firms on a limited number
of activities
- Makes an economy more efficient since people can get really good at one thing
Why Do Markets Exist?
- Markets exist because none of us produces all the goods and services we require to satisfy our needs
and wants
The Free Market Economy
- Based on voluntary exchanges, in which households (individuals), and business firms use markets to
exchange money and products
- Household​: person or group of people living in the same residence
- Firm​: organization that uses resources to produce and see a product
- Transform inputs (factors of production) into outputs (products)
- The 3 economic questions are answered by households; not government
- Households own factors of production (Land,Labor,Capital)
- Privately owned; not by the government
Circular Flow Diagram
- Circular Flow Diagram​: a way to represent the exchange from businesses to individuals
- Factor market​: market in which firms purchase the factors of production from households
- Includes purchasing land or resources from people, hiring workers or paying them wages, and
borrowing money for investments
- Product market​: market in which households purchase the goods and services that firms produce
How Does a Free Market Work?
- Profit​: Financial gain made in a transaction
- Since the free market is based entirely on voluntary exchanges:
- In every transaction, the buyer and seller consider only their ​self-interest​: or their own personal
gain
- Used by Adam Smith to explain how buyers and sellers both consider their own best interests
whenever making a transaction
- Self-interest is the ​motivating​ force in the free market
- Incentive​: an expectation that encourages people to behave in a certain way
- Buyers choose the cheaper product and producers make what they have, to have a greater
chance of selling for profit $$$
Self-interest Creates Competition
- Producers in a free market struggle for the dollars of consumers → This is known as ​competition
- Competition is the ​regulating​ force of the free market
Competition Creates the Invisible Hand
- Incentive​: an expectation that encourages people to behave in a certain way
- “The ​invisible hand​ of the marketplace”:
- self-interest makes consumers decide to purchase certain goods; competition among the
producers causes them to provide these desirable goods at a lower cost
- Result ​→ consumers get the products they want, at costs closely reflecting the cost it
takes to make them
Advantages of the Free Market
- The Free Market allows buyers and sellers to interact with no government interaction
- This happens through:
- Economic Efficiency
- Economic Growth
- Economic Freedom
- Consumer Sovereignty
- Economic Efficiency - producers make what consumers want, and at prices they are willing to pay
(self-regulating)
- Economic Freedom - highest degree of economic freedom of any economic system (wider variety of
goods/services)
- Economic Growth - competition encourages innovation, so free markets encourage growth
- Entrepreneurs are always looking for new profitable opportunities
- Consumer Sovereignty​: the power of consumers to decide what gets produced
- Producers are going to make what people will buy, so by purchasing only what they want,
consumers ultimately decide what producers make

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