Deck 2: The Market System and the Circular Flow

Question 1

Suppose Tom,Dick,and Harry live in a barter economy.Tom produces wine,Dick bakes bread,and Harry makes cheese.Tom wants some bread to go with his wine and is willing to trade 1 litre of wine for two loaves of bread.Dick wants some cheese to go with his bread and is willing to trade one loaf of bread for one-half kilogram of cheese.Harry doesn't want bread,but wants some wine to go with his cheese and is willing to trade cheese for one litre of wine.It is not possible for all three of them to meet together at one time.
(a)Explain how this situation illustrates the difficulty with a barter economy.
(b)Devise a money system using rubies where four rubies are equivalent in value to one litre of wine.In other words tell how much bread and cheese would be worth in terms of rubies in this economy.In this system,how much cheese must Harry sell in order to buy one litre of wine?

Answer 1

(a)The lack of coincidence of wants is illustrated in this situation.Tom wants the bread that Dick has,Dick wants Harry's cheese,and Harry wants Tom's wine but for any two of them there is no incentive to trade for something each does not want.In other words,there is no coincidence of wants.
(b)If rubies could be used as a medium of exchange,Tom could receive four rubies for each litre of wine.According to their initial exchange values,he should be willing to pay two rubies for each loaf of bread.Dick would then have four rubies to purchase one kilogram of cheese and Harry could buy wine with the four rubies he earned from selling this cheese.In terms of ruby prices,bread is worth two rubies per loaf and one litre of wine and one kilogram of cheese are each worth four rubies in this economy.

Question 2

Explain why the market system is an organizing mechanism.

Answer 2

Markets and price give the economic system its ability to coordinate millions of economics decisions made on a daily basis.The system is an extensive communication network for expressing the wishes of consumers to producers.The price signals given by markets direct resources to the goods and services people want and indicate where profits are to be made for producers.Producers who fail to heed the market signals are punished.Consumers also use the market price to figure out how to make the best use of their limited incomes.

Question 3

Explain the most important consequence of legally enforceable property rights?

Answer 3

The most important consequence of legally enforceable property rights is that they encourage people to cooperate by helping to ensure that only mutually agreeable economic transactions take place.Without legally enforceable property rights the strong could simply take whatever they wanted from the weak without giving them any compensation.But in a world of legally enforceable property rights,any person wanting something from you has to get you to agree to give it to them.And you can say no.The result is that if they really want what you have,they must offer you something that you value more highly in return.That is,they must offer you a mutually agreeable economic transaction-one that benefits you as well as them.

Question 4

One of the characteristics of a modern market economy is an "active,but limited,government." How can the government "help" the economy?

Question 5

List nine characteristics of the market system.

Question 6

Respond to the following question: "Producing capital goods takes time,so how can that be a more efficient form of production of consumer goods?"

Question 7

What conditions are necessary for economic competition to exist?

Question 8

Why does specialization require a convenient means of exchanging goods?

Question 9

How does the use of money differ from the use of barter in the exchange of goods and services?

Question 10

What roles do freedom of enterprise and freedom of choice play in capitalism? How important are they to the operation of a competitive market economy?

Question 11

Describe two types of specialization in production.

Question 12

Describe all the advantages a money economy has over a barter economy?

Question 13

What is the importance of competition in relation to self-interest in a market system?

Question 14

Explain the term "laissez-faire capitalism.

Question 15

Describe three ways that the division of labour contributes to society's output.

Question 16

Why is the right of private property an essential characteristic of a market system?

Question 17

What are the economic advantages of the division of labour?

Question 18

Explain what is meant by a command economy.

Question 19

What is money and what important function does it perform? Explain how it overcomes the disadvantages associated with barter.What conditions are necessary for people to accept paper currency in exchange for the goods and services,which they sell?

Question 20

Explain the importance of self-interest in the operation of a market system.

Question 21

Explain the two different motives that firms have for choosing the lowest-cost production methods to produce goods and services?
The first motive is that because inefficiency drives up costs and lowers profits,any firm wishing to will make great efforts to minimize production costs.These efforts will include using the right mix of labour and capital,given the prices and productivity of those resources.They also mean locating production facilities optimally to minimize production and transportation expenses.
The second motive is due to competition,consumers strongly prefer low prices and will shift their purchases over to the firms that can produce a quality product at the lowest possible price.Any firm foolish enough to use higher-cost production methods will go bankrupt as it is undersold by its more efficient competitors who can still make a profit when selling at a lower price.In other words,competition eliminates high-cost producers,and so firms are motivated to choose the lowest-cost production methods to produce goods and services.

Question 22

"Every economy is based on 'planning' of one sort or another." Interpret and explain.

Question 23

Explain this quote from Adam Smith: "It is not from the benevolence of the butcher,the brewer,or the baker that we expect our dinner but from their regard to their own interest."

Question 24

What factors determine who will get the output?

Question 25

How can technological advance result in creative destruction?

Question 26

Describe the basic features of the circular flow model.

Question 27

Describe the three major virtues of a market system.

Question 28

What is the relationship between businesses and households in the circular flow model?

Question 29

Provide examples of prominent Canadian corporations and describe the unique implications that arise due to the fact that such corporations are independent legal entities?

Question 30

"Competition is the mechanism that brings order out of potential chaos in a price-directed economy." Explain.

Question 31

Assume that a firm finds that its profits will be maximized (or losses minimized)when it produces $30 worth of product X.Each of these techniques shown in the following table will produce exactly $30 worth of X.

Question 32

List and describe the three main categories of businesses?

Question 33

Assume that a firm finds that its profits will be maximized (or losses minimized)when it produces $50 worth of product X.Each of these techniques shown in the following table will produce exactly $50 worth of X.

Question 34

How does consumer choice differ from consumer sovereignty in a market system?

Question 35

What is meant by the guiding function of prices?

Question 36

List two problems that have contributed to the decline of command systems on a national scale.

Question 37

Why is the consumer the king (or queen)in a market system?

Question 38

In the below circular flow diagram,the household and business sectors are labelled with arrows representing the flows of income and output labelled (a)through (f)and the two appropriate markets labelled (g)and (h).Supply the correct descriptive titles for each of these labels (a)through (h).

Question 39

How does the market system accommodate change in consumer's preferences?