THE MARKET SYSTEM AND THE CIRCULAR FLOW

Pertemuan 2

Matakuliah : J0594-Teori EkonomiTahun : 2009

Bina Nusantara University 3

Economic Systems

• Economic System Defined– Ownership of Factors of Production– Method Used to Motivate, Coordinate,

and Direct Economic Activity• Command System

– Socialism or Communism• Market System

– Capitalism– Pure Capitalism – Laissez-Faire

2.1

Bina Nusantara University 4

Economic System

• The Command SystemThe command system is also known as socialism or communism. In that system, government owns most property resources and economic decisions making occurs throught a central economic plan

• The Market SystemThe polar alternative to the command system is the market system, or capitalism. The system is characterized by the private ownership of resources and the use markets and price to coordinate and direct economic activity

Bina Nusantara University 5

Characteristics of The Market System

• Private proverty

• Freedom of enterprise and choice

• Seft-Interest

• Competition

• Market and Prices

• Technology and Capital Goods

• Specialization

• Use Money

• Active, but Limited Government

Bina Nusantara University 6

Five Fundamental Questions

The key features of the market system heps explain how market economic respon to pive fundamental questions :

1. How will the goods and services be produced ?

2. Who will get the goods and services ?

3. How will the system accommodate change ?

4. What goods and services will be produced ?

5. How will the system promote progress?

Bina Nusantara University 7

The Market System

• Two Insurmountable Problems– The Coordination Problem– The Incentive Problem

Demise of Command Systems

Bina Nusantara University 8

The Invisible HandIn his 1776 book The Wealth of Nations, Adam Smith first note that the operations of a market system creates a curious unity beetween private interst and social interest

– Efficiency– Incentives– Freedom

Firms and resource supplier, seeking to further their own self-interest and operating within the framework of a highly competitive market system, will simultaneously, as though guided by “invisible hand”, promote the public or social interest

Bina Nusantara University 9

The Circular Flow Model