Question

summarize chapter 2. THE MARKET SYSTEM AND THE CIRCULAR FLOW. BY MCCONNELL BRUE FLYNN. MACROECONOMICS

Answer 1

Economic system
An economic system relates to a system that addresses the problems concerning economic activity. It is one of the quintessential needs of a society.
However, there are many types of economic system. They mainly differ on the following basis
i) Who is in control of the factors of production
ii) medium employed to motivate, coordinate and encourage economic activities.

The two opposite and furthest systems are Command and Market.
1) Command system: Usually known as socialism or communism. All the economic decisions are taken by a central authority i.e government which owns almost all the property through central planning.
Examples of Command system operating includes China (for most part), North Korea and Cuba etc.

2) Market system: A system quite opposite to command economy relates to private ownership of resources and a free market economy that hails the idea of self interests. Government plays rather a passive role.
Examples: United States is a laissez faire economy with minimal interference of the government.

Characteristics of a Market system
1. Private Property: One of the essence of market system is that there is private ownership of property. Individuals and private corporations are given property rights to make use of their rationality and self interests that is argued to increase investment, create innovations and help in boosting economic activity.
2. Freedom of Enterprise and choice: Similar to private ownership, freedom of enterprise and choice helps the individuals and firms to decide allocation and use of private property and economic resources to the full satisfaction of their economic interests. All these are choices and freedom are given under a legal framework.
3. Self interest: The market system worships the idea of self interest. It allows the economic agents to explore their economic options and work accordingly to achieve full success and to reach maximum level of profit.
4. Competition: Market system relies on competition. The fundamental idea behind competition is allowing freedom of enterprise and choice to earn maximum profit.
Due to competition,
1) Economic power is shared such that prices are set according to market. No single firm enjoys full power.
2) There is free entry and exit scenario
5. Market and prices: The main coordination and interaction of buyers and sellers take place with the help of market. The prices are the main tools that brings about equilibrium in the market.
6. Technology and capital goods: Advancement in technology and reliance on capital goods help the market system to bear the fruits of private ownership, competition, self interest and market more efficiently as these two leads to greater output and hence greater economic gains.
7. Specialisation: This relates to production of few goods that we have comparative advantage in and then exchanging some goods for others and thus helping an economy from production of all goods. Division of labour and geographical basis form important basis for specialisation.
i) It makes use of differences in ability
ii) Develops the idea of learning by doing.
iii) Specialisation leads to save in time.
8. Money: Acting as a medium of exchange, money is one of the powerful agents bound to keep market system flourishing instead of barter.
9. Active, but limited Government: Due to the argument of market failure, modern advanced capitalist economies have allowed interference of the government, but limited only.

Five Fundamental Questions
1) What goods and services to produce?
the market economy is faced with the problem of deciding which goods and services should be chosen so that profits are maximum and economic efficiency is achieved.
2) How will the goods and services be produced?
Profit maximisation being the priority, the system tries to choose that method that minimising the cost per unit of output.
3) Who will get the output?
The decision regarding the distribution of total output is taken according to willingness and the ability of consumers to pay.
4) How will the system accommodate change?
Markets are highly volatile. Any change in consumer preferences, tastes etc leads to change in demand. The market is able to accommodate to this change through the incentive of earning more profits. This change is accommodated through changes in prices and expansion of output due to prospects of profits.
5) How will the system promote progress
1) Technological advancement not only leads to development, but allows the firms to expand their base and earn more consumer base and help the system reach greater heights through competition.
2) Creative destruction: it is called creative destruction because it promotes innovations in such way that new products and services completely change the platter of the market by replacing old ones.

"Invisible Hand"
A phrase popularised in Adam Smith's phenomenal work "Wealth of Nations" 1776.

Adam Smith seems to assert that market system, the process of economic activity works with the help of an invisible hand that leads to equilibrium between supply and demand, prices and quantity, individual and social interests by the working of free market mechanism.

Merits of Free market system leads to i) Efficiency ii) incentives iii) Freedom

The demise of Command system includes
1) Coordination problem: One of the criticisms of command system is that a central authority becomes inefficient in deciding and taking well informed decisions for all economic units.
2) Incentive problem: Lack of incentives in a command system leads to inefficient and underutilization and even exploitation of scarce economic resources.

The circular flow
The market economic system creates a continuous flow of goods and services, products, factors of production and money without a glitch.
Working: Goods Part:Resources in the form of raw material and labor flow from resource market to businesses and households.The products flow from businesses to households through product market.
Monetary flow: The factor income flow from businesses and households i.e costs of production  to factors in the resource market and businesses gets their revenues through sales from households ( also consisting of factors) through product market.