Chapter02 – The Market System and the Circular Flow
2-1
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Brue, McConnell, Flynn
Essentials of Economics 3e
Chapter 2
The Market System and the Circular Flow
QUESTIONS
Question 1
Contrast how a market system and a command economy try to cope with economic scarcity.
Answer
A market system allows for the private ownership of resources and coordinates economic
activity through market prices. Participants act in their own self-interest and seek to maximize
satisfaction or profit through their own decisions regarding consumption or production. Goods
and services are produced and resources are supplied by whoever is willing to do so. The result is
competition and widely dispersed economic power.
The command economy is characterized by public ownership of nearly all property resources
and economic decisions are made through central planning. The planning board, appointed by
the government, determines production goals for each enterprise. The division of output between
capital and consumer goods is centrally decided based on the board’s long-term priorities.
Question 2
How does self-interest help achieve society’s economic goals? Why is there such a wide variety
of desired goods and services in a market system? In what way are entrepreneurs and businesses
at the helm of the economy but commanded by consumers?
Answer
The motive of self-interest gives direction and consistency to the economy. The primary driving
force of the market system is self-interest. Entrepreneurs try to maximize their profits; property
owners want the highest price for their resources; workers choose the job with the best wages,
fringe benefits, and working conditions. Consumers apportion their expenditures to maximize
their utility while seeking the lowest possible prices. As individuals express their free choice, the
economy is directed to produce the most-wanted goods at the lowest possible cost.
Each individual consumer will choose a variety of goods and services that in combination will
maximize his/her satisfaction (utility). There are a wide variety because individual wants are
diverse. To maximize profits, producers must respond to the desires of the individual consumer.
Chapter02 – The Market System and the Circular Flow
2-2
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Although producers are free to choose what products they will produce, if the producers are to
maximize profits, these goods and services must be what consumers desire. Entrepreneurs can
drive the economic ship where they want (at least for a while), but the ship will run aground
(businesses will fail) if entrepreneurs at the helm don’t listen to the consumers that command
them.
Question 3
Why is private property, and the protection of property rights, so critical to the success of the
market system? How do property rights encourage cooperation?
Answer
The ownership of private property and the protection of property rights encourages investment,
innovation, and, therefore, economic growth. Property rights encourage the maintaining of the
property and they facilitate the exchange of the property. However, the most important
consequence of property rights is that they encourage people to cooperate by helping to ensure
that only mutually agreeable economic transactions take place.
Question 4
What are the advantages of using capital in the production process? What is meant by the term
“division of labor”? What are the advantages of specialization in the use of human and material
resources? Explain why exchange is the necessary consequence of specialization.
Answer
Capital goods enable producers to operate more efficiently and to produce more output.
“Division of labor” means that workers perform those tasks that are best suited to their individual
abilities and skills.
The advantages of specialization for workers are that they can choose work according to their
natural aptitudes, have the opportunity to perfect those skills, and save time in not having to shift
continually from one task to another. Material resources will be developed and adapted for a
specific use. On a regional basis, each region will produce those products for which it is best
suited. By specializing in its comparative advantage, each region or set of human and material
resources is being used to maximize efficiency.
When resources are specialized, they are no longer self-sufficient. To obtain the goods and
services one needs, exchange is necessary. Also, specialization will result in a surplus of a
specific good being produced. The surplus of one good will be exchanged for the surplus
production of other goods.
Chapter02 – The Market System and the Circular Flow
Question 5
What problem does barter entail? Indicate the economic significance of money as a medium of
exchange. What is meant by the statement “We want money only to part with it”?
Answer
Barter requires the “double coincidence of wants.” If someone wants something, he/she will have
to find someone who wishes to part with that good and at the same time wishes to exchange the
good for something that the first party wishes to part with.
With money as a medium of exchange, one knows the purchase price of the item to be purchased
and its relative price to other items. Money is a very convenient common denominator, a
