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  1. 1. The Market System Profit and Competition03/14/13 1
  2. 2. Efficient Markets The Evolution of the Market System03/14/13 2
  3. 3. What do we want from an economy? Production – getting the most from scarce resources Exchange – minimizing transaction costs03/14/13 7 Market System 3
  4. 4. Social Cooperation: How does this happen? Kenyan coffee Scottish sweaters Bananas from El Salvador Dishwashers assembled in Mexico Thai restaurants French movies Stereos from Hong Kong03/14/13 7 Market System 4
  5. 5. Because of scarcity, someone will always be told NO! The trick is to get as much as possible from scarce resources. What are the most efficient systems of production and exchange?03/14/13 7 Market System 5
  6. 6. What are the different methods of production and exchange? Tradition -There is no need for success; you do what your parents did. Command – You do as you’re told. The Market - You do what is in your own best interests and by so doing, provide the material wants of society; incentives are the key.03/14/13 7 Market System 6
  7. 7. Market: the place for the interaction of buyers and sellers03/14/13 7 Market System 7
  8. 8. Necessary Components of a Market (or “.C.I.I.P.”) Competition Information Incentives Property Rights03/14/13 8
  9. 9. Traditional Feudalism didn’t include .C.I.I.P. Competition Information Incentives Property Rights03/14/13 7 Market System 9
  10. 10. Andreas Ryff - Germany, 1550 Customs toll every ten miles Each community has its own: – money – rules and regulations – law – measures Transaction costs are very high03/14/13 7 Market System 10
  11. 11. Robert Keayne - Boston, 1639Crime - sixpence profit on a shilling, fined 200poundsFalse principles of trade That a man might sell as dear as he can, and buy as cheap as he can. (Buy low; sell high.) If a man loses, by casualty of sea, etc., in some of his commodities, he may raise the price of the rest. That he may sell as he bought, though he paid too dear.
  12. 12. Colbert - France, 1666 Too much initiative - the “reglement” – Dijon and Selangey - 1,408 threads – Auxerre, Avalon, & 2 others - 1, 376 threads – Chatillon - 1,216 threads If fabrics don’t conform, they will be pilloried; if found three times to be objectionable, the merchant is to be pilloried.03/14/13 7 Market System 12
  13. 13. FEUDALISM Traditional No property rights, no productive resources, no innovation03/14/13 13
  14. 14. LAND Traditional Land was not real estate to be bought be bought or sold Land formed the core of social life Lord could not sell his land03/14/13 7 Market System 14
  15. 15. HUMAN CAPITAL Traditional No labor market Peasant tied to Lord’s estate Performed duties as a serf03/14/13 7 Market System 15
  16. 16. FINANCIAL CAPITAL Traditional No risk, no change, safety first Longest and most time consuming technique of production preferred Producing product better than colleagues treasonable Mass production and innovation forbidden03/14/13 7 Market System 16
  17. 17. FEUDALISM Traditional Production and exchange are inefficient ~ Market components (.C.I.I.P.) don’t exist Competition Information Property Rights Incentives ~ Transaction costs are high03/14/13 7 Market System 17
  18. 18. THE SOVIET UNION Command Production and exchange were inefficient ~ Market components (.C.I.I.P.) don’t exist Competition Information Property Rights Incentives ~ Transaction costs are high03/14/13 7 Market System 18
  19. 19. Will Russia develop into a market system? Competition – most industries run by monopolists Information – difficult to obtain Incentives – Russians not used to profit motive Property rights – yes, for the few03/14/13 7 Market System 19
  20. 20. What caused emergence of market system?  National political powers – royal patronage for industries – national laws, common measures, standard currencies – encouragement of foreign adventure  Decline of religious spirit, rise of humanism – Max Weber: Capitalism and the Protestant ethic03/14/13 7 Market System 20
  21. 21. What caused emergence of the market system?  Material changes – towns – roads  Familiarization with money and markets  Double entry bookkeeping  Scientific curiosity and idea of invention – printing press, paper mill, mechanical clock, map, compass and other navigational tools, longitude03/14/13 7 Market System 21
  22. 22. The Plague – 14th century One third of European population dies Workers bargaining power increases A labor market develops03/14/13 7 Market System 22
  23. 23. What caused the marketsystem to replace feudalism? Emergence of market components (.C.I.I.P.) Competition Information Property Rights Incentives Reduction of transaction costs
  24. 24. 177603/14/13 7 Market System 24
  25. 25. ADAM SMITH (1723 - 1790) Profit is the motivator, competition is the regulator.03/14/13 7 Market System 25
  26. 26. Profit is the Motivator “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 self-interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our necessities, but of their advantages.”03/14/13 7 Market System 26
  27. 27. Competition is the Regulator “If he charges too much for his wares, or if he refuses to pay as much as everybody else for his workers, he will find himself without buyers in the one case, and without workers in the other.”03/14/13 7 Market System 27
  28. 28. The Invisible Hand (self-interest & competition): rewards efficient producers and buyers results in: – goods society wants – quantity society wants – prices society is willing and able to pay – normal profits03/14/13 7 Market System 28
  29. 29. The Entrepreneur: the driver of the market system. combines resources to produce a product takes the risks associated with innovation the “residual claimant”03/14/13 7 Market System 29
  30. 30. Why the market? because scarcity exists because societies must find a way to allocate scarce goods and services because in any allocating mechanism some people will be told “No.” The market system is efficient, but ~ neither markets nor other economic systems are “fair”03/14/13 7 Market System 30
  31. 31. Main Points A market is an interaction of buyers and sellers. Markets are based upon and work with competition, information, incentives, and property rights (.C.I.I.P.). Feudalism had high transaction costs and none of the components of a market system.03/14/13 7 Market System 31
  32. 32. Main Points The market system developed as legal, social, political, and commercial institutions evolved. Adam Smith’s An Enquiry into the Nature and Causes of the Wealth of Nations, published in 1776, described the market system. According to Smith, the “Invisible Hand” is the combination of profit and competition resulting in the efficient production and exchange of the goods and services desired by society.03/14/13 7 Market System 32
  33. 33. Main Points In a market system, profit is the motivator and competition is the regulator. The entrepreneur is the driver of the market system. The market system is efficient; neither it nor any other economic systems are “fair.”03/14/13 7 Market System 33