Topic 1

1.0 The Market System and the

Circular Flow
SCARCE RESOURCES
ECONOMIC RESOURCES
PROPERTY RESOURCES
1. LAND

2. CAPITAL

HUMAN RESOURCES
3. LABOR
4. ENTREPRENEURIAL ABILITY
Resource payments: correspond to resource
categories
PROPERTY RESOURCES
RENTAL
LAND
INCOME
INTEREST
CAPITAL
INCOME
HUMAN RESOURCES

LABOR WAGES
PROFIT &
ENTREPRENEUR
LOSS
 Economic Systems
• Each society has to select an economic system
that addresses the economizing problem
• Definition: An economic system is a system of
production and exchange of goods and services
as well as allocation of resources in a society.
• Economic systems differ as to:
1) who owns the factors of production
2) the method used to motivate, coordinate, and
direct economic activity.
 The Command System
• The government owns most property resources
and economic decision making occur through a
central economic plan.
• The central planning board determines
production goals for each firm and resources to
be allocated.
 The Market System (capitalism)
• There is private ownership of resources.
• Markets and prices coordinate and direct
economic activity.
• Each participant acts in its own self-interest.
• In pure capitalism the government plays a very
limited role.
 The Circular Flow Model

• There are two groups of decision makers in the

private economy: households (resource owners)
and businesses (resource users)

• Markets are grouped into resource market and

the product market
What happens in the resource markets?
a. Households sell resources directly or indirectly
(through ownership of corporations) to
businesses.
b. Businesses buy resources in order to produce
goods and services.
c. Interaction of these sellers and buyers
determines the price of each resource, which in
turn provides income for the owner of that
resource.
d. Flow of payments from businesses for the
resources constitutes business costs and resource
owners’ incomes.
 The Circular Flow Diagram

RESOURCE
MARKET

RESOURCES INPUTS

BUSINESSES HOUSEHOLDS

9
 The Circular Flow Diagram

FACTOR
MARKET

RESOURCES INPUTS

BUSINESSES HOUSEHOLDS

GOODS & GOODS &

SERVICES SERVICES
PRODUCT
MARKET
What happens in the product markets?
a. Households are on the buying side of these markets,
purchasing goods and services.

b. Businesses are on the selling side of these markets,

offering products for sale.

c. Interaction of these buyers and sellers determines

the price of each product.

d. Flow of consumer expenditures constitutes sales

receipts for businesses.
 The Circular Flow Diagram
Mixed Economy
FACTOR
RESOURCES MARKET
INPUTS

GOODS & GOODS &

SERVICES SERVICES
BUSINESSES GOVERNMENT HOUSEHOLDS
TAXES TAXES

GOODS &
GOODS &
SERVICES
SERVICES
PRODUCT
MARKET
 The Circular Flow Diagram
Mixed Economy
• In a mixed economy we also have the government as an
important actor in the economy.
• Households pay taxes to government, personal income
tax.
• Businesses also pay taxes to government, corporate tax
or company tax.
• The government uses the tax revenue to provide public
goods both to households and businesses. What is a
public good?
Circular Flow further expanded
Capital and Labour Controlled
income Capital
And
Resource Labour
Market flows

Foreign
Businesses Government Households Exchange
Market

Product
Market
 Capital and Labour Controlled
income Capital
And
Resource
Market
Labour
flows

Foreign Foreign
Businesses Government Households Exchange
Market Sector

Export and
Import of
Product Goods and
Market Services

Export, Import payments