4 - 1

Markets and Prices

Chapter 2

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and the Market System

Capitalism

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EARLY ECONOMISTSMERCANTILISTS

•Wealth is Gold

•Gold is Limited

•Whoever has the most Gold, Wins

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EARLY ECONOMISTSMERCANTILISM

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EARLY ECONOMISTSMERCANTILISM

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EARLY ECONOMISTSMERCANTILISM

•Wealth is Gold

•Gold is Limited

•Whoever has the most Gold, Wins

1576

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EARLY ECONOMISTSMERCANTILISM

1776

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ADAM SMITH

“It is not from the benevolence of the butcher, the brewer, and the baker that we expect our dinner, but from their regard to their own self-interest.”

-The Wealth of Nations1776

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FREEDOM OF CHOICE

MARKETS

NOGOVERNMENT

INTERFERENCE

COMPETITION

Smith’s Free Market

PRIVATEPROPERTY

SELF-INTEREST

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Other Characteristics

Specialization and Trade

•Differences in Ability•Division of Labor•Increased Productivity

Smith’s Free Market

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Other Characteristics

Investment in Technology and Capital

Technological Innovation and

RoundaboutProduction

Smith’s Free Market

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Other Characteristics

Use of Money

•Means of Exchange•Measure of Value•Store of Value

Smith’s Free Market

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FREEDOM OF CHOICE

MARKETS

NOGOVERNMENT

INTERFERENCE

COMPETITION

Smith’s Free Market

PRIVATEPROPERTY

SELF-INTEREST

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Use of MoneyFinancial capital

Specialization and Interdependence

Investment in Technology and Capital

CAPITALISM

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Production Possibility Frontier

Capital Goods

Consumer Goods

• Increased

Resources

• Trade

• Technology

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FREEDOM OF CHOICE

MARKETS

NOGOVERNMENT

INTERFERENCE

COMPETITION

Smith’s Free Market

PRIVATEPROPERTY

SELF-INTEREST

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The Four Fundamental Questions...What will be produced?

CAPITALISM AT WORK

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The Four Fundamental Questions...

How will the goods be produced?

What will be produced?

CAPITALISM AT WORK

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The Four Fundamental Questions...

How will the goods be produced?

What will be produced?

Who will get the goods and services?

CAPITALISM AT WORK

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The Four Fundamental Questions...

How will the goods be produced?

What will be produced?

Who will get the goods and services?

CAPITALISM AT WORK

How do we get MORE?

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TheInvisible

Hand

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The Case for the Market System

EfficiencyGrowth

Freedom

COMPETITION ANDTHE INVISIBLE HAND

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ASSIGNMENTAssignment:

Name ONE product or service that CANNOT be provided by private individuals for profit.

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The Circular Flow

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ENTREPRENEURS• INNOVATE• ORGANIZE RESOURCES FOR

PRODUCTION• TAKE RISKS• KEEP PROFITS

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OBJECTIVE

HOW ARE BUSINESS

FIRMS ORGANIZED?

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Types of Business Firms

• Sole Proprietorship: Owned by a single individual

• Partnership: Two or more people own and manage a business

• Corporation: A fictitious legal person separate and distinct from its owners

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SOLE PROPRIETORSHIP

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Types of Business Firms• Sole Proprietorship: Owned by a

single individual• Advantages

– Easy and inexpensive to establish– Owners have complete control of

business

• Disadvantages– Limited resources– Unlimited liability

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PARTNERSHIP

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Types of Business Firms• Partnership: Two or more people

own and manage a business• Advantages

– Easy and inexpensive to establish– Access to greater resources– More specialization

• Disadvantages– Limited life– Unlimited liability– Shared control– Split profits

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CORPORATION

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Types of Business Firms• Corporation: A fictitious legal

person separate and distinct from its owners

• Advantages– Limited liability– Unlimited life– Unlimited access to resources

• Disadvantages– Shared profits (dividends)– Double taxation– Lack of control

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OBJECTIVE

HOW ARE BUSINESS

FIRMS FINANCED?

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Business Finance• Retained Earnings

– Revenue not kept as profits but instead reinvested in the company

• Commercial Paper– Loans from Banks.

• Bonds– Loans from Individuals

• Stock– Selling Ownership by Going Public

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Business Finance• Retained Earnings

– Revenue not kept as profits but instead reinvested in the company

• Commercial Paper– Loans from Banks.

• Bonds– Loans from Individuals

• Stock– Selling Ownership by Going Public

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The Economic Functions of the Stock Market

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Each share of the stock represents partial ownership in the firm.

People buy the stock of a corporation :

get future dividends paid from corporate earnings

capital gains derived from increases in share prices.

Stockholders may resell their shares on the market, but resales do not put any money in the hands of the corporation.

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Stock Prices

52-Wk

High

52-Wk Low

Name (Symbol) Div Vol Yld P/E Last Net Chg

21.50 8.00SkyHighCorp

(SHC) 3143 76 21.25 +.25

47.00 31.75LowDownInc

(LDI) 2.35 2735 5.7 18 41.00 –.50

25.00 21.00ValueNowInc

(VNI) 1.00 1894 4.5 12 22.00 +.10

83.00 33.00DoinBadlyCorp

(DBC) 7601 33.50 –.75

The table below shows a sample stock table. Each item gives you some clues about the current state of affairs for a particular company.

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Investors Long term Income and growth Fundamental

analysis Quantitative:

dividends, assets, earnings

Qualitative: Management,

product, market

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Speculators Short term Capital gains

from changes in the market price

Technical analysis: Price trends Pe ratio

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A Moving Average

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How the Stock

Market Works

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ChapterConclusions

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4 - 52Copyright McGraw-Hill/Irwin, 2002 BACK END

TRADITIONALBARTER

TRANSACTION COSTSCOINCIDENCE OF

WANTSCAPITALISM

PRIVATE PROPERTYLAISSEZ FAIRE

ENTREPRENEURINVENTION

INNOVATIONMASS PRODUCTIONDIVISION OF LABOR

SPECIALIZATIONCIRCULAR FLOW

FINANCIAL CAPITALCONSUMER

SOVEREIGNTYHOUSEHOLD

RESOURCE MARKETPRODUCT MARKET

REVENUEINCOME

WAGES, RENT, INTEREST

BUSINESS FIRMLIABILITY

SOLE PROPRIETORSHIP

PARTNERSHIPCORPORATION

BOARD OF DIRECTORS

CEO, CIO, COO, and CFOREINVESTMENT

COMMERCIAL PAPERBOND

PUBLIC OFFERINGUNDERWRITER

STOCKCAPITAL GAIN

DIVIDENDFUNDAMENTAL

ANALYSISTECHNICAL ANALYSIS

INVESTORSPECULATORSHORT SELL