THE MARKET ECONOMYTHE MARKET ECONOMY

The Industrial Revolution

The answer to our question seems to lie in the political and legal institutions of each nation Rule of law—what you own depends not

on force or who you know, but is protected by law that treat all persons equally

Private property rights—the rights to use and sell resources are clearly defined, cheaply enforceable, and fully transferable

Open markets—people are free to buy and sell when, where and to or from whom they wish, including citizens of other nations

Secure property rights, rule of law, and open markets encourage people to make long term investments in human and physical capital Education, buildings, innovation, land quality,

infrastructure, etc These investments raise the capital stock—

both physical and human capital stocks This in turn generates income over the long

run, raising living standards and human well being

Every society must answer three economic questions…

1. WHAT?2. HOW?3. FOR WHOM?

How that society answers the questions determines which type of economic system that society employs

WHAT goods and services will be produced with the available resources?

Economists classify resources into 4 categories1. Land

Natural resources The payment for Land is RENT

2. Labor Human resources The payment for Labor is WAGES

3. Capital (a product of Investment) Tools, machines, factories The payment for Capital is INTEREST

4. Entrepreneurship The special ability of risk-takers to combine land, labor and capital in new ways in order to make profit The payment for Entrepreneurship is PROFIT

At the top of a paper write Natural Resources , Human Resources and Capital Goods . Place these items

under the correct heading. • Delivery Truck • Teacher • Factor • Tree • ATM machine • Bushel of corn • River • Hair stylist • Gold • Barrel of oil • Doctor • Farmer • Bulldozer • Tractor • Factory worker

HOW will the available resources be combined to produce goods and services?

WHOM will be the consumer of the product or service?

Command Economies

Traditional Economies

Market Economies

Answer the key questions by a system of supply and demand. (in other words, it allows buyers and sellers to voluntarily exchange things)

The ability of markets to coordinate economic activity is emphasized by Adam Smith in

“The Wealth of Nations.” This is what he referred to as

the Invisible Hand

...every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

What is Adam Smith basically saying with this passage? If individuals are allowed to pursue their

own self-interest, then the often times the result will be a more efficient economy. There is NO PLANNING

What do you think Adam Smith envisioned as the role of Government in the economy?

Answer the key questions through a central authority made up of an individual or a number of individuals who make the decisions of what to make, how to make it, and for whom things should be made. (Self-Interest and Competition are absent) Communism Socialism

Answer the key questions by relying on past customs and practices:

“The Inuit of northern Canada serve as a prime example of a traditional economy. For thousands of years, the Inuit parents have taught their children the survival skills needed to survive in the Arctic Circle's severe climate. The children are taught to fish, hunt, and make effective tools. Once learned, these skills are passed down to the next generation.”

Efficiency (maximize what you have) Freedom (ability to make choices) Security (goods/services will always be

available) Equity (Fairness, Opportunity) Growth (Economy must grow with

population; innovation)