Students Again

Characteristics of the Market System:

1. Private Property – without private property rights, we would never invest. Do you ever mow someone else’s lawn for free? Would you leave your keys in your car so anyone else can use it (and maybe even bring it back?). If we can’t keep what we earn, why work for it? It sounds simple, but this is largely what caused the communist system to collapse under it’s own weight.
2. Freedom of Enterprise – we can enter any industry we want
3. Freedom of Choice – we can buy whatever we want
4. Self-Interest – we seek to maximize our own happiness. This isn’t synonymous to greed, because we may be happiest by giving  everything away. Noble – but unusual.
5. Competition -
6. Markets and Prices – competition for resources and goods, drives prices of these goods. In non-market economies, government often sets prices.
7. Reliance on Technology and Capital Goods (K) – growth requires we use whatever capital makes us the most productive we can be. By using technology, we lower the cost of production and thus our prices.
8. Specialization – to produce more efficiently, we often divide jobs into smaller parts (like an auto assembly line). This speeds up the production process and lowers costs. How many cars could you produce in a year in your garage, by yourself? Even with the ability and knowledge, the set up time for each different job, and the
9. Division of Labor
   
   • Differences in Abilities
   • Fosters Learning by Doing
   • Saves Time
10. Geographic Specialization – there’s a reason we make cars in Detroit, Steel along the Ohio River, Oranges in Florida and  California and Apples in Washington. Sometimes it’s where the right type of conditions exist (enough labor, raw materials etc).  Sometimes it’s the weather, (warm enough to grow oranges). And sometimes it’s based on the topography (near running water which is a cheap source of energy, as well as a way to transport a good to market in bulk).
11. Use of Money – Money allows us to: trade goods with people who may not want what we have to offer (double coincidence of wants problem). It decreases the costs of transactions (I don’t have to drag my goods all over the place in order to trade). And it is a good store of value (which is why no one uses milk as money – after a while – it stinks).
12. Active but limited Government – Government has a job (actually many) in the economy but it can’t dominate an economy and still let it work properly. All the advantages of a market system disappear if the government stands too hard on the brake.

The Market System at Work:

1. What will be Produced? Frankly, producers don’t directly care what they produce; they produce to make profits. If they have to change what they’re making they will. This is why GM, Ford et al are making SUV’s when they used to make mostly just cars. As the goods, consumers demand change, the producer change what they make.
   • Economic Costs and Profit – Total costs to an economist include both explicit costs (a.k.a. accounting costs – like raw material costs, wages etc) as well as economic costs (implicit costs like opportunity costs). A firm covering opportunity costs (the profits they could have made elsewhere) but no more, would neither expand nor divest since they are doing no worse than any other industry. This is what economists refer to as NORMAL PROFIT (covering just explicit costs and opportunity costs). Economic Profits are in excess of what is being earned elsewhere (over and above explicit costs and opportunity costs)
   • Profits and Expanding Industries – if any industry is earning unusually large profits, other entrepreneurs will leave the industry they are in and enter this more profitable industry. This makes that industry more competitive – and lessens each firm’s profits (they all get a smaller share of the pie). Forms continue to enter the industry until the returns earned in this industry are no better than they
     could earn elsewhere.
   • Losses and Declining Profits – if any industry is doing worse than other industries, firms will leave the industry in search of better returns – leaving fewer firms to divide the pie. That makes all the remaining ones more profitable. Firms continue to leave until the returns in this industry are equal to the returns in other industries.
   • Consumer Sovereignty and Dollar Votes – as consumers we decide what firms make. If we choose to not buy at a price they can make profits on, they make something else in search of something we will buy at a price they can make a profit on. In a way, we vote for what products we like, by buying them and vote against others, by not buying them.
   • Market Restraints on Freedom – again, this says that firms aren’t really “free” to produce whatever they want (we didn’t buy Edsels – but Ford wanted to make those). They can only produce what we want to buy – if they want to stay around very long. IN the same way, we are not free to be any type of supplier of labor or other resource – we can only sell what the market wants. There is no market for me to be a running back, because the market doesn’t want my services as a running back. In the same way, there is no market for incompetent brain surgeons, slow computers, illiterate tutors, etc.
2. How will the goods and services be produced?
   • Least-Cost Production
   • K (Capital) / L (Labor) / A (Land) Mix depends on prices of those resources PK (Price of Capital = interest), PL (Price of Labor = Wages), PA (Price of Land = Rent). If the price of one rises, forms switch to a production method that uses less of that input and more of the other (relatively cheaper) ones.
3. Who gets what’s produced?
   • It basically comes down to who has the willingness and ability to pay the most for it. Producers sell to the highest bidder (rational self-interest) and therefor, even if a person may “need it the most”, that person must still be “able” to pay for it to get it. Nothing says the market result is “fair” – but it is generally efficient.
4. How will the system accommodate change?
   • Guiding Function of Prices – Price changes lead firms to make more of a good as the price rises and less of it as the price falls. This signal leads businesses to invest in goods we value the most.
   • Role in Promoting Progress – Forms must invest in cost saving technologies in order to stay competitive and earn profits. If they did not, other firms would and then sell all the market desires at a price cheaper than the firm can profitably sell their good at.
   • Technological Advances – the desire for maximizing profits leads firms to invest in strategies to get a cost advantage over their competition, driving production up, prices down and the standard of living higher.
   • Capital Accumulation – the use of capital reduces costs per unit to produce and therefor, firms must accumulate capital to remain competitive.
5. Competition and the “Invisible Hand”
   • Efficiency – Since each firm/industry competes for resources (labor for example), we know that the limited amount of labor available will be used where it most valued. Each worker will take the highest wage rate offered (all other things equal). Each firm decides what it can pay based on the value that labor can produce. Add it up and the firm that uses the labor for the greatest use, can sell it for the highest profit and therefor can afford to outbid the other potential uses of that labor.
   • Incentives
   • Freedom