Slide 1Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Chapter 2.2 The Free Market Economic SystemChapter 2.2 The Free Market Economic System

• Essential Question: What are the characteristics of a free market economy?

Slide 2Copyright © Pearson Education, Inc.Chapter 2, Section 2:

ObjectivesObjectives1. Explain why markets exist.

2. Analyze a circular flow model of a free market economy.

3. Describe the self-regulating nature of the marketplace.

4. Identify the advantages of a free market economy.

Households not self-sufficient. Trade/exchange to get goods/services to satisfy needs/wants

Product market: Households buy goods/services from firms

Factor market: Households sell factors of prod. To firms

Self-interest provides incentive for competition and efficiency in markets

Economic goals valued: Efficiency, Growth, Freedom, Security

Slide 3Copyright © Pearson Education, Inc.Chapter 2, Section 2:

• Markets eliminate the need for any one person to be self-sufficient.

• Rather than being self-sufficient, each of us specializes in a few products or services.– Specialization leads to efficient use of land, labor,

and capital.

– Specialization means to focus on a limited number of related products or services.

Why do Markets Exist?Why do Markets Exist?

Slide 4Copyright © Pearson Education, Inc.Chapter 2, Section 2:

• Because of specialization, markets are needed

• Markets allow us to exchange the things we have for the things we want.

Why do Markets Exist?Why do Markets Exist?

Slide 5Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Free Market EconomyFree Market Economy

• In a free market,

– answers to the three key economic questions are made by voluntary exchange in the marketplace.

– Choices made by individuals determine what gets made, how it is made, and how much people can consume.

– individuals and privately owned businesses own the factors of production.

Slide 6Copyright © Pearson Education, Inc.Chapter 2, Section 2:

• What are the characteristics of a free market economy?– Households and firms

– Factor and product markets

– Specialization

– Self-interest

– Competition

– Economic freedom, efficiency, and growth

Free Market EconomyFree Market Economy

Slide 7Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Households /Consumers

GovernmentFirms /

Producers

Product Markets

Factor Markets

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Land, Labor,

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services

Taxes ($) services

Taxes ($)

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Circular Flow of Income and Output

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Slide 8Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Self-Regulation of the Market:Self-Interest and CompetitionSelf-Regulation of the Market:Self-Interest and Competition

• In the product and factor markets, the buyer and seller consider only their self-interest.

– Self-interest is the motivating force in the free market.

• Households have the incentive to look for lower prices.

• Firms have the incentive to charge the highest prices and make the most profits

– Competition among other firms makes it hard for firms to raise prices

– Self-interest and competition work together to regulate the marketplace

Slide 9Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Free Market and Economic GoalsFree Market and Economic Goals

• The Free Market economic system values the following economic goals:– Economic Freedom

• Households and firms make individual choices to participate in markets

– Economic Efficiency• Competition ensures efficient use of resources• Firms produce only goods/services households will

buy– Economic Growth

• Self-interest encourages innovation• Creators of new ideas will capture markets

Slide 10Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Key TermsKey Terms

• market: any arrangement that allows buyers and sellers to exchange things

• specialization: the concentration of the productive efforts of individuals and businesses on a limited number of activities

• free market economy: an economic system in which decisions on the three key economic questions are based on the voluntary exchange in markets

• household: a person or group living in a single residence

Slide 11Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Key Terms, cont.Key Terms, cont.

• firm: an organization that uses resources to produce a product or service, which it then sells

• factor market: the arena of exchange in which firms purchase the factors of production from households

• product market: the arena of exchange in which households purchase goods and services from firms

• self-interest: an individual’s own personal gain

Slide 12Copyright © Pearson Education, Inc.Chapter 2, Section 2:

Key Terms, cont.Key Terms, cont.

• incentive: the hope of reward or fear of penalty that encourages a person to behave a certain way

• competition: the struggle among producers for the dollars of consumers

• consumer sovereignty: the powers of consumers to decide what gets produced